According to Finnerty in 2007, International tax law framework has been used to indicate a set of rules that affect the tax treatment of cross-border operations. This set of rules is constituted primarily by domestic tax rules, whose application is generally limited by double tax treaties and other international law instruments.
In Kenya for instance, the case “Unilever Kenya Ltd v. Commissioner of Income Tax (Income Tax Appeal No. 752 of 2003)” was as the first transfer pricing case to go to court for which a judgment was delivered. One of the core issues was the relevance of the OECD Transfer Pricing Guidelines in Kenya.
The Kenya Revenue Authority (KRA) contended that the guidelines were not applicable because Kenya is not a member of the OECD, the guidelines were not incorporated into or adopted in the legislation, and the guidelines could be used only if Kenya had adopted the guidelines in a tax treaty with another country.
For its part, Unilever Kenya contended that the guidelines were applicable because in the absence of specific guidelines by the KRA reference ought to be made to international best practice, as represented by the OECD Transfer Pricing Guidelines; guidelines adopted by other countries essentially endorse or adopt the principles set forth by the OECD guidelines; and countries that are not members of the OECD have adopted the guidelines.
The court found that where the legislation gives no guidelines, hence other guidelines should be looked at. It thus ruled that the OECD guidelines are applicable in Kenya. In reaching this conclusion, the judge stated: “It would be foolhardy for any court to disregard internationally accepted principles of business as long as these do not conflict with our own laws. To do otherwise would be highly short-sighted.” Kenya has revised its transfer pricing legislation since this decision with the recent developments being made in terms of documentation, reporting and applicable penalties.
Therefore, when considering the design, implementation, and application of a country’s transfer pricing regime, it is important to refer to the relevant international legal framework.
Apart from other international instruments, the legal framework to consider is tax treaties in place which contain key articles relevant to transfer pricing. These articles include but not limited to;
- Article 9 (Associated Enterprises): Tax treaties that incorporate provisions based on Article 9(1) of the OECD and UN models set the arm’s-length principle as the boundary for applying each of the contracting states’ domestic transfer pricing legislation in relation to transactions that fall within their scope.
- Article 25 (Mutual Agreement Procedure): The MAP article plays a crucial role in eliminating double taxation by providing a legal framework for the competent authority of one contracting state to join with the competent authority of the other contracting state to endeavor to remedy instances of “taxation not in accordance with the provisions of the Convention.
- Article 26 (Exchange of Information): Exchange of information provisions provide the legal basis for a contracting state’s competent authority to request information from the other contracting state, as required, to assess the proper allocation of profits in accordance with the application of the arm’s-length principle. Because of the highly factual nature of transfer pricing cases and the growing importance of the exchange of information, the role and importance of exchange of information in transfer pricing enforcement is increasing. Depending on their scope, exchange of information articles can also provide a legal basis for carrying out simultaneous tax examinations by tax administrations through their competent authorities.
Tax treaties therefore provide taxpayers with a level of certainty regarding the treatment of their associated party transactions by setting boundaries for the application of the contracting states’ domestic law and by providing an international legal framework for the avoidance and elimination of economic double taxation. In addition, tax treaties provides a legal basis for contracting states to exchange information that can help them enforce their domestic tax laws, including laws relating to transfer pricing.
In conclusion, it is important to note that in addition to tax treaties, other instruments of international law and regional bodies may have a direct or indirect impact on the design and application of a country’s transfer pricing regime, depending on their applicability, they include but not limited to;
- The OECD Transfer Pricing Guidelines
- UN Practical Transfer Pricing Manual for Developing countries
- African Tax Administration Forum (ATAF)
- Inclusive Framework on BEPS Actions
- Africa Tax Initiative
Author: Eddie Opiyo