Ethiopia recently adopted new transfer pricing rules in the form of Directive 43/2015 ("the Directive") issued by the Ministry of Finance and Economic Development. The Directive provides detailed guidance as to the application of Article 29 of the Income Tax Proclamation (ITP) 286/2002, which requires taxpayers to ensure transactions between related persons are conducted at arm's length, and is effective as of 12 October 2015. The Directive is largely consistent with international standards and will provide Multinational Enterprise Group's doing business in Ethiopia with clarity concerning the application of Ethiopia's transfer pricing rules as well as the possibility to obtain certainty through an advance pricing agreement (APA). This tax insight presents a summary of this recent development.
Legal Framework (Article 29 ITP 286/2002)
Prior to this new Directive the only reference to transfer pricing in Ethiopian tax law was Article 29 of the ITP 286/2002, which required the application of the arm’s length principle in transactions between related persons and provided a legal basis for advance pricing agreements (APAs) to be entered into between a taxpayer and the Ethiopian Revenue and Customs Authority (ERCA). No further guidance was provided as to the application of this Article.
Summary of the new Directive (Directive 43/2015)
The new Directive details the application of Article 29 and is closely aligned with the principles detailed in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2010 ("OECD Guidelines"). Key features of the Directive are as follows:
- Scope: Article 3 of the Directive clarifies the scope of Article 29 as covering transactions between resident taxpayers and their related non-resident entities ("international transactions") as well as any transaction between two related resident taxpayers ("domestic transactions") having an annual turnover of more than 500,000 Ethiopian Birr (approx. USD 22,000).
- Arm's length principle: Article 4 of the Directive provides a definition of the arm's length principle that is consistent with international standards, by referring to conditions that would have applied between unrelated persons in comparable transactions carried out under comparable circumstances.
- Comparability: The concept of comparability is defined in Article 5 of the Directive consistently with the OECD Guidelines. The five comparability factors specified ((1) characteristics of the goods or services, (2) functions, assets and risks of the parties to the transaction, (3) contractual terms, (4) economic and market circumstances and (5) business strategies) are also consistent with the factors details in the OECD Guidelines.
- Transfer pricing methods: Article 6 of the Directive specifies five methods that are considered to be "approved transfer pricing methods". These five methods (comparable uncontrolled price method, resale price method, cost plus method, transactional net margin method and transactional profit split method) are consistent with the transfer pricing methods elaborated in the OECD Guidelines. Provision for the use of "other method" by a taxpayer is also made, provided that it can be demonstrated that none of the approved methods can be reasonably applied and that the other method produces a result consistent with the arm's length principle.
- Selection of transfer pricing method: The Directive specifies (Article 7) that consistency with the arm's length principle shall be determined by application of the most appropriate transfer pricing method given the facts and circumstances of the case. A list of four criteria that require consideration when determining the most appropriate method are specified. These criteria are consistent with the guidance on method selection provided in the OECD Guidelines. Also consistent with the OECD Guidelines the Directive specifies a preference for the comparable uncontrolled price method or the resale price or cost plus method in cases where such methods can be applied with equal reliability to one or more of the other approved methods. Where a taxpayer has selected a method consistently with this guidance Article 7(5) makes it clear that the tax authority must respect the method applied by the taxpayer, unless it can provide that it is not the most appropriate method.
- Arm's length range: The concept of arm's length range in introduced in Article 10 of the Directive. This article specifies that a controlled transaction shall not be subject to an adjustment under Article 29 of the ITP where the relevant financial indicator being tested is within the arm's length range. Where the result falls outside the arm's length range, any adjustment by the tax authority is required to be made to the median unless the taxpayer or the tax authority can demonstrate that adjustment to another point in the range is more appropriate. The concept of arm's length range introduced in the directive is the "full range" of financial indicators observed from the uncontrolled transactions that are all of equal reliability and comparability.
- Sources of information: Article 11 provides guidance as to the possible sources of information on comparable uncontrolled transactions. Specifically, Article 11(2) prohibits the use of "secret comparables" by the tax authority as a basis for an adjustment under Article 29 of the ITP, and Article 11(3) provides for the same with respect to taxpayers (i.e. a taxpayer cannot rely of a "comparable" unless they make the relevant information available to the tax authority). As regards the use of so-called "foreign comparables", Article 11(4) provides for their use where there is no information from the same geographic market (country or region) as the controlled transaction.
- Transfer pricing documentation: Article 15 specifies that taxpayers must have in place contemporaries documentation and lists nine elements which must be included in the documentation. Documentation can be submitted in Amharic or English, and is considered to be contemporaneous if it is place at the statutory tax returns filing date.
- Specific guidance (Services and Intangibles): The Directive contains some specific guidance on the application of the arm's length principle to service transactions and intangibles transactions. This guidance is consistent with the OECD Guidelines and elaborates on concepts such as shareholder costs, as well as specifically providing for the possibility to apply indirect methods for service charges.
- Corresponding adjustments: The Directive contains specific articles (Art. 16 and 17) dealing with corresponding adjustments. Article 16 provides that where a "primary adjustment" is made to a domestic transaction, the authority shall make a corresponding adjustment. Article 17 details the procedure for applying for a corresponding adjustment where a transfer pricing adjustment is made by a foreign tax authority.
- Relevance of the OECD Guidelines: Although Ethiopia is not an OECD Member, the Directive is clearly heavily influenced by the principles elaborated in the OECD Guidelines. Article 18 specifies that the OECD Guidelines are a source of interpretation for the Directive, but that in case of any differences or conflicts with domestic law, the domestic law will take precedence.
Possibility to seek an APA in Ethiopia
Advance pricing agreements are becoming an increasingly popular tool for taxpayers (and tax authorities) to proactively manage and address transfer pricing issues. In recent years an increasing number of countries, including many emerging and developing economies, have been introducing the possibility for taxpayers to seek advance pricing agreements into their legislation. On the African continent however, the possibilities to seek an APA are still very limited. Ethiopia has followed the trend being observed on other continents and has introduced rules and procedures concerning APAs in this new Directive. Making it amongst only a handful of African countries that currently offer APAs.
Under article 12 of the Directive a taxpayer may apply for APA which can be unilateral, bilateral or multilateral. The request to apply for an APA by the taxpayer shall be accompanied by the description of the taxpayer's activities and transaction, a comparability analysis as well as an economic analysis, the identification of other country(ies) (if applying to a bilateral or multilateral APA), the scope of the agreement and proposed duration, which may not exceed five fiscal periods beginning after the date of approval.
For more information on transfer pricing in Ethiopia, or transfer pricing generally, please contact Joel Cooper who, in his previous position with the World Bank Group was involved in the provision of technical assistance on transfer pricing to the Ethiopian Ministry of Finance and Economic Development and to the Ethiopian Revenue and Customs Authority.