Rethink - Transfer Pricing | Should African countries push back on Pillar 1?

12 October 2020 saw the Organisation for Economic Co-operation and Development’s (OECD) release of the much-anticipated Pillars 1 and 2 blueprints – the recommended (and still draft) approaches towards addressing the tax challenges of digitalisation. The release includes a public consultation document containing specific questions regarding the pillars, with submissions provided by various stakeholders in December 2020. Whilst the developed world, with corporate digital players like Facebook, Amazon, and SAP on one hand and governments on the other, are analysing how the proposals will affect their tax bills or collections, respectively, African countries may be sitting back and wondering whether the OECD blueprints are fit-for-purpose in the African context.


In short, Pillar 1 focuses on nexus and profit allocation, whereas Pillar 2 is focused on a global minimum tax intended to address remaining BEPS issues. This article focuses on Pillar 1 (in general), as covering all aspects of both blueprints is a daunting task in this space.

Pillar 1 posits that, in an increasingly digital age, the allocation of taxing rights with respect to business profits is no longer exclusively circumscribed by reference to physical presence. Its key elements are grouped into three components:

  1. Amount A: a new taxing right for market jurisdictions over a share of residual profit calculated at an MNE group (or segment) level
  2. Amount B: a fixed return for certain baseline marketing and distribution activities taking place physically in a market jurisdiction, broadly in line with the arm’s length principle
  3. Processes to improve tax certainty through effective dispute prevention and resolution mechanisms.

Amount A – scoping issues

Amount A is described as an allocation of a portion of residual profit of in-scope businesses to market or user jurisdictions. The solution is targeted and will build in thresholds (e.g., the EUR750m group turnover threshold following the CbCR approach is suggested), in an effort to minimise compliance costs for taxpayers. The types of businesses which could potentially fall into the scope are those characterised as “automated digital services” (ADS) or “consumer-facing businesses” (CFB).

From an African point of view, the obvious question is how many multinational enterprises (MNEs) based in Africa potentially could be in-scope. While there certainly exist African-based businesses that will fall within the proposed threshold, on a global aggregate basis a small percentage will be represented by “homegrown” African MNEs. This is unsurprising given the relative size of the economies viz. the rest of the world. However, this is the first, albeit obvious, indicator that Amount A may be geared toward a certain audience. In the absence of concrete considerations, the most we get from the OECD is that more work has yet to be done, or “consideration will be given to using a lower nexus standard for developing economies,” many of which are located in Africa. 

Even more uncertain are the scoping issues in defining Amount A. The OECD has yet to provide a solid way forward into what businesses fall in scope and which do not. For example, the blueprint for Pillar 1 already states that certain sectors are out-of-scope, including certain natural resources; certain financial services; construction, sale and leasing of residential property; and international air and shipping business. Furthermore, the intensity of activities may push a company out-of-scope. An example, which is quite relevant to many African countries, suggests that the extraction of resources is currently out-of-scope, but processing the resource into finished or semi-finished goods may be in-scope.

Amount B – most African companies are already out?

Amount B seeks to simplify transfer pricing related to functions which would fall within the definition of “baseline distribution and marketing activities.” The approach is taken to provide more certainty to businesses and tax authorities alike, the reason being that distribution and marketing companies (BDMs) are often the focus of transfer pricing audits. The approach is to identify a standard baseline return for in-scope functions, segmented on a business/industry and regional basis. In determining the base return, it is likely that the transactional net margin method (TNMM) will be applied, using either an EBT- or EBIT- over-turnover profit level indicator. The move towards a simplified approach is welcomed, and we acknowledge that it is a noble approach indeed, but its relevance for the African context is questionable.

The blueprint provides an overview of the types of functions, assets, and risks that would be considered in-scope to be classified as a BDM (i.e., the “positive list”) as well as items which would indicate a company is out-of-scope (i.e., the “negative list”), including quantitative thresholds via certain financial ratios. In general, the positive list items in the functions and assets are more-or-less what is expected in a BDM-type business (i.e., they will look very similar to what many transfer pricing specialists would characterise as a “limited risk distributor/service provider”). However, when one examines the risks as well as the financial ratios that would subscribe an entity into the negative list, the relevance to African countries becomes circumspect.

For example, according to the blueprint, a BDM would not be expected to carry significant foreign exchange risk. However, in the African context, where functional currencies are often volatile compared to “reserve” currencies (e.g., the USD and EUR), some degree of foreign exchange risk is inevitable. Another good example is the inventory/fixed net sales ratio that may be used to determine whether one is “in or out.” Africa is an immense continent, and doing business comes with some unique challenges. From the sheer size of distribution chains, transport costs and risks are often high, comparatively, and accounts receivable (credit) risk are generally managed locally. Taking the OECD’s prescriptive list, Amount B just does not seem to fit the business reality of African companies.

To be fair, the OECD has also mentioned that they are considering broadening the scope of Amount B in order to draw more types of companies, for example commissionaires and sales agents, into the scope. Whilst this would certainly appeal to more African countries, we are skeptical if this is enough to make Amount B relevant for the continent. One potential option would be to segment the functional profile (including assets and risks) of a BMD company on a geographical/risk-basis in order to account for more businesses. This could inevitably help more than just African companies.

Dispute resolution in Africa – a non-starter?

The third component of Pillar 1 focuses on improving tax certainty through effective dispute resolution and similar measures. Whilst we agree that this is, again, a noble undertaking, the reality on the ground in Africa is different. One of the features of this portion is to rely on mutual agreement procedures (MAPs) and other similar mechanisms. In short, the track record of African countries that have a MAP programme is not great.

In South Africa, companies are looking more to mechanisms like MAP to resolve TP disputes, but they are often encountered with long resolution timelines (including an administrative backlog) with no clear direction whether the matter will, in fact, resolve or not. In the absence of an APA programme,[1] as well as a common practice to refrain from TP-related tax rulings, most dispute resolutions are dealt with once an assessment has already been raised. So, the questions arises whether implementing Pillar 1 will change anything on the ground, in terms of dispute resolution, when the base is already low.

What are alternatives? The United Nations to the rescue?

One of the most talked-about alternatives to the OECD approach has been the introduction of Article 12B by the United Nations (UN). According to the UN, the OECD-approach does not consider some of the challenges that developing countries face. A few of the specific items mentioned include (1) the capacity of MNEs and tax authorities in developed vs. developing countries to carry out the administrative requirements to implement Pillars 1 and 2; and (2) the fact that many developing countries do not have the treaty network required under the OECD blueprints to govern implementation and resolve disputes.

Article 12B, proposed on 11 October 2020, would simply state that income from ADS arising in a “Contracting State” and paid to a resident of another Contracting State may be taxed in that other Contracting State. To avoid double taxation, the tax would not exceed a percentage (to be established through bilateral negotiations) of gross amount income arising from the ADS, where the “arising” Contracting State is a beneficial owner of the income generated and is resident of the other Contracting State. Whilst certainly a simplified approach, the UN approach appears to rely on existing treaty networks, which itself is argued as a pitfall of Pillars 1 and 2. Furthermore, it is unclear to what extent other countries, which appear to be more focused on the OECD developments (read: developed countries), would adopt the UN approach. Without their buy-in, it is unlikely that the UN approach will have teeth.

Going it alone – unilateral actions

The other option is, of course, to implement unilateral measures aimed at taxing the digital economy, which some countries (including those in Africa) have done. For example, Kenya has introduced a new digital services tax on service income provided through digital marketplaces at the rate of 1.5% of gross transaction value. Zimbabwe has implemented a 5% tax on gross income from satellite broadcasting services and e-commerce operators providing/delivering goods to residents of Zimbabwe. Tunisia has a 3% tax on gross income from sales of computer applications and digital services.

Closer to our home, in South Africa, the Parliamentary Budget Office (PBO) issued its tax policy considerations in June 2020 which states that South Africa’s approach to international taxation has always been to await guidelines provided by the OECD to ensure that global tax predictability and cooperation is maintained. However, given the current economic climate, waiting for a multilateral approach might not provide much needed revenues. Furthermore, the government is looking into tax reforms related to the digital economy. The PBO further stated in October 2020 that they have engaged the African Tax Administration Form (ATAF) on the progress of African economies in taxing the digital economy. ATAF’s stance, according to the PBO, has been to warn African countries against a “wait and see” approach for taxing digital economic activities. In fact, ATAF has gone so far to release a draft law (i.e., template format) on the taxation of the digital economy for countries to simply implement.

The risk African countries run in taking a unilateral approach is retaliation from the digital “source” country. We have seen this play out in other parts of the world, for example, in threats of a trade war between the French digital service tax, whose burden may fall disproportionately on tech companies in Silicon Valley and Seattle, and the US-proposed taxes on French wine and luxury goods. Another risk may be countries losing out on potential tax revenue whilst waiting for international organisations to complete their work.

Where do we go from here?

It appears that many in the tax and transfer pricing fields are reactive to the release of the OECD guidance on the digitalisation of taxes; however what remains unclear is where we all go from here. The OECD has set a tight deadline of finalising the blueprints by June 2021, after which members, including non-members who have signed onto the Multilateral Instrument, will need to ratify and implement the measures into domestic law. Will we get consensus? That will be a tall order in itself; however, the blueprints themselves are a step in the right direction. Whether the technical contents make sense for Africa is questionable, though. So it is likely we will see more unilateral actions taken, unless what comes in June 2021 brings Africa back into a broader scope of application.

[1] As of November 2020, South African Revenue Service is considering implementing an APA programme.


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