Reproduced with permission from BNAI European TaxService Monthly Digest, 18 ETS, 11/30/16. Copyright !2016 by The Bureau of National Affairs, Inc.(800-372-1033) http://www.bna.com

NOVEMBER 2016

transfer pricing

African TransferPricingControversies ofSwiss CommoditiesCompaniesMehdy Ben Brahim and Stephen AllewayQuestro International

The commodities sector has come under wide scrutiny from taxauthorities and public society, with Switzerland attracting specialattention due to its leading position as a business hub forcommodity traders. Numerous transfer pricing (‘‘TP’’) controversieshave publicly raised questions about the contribution of Swisscommodities companies to the public finances of the extractivecountries in which they operate, with a particular focus on Africa.

I. Executive Summary

Several long-term factors are attracting and willcontinue to attract public attention to thecommodities sector, including the major role

of taxes in sustainable development, the influence ofnatural resources on African economies, the publicoutrage against tax optimized structures, and thestrengthening of TP legislation in Africa.

As the TP environment is evolving, companies arenot only expected to comply with regulations but alsoto pay their ‘‘fair-share’’ of taxes. Tax authorities andpublic society are exerting an intense pressure on cor-porations to become more transparent in their TP ar-rangements.

In order to address this changing environment,Swiss-based commodities companies should carefullyreview their intragroup transactions, assess the busi-

ness and tax environment in which they operate, andestablish a communication framework adapted totheir situation and the expectations of their stakehold-ers.

Addressing reputational risk and stakeholder man-agement now, within the context of a sustainable TPmodel can help mitigate the reputational risks andbrand damage associated with negative media atten-tion, as well as limit the scope for future contentioustax audits.

II. A Sector under Scrutiny

Many multinational companies have established cen-tralized trading companies in Switzerland to optimizethe matching of worldwide supply and demand ofcommodities, taking advantage of a stable and pre-dictable political, economic, and legal environment.

Mehdy Ben Brahimis Transfer PricingCounsel and Ste-phen Alleway isTransfer PricingPartner at QuestroInternational

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This tradition has developed to such an extent that thecommodity cluster contributes some 3.5 percent toSwitzerland’s GDP.1

Nevertheless, this ‘‘rise has been accompanied byconcerns about transparency, appropriate regulation,and risks to resource-exporting developing coun-tries.’’2 As this sector is operating to a significantextent in developing countries, the involvement inhost countries’ domestic burdens is highly scrutinizedand issues such as corruption, environmental impact,human rights, business in conflict zones or in coun-tries with volatile political systems, and tax optimiza-tion have attracted significant public debate. Bothgovernments and companies have been under attackfor their roles in the poor governance and limitedlocal benefits received from the exploitation of naturalresources. A call for transparency has emerged as aclear response to this public debate. The ExtractiveIndustries Transparency Initiative (‘‘EITI’’), globalstandard to promote the open and accountable man-agement of natural resources, is one example of aninitiative to try to pressure the relevant actors to pub-licly account for their actions and to disclose detailedfinancial and tax information.

A key focus point within this controversy is the con-tribution of commodities trading companies to the taxbase of developing countries which has received in-creasing attention locally in Africa and globally fromWestern governments and civil society. High profilecases of alleged ‘‘transfer mispricing’’ related to hardand soft commodities have emerged, attracting sig-nificant negative media attention and renewed tax au-thority focus. The debate has now spread beyondAfrica and commodities trading hubs are now underattack globally. The recent release by the AustralianTaxation Office of a risk framework dedicated to off-shore hubs3 illustrates the eagerness of governmentsto assess thoroughly the risks of tax base erosion re-lated to centralized trading models.

III. A Long Term Change to the African TPEnvironment

Beyond the controversies around individual transferpricing (‘‘TP’’) cases, several broader trends are driv-ing increased attention towards the commoditiessector.

First, improved taxation is considered as the mainsource of financing for development in Africa. ‘‘Cur-rently, the governments of developing countries col-lect much lower proportions of their GDPs in taxrevenue than do the governments of the OECD coun-tries: 10-20% rather than 30-40%.’’4 Even though esti-mates are inherently imprecise, they all suggest asignificant loss of revenues for developing countriesdue to aggressive tax planning and/or evasion. Two es-timates to consider are:s the revenue losses through avoidance activities as-

sociated with tax havens are estimated in the orderof something over one percent of GDP in the longrun;5 and

s the OECD estimated that developing countries lostthree times more to tax havens than they received ininternational aid each year;6

the Third International Conference on Financingfor Development held in Addis Ababa represented a

key milestone to establish the mobilization and effec-tive use of domestic resources, as central to thecommon pursuit of the United Nations sustainable de-velopment goals.7

Second, Swiss commodity companies are playing amajor role in the economies of developing countries,with direct consequences on social, employment andenvironmental factors. The Swiss trading hub sectorrepresents a dominant position in certain crucialcommodities, with a leading market share amongstthe world’s main trading hubs8 such as 35 percent ofcrude oil; 60 percent of metals; 35 percent of grain; 50percent of sugar; and 60 percent of coffee. This influ-ence directly affects the level of tax revenue receivedby producing countries.9

Third, transfer mispricing and/or under-taxation ofnatural resources are considered by many as a keysource of base erosion profit shifting (‘‘BEPS’’) inAfrica. According to the African Development Bank,‘‘the already shallow tax-base in most African coun-tries is eroded further by excessive granting of taxpreferences, inefficient taxation of extractive activitiesand an inability to fight abuses of transfer pricing bymultinational enterprises’’.10 A study dedicated toWest Africa estimated that ‘‘global capital leakagefrom transfer pricing will increase from 11 billion USdollars in 2011 (60% of the total of illicit financialflows in 2011) to 78 billion US dollars in 2018, leadingto losses in government revenues from 3 billion USdollars in 2011 to 14 billion US dollars in 2018.’’11

Activists have taken a high stakes and, at times,unfair role in examining the TP practices of commodi-ties companies. NGOs are robustly enquiring into theTP structures of multinationals and their impact onpublic finances. For example, Publish What You Paypublically states that ‘‘over 110 billion USD have dis-appeared through mispricing of crude oil in the USand the EU between 2000 and 2010’’12 and suggeststhat profits have been moved from various sourcecountries to countries where commodity companieshave their HQs or trading hubs.

Finally, parallel to the evolution of public aware-ness, the legislative environment is also changing rap-idly. Country-by-Country Reporting (‘‘CbCR’’) israpidly coming into force with, as of May 2016, nofewer than 39 countries implementing domestic legis-lation and agreeing in principle to exchange informa-tion via the Multilateral Competent AuthorityAgreement on the Exchange of Country-by-CountryReports.13 Although Switzerland is expected to enactthe corresponding legislation with regard to fiscalyears from 2018 only, many Swiss based groups willbe subject to CbCR requirements for fiscal year 2016via their local affiliates. TP legislation and documen-tation requirements are also developing rapidly inAfrica, with at least 18 countries having implementedformal transfer pricing regulations in 2014.14 A widerange of legislative reforms and initiatives at local andregional level, such as the EU automatic exchange ofinformation on tax rulings15 are boosting tax trans-parency worldwide.

IV. TP as a Matter of Social Responsibility

The general media interest in commodities companieshad led to, and probably will see more numerous

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cases of, alleged transfer mispricing in Africa on thefront pages of newspapers. Such allegations oftenoriginate from NGOs’ enquiries (using public avail-able information, leaked information by companystakeholders, disgruntled employees, journalistic re-search, or leaked tax audit information).

How to approach or analyze these cases is a delicatematter, particularly because certain reported factsoften appear contradictory. In addition:s African governments are often ‘‘active participants’’

in such arrangements and have approved the inter-national pricing mechanisms explicitly in advance;

s tax planning by businesses to optimize their overalltax burden is both legitimate and prudent, and thealleged mispricing is usually within the law andsigned off by Big 4 advisors;

s due to the confidential nature of these internal com-pany affairs, the public information used is usuallyincomplete, and often misleading;

s TP is a subjective and complex matter and diver-gence of opinions are common even among special-ists; and

s the interpretation of publicly available informationis often based on ‘‘fairness’’ rather than ‘‘legality.’’

By putting into question the morality of the multi-nationals under scrutiny, public TP debates have anegative impact on taxpayers’ reputation and brandvalue. Stakeholders, internal and external, can havestrong reactions to allegations of tax misconduct, dis-associating themselves from the company. Tax au-thorities are also sensitive to such reports and arelikely to launch formal tax audits in the group’s sub-sidiaries in and out of the country of origin of thedebate. Customers may prove reluctant to engage inagreements with alleged ‘‘bad corporate citizens’’ orseek additional safeguards.

Behind the public anger against abusive TP prac-tices stands a framework of secrecy. Most accusationsrelate to the ‘‘use of complex tax schemes’’, the ‘‘chan-nelling of profits to low tax jurisdictions’’ and/or‘‘sweetheart deals’’, concepts drawing on suspicion ofa voluntary and organized misconduct made possibleby a lack of transparency. While this may undoubtedlyprove true in some situations, it is also likely that com-panies will be criticized for their transfer pricingstructures unfairly based on limited, partial informa-tion that does not reflect the full reality.

The bad press around TP has become so dominantthat many news articles now define TP broadly as ascheme used by multinational companies to avoidtaxes, rather than a legal compliance requirement.Being compliant with the regulations in a way thatsatisfies all stakeholders (accepting technical com-plexity of the regulations, difficulties to forecast busi-ness profitability, conflicting interpretations fromvarious tax authorities, etc.) provides a fertile groundfor challenge.

V. Implementing a Sustainable TP Model

Multinationals are not in the habit of disclosing infor-mation on their TP structure. Addressing reputationalrisk and stakeholder management is a new task formany Heads of Tax. Nevertheless, transparency andcommunication are useful tools to mitigate the risksof media attention, public controversies and costly tax

audits. Increased public scrutiny and transparency re-quirements such as CbCR or the EITI will continue toexert pressure on companies’ TP disclosures. Refusalto disclose information is likely to reinforce the ‘‘mustbe hiding something’’ secrecy mindset and to heightenreputational risk and its associated consequences. Incontrast, several leading groups within the commodi-ties sector have engaged in pro-active communicationbeyond their legal requirements to endeavor to inte-grate TP into their corporate social responsibilityagenda.

Implementing a holistic TP and communicationstrategy is now ‘‘best practice’’ for multinationals inorder to address the move of public opinion towardsincreased public disclosure of tax strategy and taxprofile data. The associated risks and opportunitiesare dependent upon a wide range of company-specificfactors, including the current TP strategy and compli-ance approach, the risk profile, the countries of opera-tions, and the approach to tax transparency andsustainability of a company’s peers. To adopt a solu-tion tailored to their own situation, Swiss-based com-modities companies can follow a detailed action planwithin a broad three-step process:s Assess their business and TP environment;s Implement a sustainable transfer pricing structure;

ands Communicate effectively on TP towards their stake-

holders.

This approach will help to balance tax risks and op-portunities with a strong transfer pricing governanceprocess, to avoid unnecessary disputes with tax au-thorities, erosion of reputation, and will help to pro-mote your corporate social responsibility agenda. Byaddressing the increased interests from investors,16

customers and governments, the implementation of asustainable TP strategy supports a company’s overalloperational and financial targets.

Mehdy Ben Brahim is Transfer Pricing Counsel and StephenAlleway is Transfer Pricing Partner at Questro International.They can be contacted atm.benbrahim@questro-international.com ands.alleway@questro-international.com.http://www.questro-international.com.

NOTES1 FDFA, FDF, EAER, Background Report: Commodities Report of the in-terdepartmental platform on commodities to the Federal Council, 20132 Swiss Academies of Arts and Science, Switzerland and the Commodi-ties Trade Taking Stock and Looking Ahead, in Swiss Academies Fact-sheets, vol. 11, no 1, 20163 Marketing hubs consultation paper; ATO compliance approach totransfer pricing issues related to centralised operating models involvingprocurement, marketing, sales and distribution functions. The purposeof this framework is to classify offshore marketing hubs according totheir risk profile from a low risk green zone to a very high risk red zone,the outcome triggering various regimes in terms of disclosure, APAprogram, review and audit proceedings.Additionally, ‘‘Australia’s tax office has said it is conducting audits of 15marketing hubs in Singapore and Switzerland that it says it expectswill raise an extra $1 billion’’ (http://www.reuters.com/article/us-singapore-tax-idUSKBN0N301T20150412).4 European Union Directorate-General for External Policies of theUnion, Directorate B Policy Department, Tax Revenue Mobilisation inDeveloping Countries: Issues and Challenges, April 20145 IMF Working Paper, Base Erosion and Profit Shifting and DevelopingCountries, Ernesto Crivelli, Ruud de Mooji and Mickael Keen, WP/15/118, May 2015.6 This estimation was mentioned in an article from the OECD GeneralSecretary Angel Gurrı́a published by The Guardian on November 27,

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2008 (http://www.theguardian.com/commentisfree/2008/nov/27/comment-aid-development-tax-havens).7 United Nations, Addis Ababa Action Agenda of the Third InternationalConference on Financing for Development, endorsed by the General As-sembly in its resolution 69/313 of July 27, 2015.8 Swiss Academies of Arts and Science, Switzerland and the Commodi-ties Trade Taking Stock and Looking Ahead, in Swiss Academies Fact-sheets, Vol. 11, No. 1, 2016.9 FDFA, FDF, EAER, Background Report: Commodities Report of the in-terdepartmental platform on commodities to the Federal Council, 2013.10 African Development Bank, Domestic resource mobilisation acrossAfrica : trends, challenges and policy options, Committee of Ten, Policybrief, No.2/2010.

11 Study by Dalberg commissioned by OSIWA, Domestic Resource Mo-bilization in West Africa : Missed opportunities, February 2015.12 Publish What You Pay Norway, Lost Billions, Transfer Pricing in theExtractive Industries, Simon J. Pak, January 2012.13 http://www.oecd.org/tax/automatic-exchange/about-automatic-exchange/CbC-MCAA-Signatories.pdf.14 Ernst & Young, Transfer pricing updates across Africa, EY Africa TaxConference, September 2014.15 i.e. the EU automatic exchange of information on tax rulings, the EUAccounting Directive, the corporate tax strategy disclosure in the UK,the Open Tax lists in Denmark, Norway and Sweden, the ExtractiveSector Transparency Measures Act in Canada.16 i.e. Dow Jones Sustainability Index at http://www.sustainability-indices.com/.

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