Why Rwanda enacted new rules on transfer pricing

By Julius Bizimungu

Multinationals that transact amongst themselves will now be required to abide by the new tax guidelines, following last week's approval of a ministerial order that establishes general rules on transfer pricing.

Transfer pricing happens whenever two companies that are part of the same multinational group trade with each other. When the parties establish a price for the transaction, this is transfer pricing.

The practice is not illegal or necessarily abusive rather what is illegal or abusive is transfer mispricing, which essentially includes trade between unrelated parties.

In 2018, a new income tax law was enacted setting out new rules on transfer pricing. The law stipulated that a ministerial order will be passed, highlighting how the new rules will be implemented.

The ministerial order was approved last week by the cabinet meeting, which was chaired by President Paul Kagame.

"The ministerial order has got rules on how transactions will be conducted at arm's length, in terms of management fees, interest payment, and anything that any subsidiary pays the head office will be subject to scrutiny," Angelo Musinguzi, Senior Tax Manager at KPMG Rwanda, told The New Times.

The 2018 Income Tax law, specifically article 33 sets out rules on transfer pricing. It requires that transactions between multinationals be carried out under the arm's-length principle.

The arm's length principle requires that transfer prices charged between related parties are equivalent to those that would be charged between independent parties in the same circumstances.

The rules, among other things, require multinational taxpayers or associated enterprises as often referred to legal terms to have documents justifying that their prices are applied according to the arm's-length principle.

This means that companies are now expected to have transfer pricing policies and documentation.

What to expect

Musinguzi, who has been following the process towards the establishment of the new rules on transfer pricing, says the general guidelines are likely to take effect this week.

"The whole aim is to make sure that all transactions happen at arm's length (fair basis) and there's no dumping of costs on Rwanda," he noted.

The rules will be enforced by the Rwanda Revenue Authority (RRA).

The tax law empowers the RRA Commissioner-General to adjust profits earned between related parties if the Commissioner considers that the trading arrangements between related parties do not adhere to the arm's length principle.

According to Hajara Batamuliza, the Commissioner for Domestic Taxes at the Rwanda Revenue Authority, the ministerial order paves way for the implementation of the new rules.

However, she said, the scope goes beyond multinationals to include local companies that may have associated relationships - those that are part of the same group.

"You can imagine if a company is enjoying a seven-year tax holiday, it would be beneficial for its own entity also located in Rwanda, to shift all the profits from a tax-eligible entity to the one that is enjoying investment preferential treatment," she explained.

Batamuliza highlighted that an analysis done across multinational companies in mining, financial sector, telecoms and other businesses, revealed loopholes in their dealings.

"Most of these companies were declaring losses and you wondered why would an entity always be in losses for 8-10 years and still remain in business? We then realized there was an issue," she noted.

During the analysis in 2018, more than 43 per cent of the tax revenues that had been lost through such dealing was recovered by the taxman, according to Batamuliza, who also said nobody objected to their findings.

Last year, Rwanda hosted the convention of the Association of Chartered Certified Accountants (ACCA) Africa during which members pointed to fraud and corruption as key challenges in Africa.

A report of the High-Level Panel on Illicit Financial Flows from Africa commissioned by the African Union (AU) and the Economic Commission for Africa indicated in 2015 that Africa loses $50 billion a year in illicit financial flows.

The flows relate principally to commercial transactions, tax evasion, corruption, and criminal activities like money laundering, among others.

Transfer pricing manipulation is one of the specific ways experts point out which countries lose millions of financial resources.

There are large differences in tax rates between countries. If left unchecked, the practice could lead to the shifting of profits from high-tax countries to lower-tax countries.

The main goal of transfer pricing regulation is to prevent such a situation and ensure that profits are taxed at the place where value is actually created.

Rwanda's move to establish rules could change the game and reduce tax leakages.

This article was originally published by The New Times. [Photo: Sam Ngendahimana]