Mining & Trade News

Transfer pricing is the general term for the pricing of cross-border, intra-firm transactions between related parties. “Transfer pricing” therefore refers to the setting of prices at which transactions occur involving the transfer of property or services between associated enterprises. Transfer pricing occurs when one company sells a product or service to another related company. Because these transactions are internal, they are not subject to market pricing and can be used by multinationals to shift profits to low-tax jurisdictions.

                     1. Objectives of Transfer Pricing

Companies use transfer pricing to reduce the overall tax burden of the parent company. Companies charge a higher price to divisions in high-tax countries (reducing profit) while charging a lower price (increasing profits) for divisions in low-tax countries.

                    2.  Transfer Pricing and Tax avoidance issues identified

Like other sectors of the economy, profit shifting pose risks in the mining sector.The IGF (Intergovernmental Forum on Mining) and OECD (Organization for Economic Co-operation and Development) has released guidance for source countries on transfer pricing in the mining sector. The transfer pricing and tax avoidance issues identified in the sector are:

                  (a) Abusive Transfer pricing

May occur during the sale of minerals and/or mineral rights to related parties. Under such circumstances, developing countries may require expertise to detect and mitigate transfer mispricing in the mining sector.

                  (b) Undervaluation of Mineral Exports
Profit shifting through the pricing of mineral products sold to related parties is a major concern for many mineral exporting countries. For developing countries, these risks are elevated where government agencies lack the mineral-testing facilities required to verify the grade and quality of mineral exports, as well as technical knowledge of the mining and mineral product pricing.

                  (c) International Tax Treaties
Most developing countries consistently raise concerns about tax treaty abuses. It is envisaged that countries with abundant mineral resources may be assisted in this area, considering how treaty provisions might have a significant impact on taxes imposed in the mining sector.

                 (d) Debt shifting

This is particularly significant for mining projects that require high levels of capital investment not directly obtainable from third parties and this makes substantial related-party borrowing a frequent practice. This creates excessive interest deductions thereby causing profits shifted to offshore via excessive interest payments.

                (e).Tax Stabilisation Clauses and harmful tax incentives.
Fiscal stabilization clauses create problems in terms of taxes because they can freeze the fiscal terms in the contract such that changes in tax law may not be applicable to existing mines. While tax incentives could encourage expansion of the sector, they may also lead to excess transfers of the gains from countries. It is on record that developing countries expect that that they will forego incentives entirely due to the pressures of attracting investment. However, it is important that countries should preposition themselves to understand how mining companies are likely to respond to those incentives.

                (i) Malawi Scenario-Kayelekera Uranium Mine.

In the Development Agreement, one of the tax incentive clauses was 10 year tax holiday.Though the mine life was beyond 10 years, it was unexpectedly put to a halt just after a 5 year production due to uranium price downturn.

The danger here was that the mine could even exhaust its mineral before the life of mine. In this regard it means the company could have mined for 10 years with a tax holiday.In the unforeseen circumstances, the mine could have been at liberty to transfer the profits to overseas so easily which means a 10 year tax holiday was likely able to make huge profits.

               (f) Offshore Indirect Transfers of Mining Assets
Transfers of ownership of company assets can generate significant income, which many countries seek to tax as capital gains. Transactions may be structured to fall outside the mining country’s tax base by selling shares in an offshore company holding the asset, without notifying tax authorities in the country where the asset/company is located.

                 (g). Abusive Hedging Arrangements
Hedging is a legitimate business practice in many commodity markets. It consists of locking in a future-selling price in order for both parties to the transaction to plan their commercial operations with predictability. A problem arises when companies engage in abusive hedging with related parties. They use hedging contracts to set an artificially low sale price for production and therefore record systematic hedging losses, reducing their taxable income.

  (i). Zambia vs Mopani Copper Mines Plc., May 2020, Supreme Court of Zambia, Case No 2017/24

Following an audit of Mopani Copper Mines Plc. the Zambian Revenue Authority found that the price of copper sold to related party Glencore International AG had been significantly lower than the price of copper sold to third parties.

A tax assessment was issued where the ZRA concluded that the internal pricing had not been determined in accordance with the arm’s length principle, and further that one of the main purposes for the mis-pricing had been to reduce tax liabilities.

This form of transfer pricing between multinational corporations and their African subsidiaries is typical of the tax avoidance practices employed by corporate taxpayers primarily to reduce their tax liabilities, as Zambia’s Supreme Court made clear in the opening paragraph of its judgement:

The ruling ordered that Mopani pay a total of 240 million Zambian Kwacha in taxes assessed for the 2006/07, 2007/08 and 2009/10 tax years within 30 days, bringing to an end a dispute that has been running since 2010.

Mopani Copper Mines Plc. first appealed the decision to Zambia’s Tax Appeal Tribunal, and after a decision was handed down by the Tribunal in favor of the ZRA, a new appeal was filed with the Supreme Court.

The Supreme Court dismissed Mopani’s appeal and ruled in favor of the Zambia Revenue Authority.

                   (h). Inadequate Ring-Fencing
It is possible that mining companies will have multiple activities within a country, creating opportunities to use losses incurred in one project (e.g., during exploration for a new mine), to offset profits earned in another project, thereby delaying payment of corporate income tax. Ring-fencing is one way of limiting income consolidation for tax purposes; however, getting the design right is critical to securing tax revenues while attracting further investment

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