Transfer pricing, these discreet but powerful accounting levers, has become one of the preferred methods for multinationals to shift profits to low-tax jurisdictions. Through subtle manipulation, billions of euros can thus escape national tax administrations, endangering public finances. For more information on this subject, Marlyse Ndjenga, Cemac approved tax expert -CEO of the “Fiscal.com” group, based in Cameroon, CAR and Congo, sheds more light on us.
What is behind the practice of profit transfer practiced by multinationals, and why should it worry companies as much as States?
To better understand this transfer practice, I will give you an example. And although it is fictitious, it will be revealing and will help us to understand the thing better. Let’s take the example of a French parent company whose sole subsidiary is based in Tunisia. The subsidiary buys components at 50 euros per unit, transforms and packages them at a total cost of 100 euros, then resells them to its French parent company at 200 euros per unit. The parent company, for its part, markets the final product on the French market for 300 euros, with an additional marketing cost of 10 euros per unit. Let’s assume that the corporate tax rate in France is 60%. This rate is, of course, increased to better illustrate the case. Here is the calculation of profits before taxes; for Tunisian subsidiary transfer price is 200 euros from which we subtract total costs of 100 euros, thus the profit would be 100 euros. For the French parent company, the sale price would be 300 euros from which 210 euros of total costs are subtracted and therefore the profit is only 90 euros. With a tax rate of 15% in Tunisia and 60% in France, the taxes paid are 15 euros and 54 euros respectively. Profits after taxes are then 85 euros for the Tunisian subsidiary and 36 euros for the French parent company. On the surface, these transactions appear to be in line with the arm’s length principle, because the transfer price of 200 euros corresponds to the market price. But now imagine that the parent company decides to set a transfer price of 290 euros instead of 200 euros. By artificially increasing the transfer price, it transfers all its profit to the Tunisian subsidiary, benefiting from a much lower tax rate. The profit would then be taxed at 15% in Tunisia instead of 60% in France, allowing a substantial tax saving.
What really pushes these multinationals to adopt this type of practice?
Simply to exploit the difference in tax rates between the two countries. By setting the transfer price at 290 euros, the profit is entirely transferred to Tunisia, thus escaping the high tax in France. This maneuver, although tempting, violates the arm’s length principle and exposes the company to tax adjustments by national authorities. Tax authorities are not fooled and often correct profits by calculating transactions according to market prices.
How can we further illustrate the complexity and issues of transfer pricing?
To illustrate the complexity and issues of transfer pricing, I will draw inspiration from an extract from the brochure — tax control of transfer pricing — written by Abderrahim Tazi El Mezouguy. Consider the case judged by the Paris Administrative Court of Appeal in 2010, involving the French company “Technipex”. For businesses that are unfamiliar with taxation, I’ll explain the case more simply: Imagine that you run a business in France that buys and sells products internationally. You have a subsidiary in another country, say Jersey, a place with 0% profit taxes. Jersey is what we call a tax haven, that is to say a country where taxes are very low or non-existent. In the case of the French company, “Technipex”, the latter bought military binoculars for 46.2 million euros from a company in Jersey, called “Hexagon Holding Ltd”. Then “Technipex” resold these same binoculars for 48.4 million euros to the Moroccan administration. So far, this appears to be a normal business transaction. However, the tax investigation revealed that the Jersey company, Hexagon Holding Ltd, had purchased the binoculars for just €20 million from another German company, Steiner Optik. This means that “Hexagon Holding Ltd” made a huge profit of €26 million (€46.2 million – €20 million). Now here’s the crucial point: since Jersey does not tax profits (0% rate), this €26 million profit was not taxed at all. It’s as if the company found a way to move its profits to a place where they wouldn’t be taxed. This arrangement is possible thanks to the manipulation of transfer prices, that is to say the prices at which companies in the same group sell goods or services to each other. In other words, the French company could have purchased the binoculars directly for 20 million euros from the German company, but by purchasing them via Jersey at a much higher price, much of the profit was transferred into a country without taxes. This means that the French company has less taxable profits in France, where taxes are higher, and this allows the company to pay less tax overall.
You mention that transfer pricing is a double-edged tax strategy. Can you explain how businesses can navigate the potential tax benefits and risks of harsh tax adjustments, while avoiding financial penalties and reputational damage?
Indeed, as you can see, the examples above show that transfer pricing is not a simple administrative formality, but a real double-edged tax strategy. Manipulating transfer pricing can provide significant tax benefits, but also exposes companies to the risks of severe tax adjustments, financial penalties and reputational damage. For multinationals, compliance with OECD transfer pricing guidelines and local country regulations is crucial. Without this, they risk having their profits corrected and taxed at higher rates, or even facing lengthy and costly tax investigations.
What advice would you give to businesses?
Transfer pricing can be the tax Trojan horse of multinationals, but the tax administration is vigilant and does not hesitate to apply severe sanctions in the event of non-compliance. Companies must therefore carefully navigate this complex sea of international regulations to avoid disastrous tax consequences. If we go back to the example I mentioned, this kind of strategy may seem advantageous for the company, but it is actually a very risky method. The tax authorities of OECD member countries such as Cameroon, Tunisia, France, Morocco, etc. do not see this favorably, because it reduces the taxes collected in their country. As a result, they can conduct investigations, adjust the amounts of taxable profits and impose severe penalties for these practices. To conclude, I would like to draw the attention of businesses to an OECD institution called “Tax Inspectors Without Borders” which is a real force for controlling multinational companies.
