Marvelous Tapera 
Value Added Tax (VAT) and transfer pricing (TP) are largely viewed as two separate fields of tax. Adjustments to one area have limited and predictable consequences for the other area.
VAT is a transaction-based tax and it is levied on supplies of goods and services. A supply is taxable for VAT purposes if parties have agreed not only that the supply will be provided, but also what consideration will be paid in return for that particular supply.
This consideration will constitute the taxable amount for VAT purposes. TP sets the rules for transactions within related parties for corporate income tax purpose using the Arm’s Length Principle (ALP).
The ALP ensures that the conditions of a transaction within related parties do not differ from a comparable transaction between independent entities on the open market.
The term ‘connected person’ is defined under Section 2 (1) of the VAT Act.
Examples include members of the same family, companies within the same group, trusts and trustees, companies and their shareholders, partners and their families. The equivalent term in the Income Tax Act is “Associated party” which is defined in Section 2A of the Income Tax Act. A supply between connected or associated parties is often influenced by the relationship between parties and for this reason it may not be done at Open Market Value or at arm’s length.
The price may either be overstated or understated or the supply may be made free of charge. The term open market value is defined in s3 as “the consideration in money that the supply of goods or services would generally fetch if supplied in similar circumstances on the relevant date in Zimbabwe in an arm’s length transaction”.
To ensure there is no prejudice to the State, the VAT Act provides that where a supply is for no consideration or for a consideration in money less than the open market value of the supply, its value shall be adjusted to the open market value. Where the consideration is not expressed in money, the open market value shall be determined by looking at what the goods or services would fetch in the market and then make necessary adjustments as required. If expressible in money terms, the consideration in money which a similar supply would generally fetch if supplied in similar circumstances at that date in Zimbabwe, being a supply freely offered and made between persons who are not connected persons would be deemed the open market value.
“Similar supply”, means any other supply of goods or services that, in respect of the characteristics, quality, quantity, functional components, materials and reputation of the first mentioned goods or services, is the same as, or closely or substantially resembles that supply of goods or services. Where the open market value cannot be ascertained, it shall be determined in accordance with a method approved by the Commissioner.
TP is focused on establishing a conceptually objective outcome (i.e. the arm’s length standard) between associated parties. This means that the results of a related party transaction should be consistent with the results that would have been realised in a comparable transaction between independent persons dealing under comparable conditions. In cases where the conditions of a related party transaction are not in accordance with the arm’s length principle, then the taxpayer must make the appropriate adjustments to ensure that the taxable income of the person is calculated in accordance with the arm’s length principle.
Where a calculation of taxable income is not in accordance with the ALP, and the result is that the measure of taxable income is understated, or a measure of taxable loss is overstated this will constitute an incorrect Income Tax Return and the Commissioner shall make the necessary adjustment to calculate the taxable income in a manner consistent with the arm’s length principle.
Interest and penalties may also be eligible in respect of the adjustment. If the two systems operate as intended, they lack significant similarities, but due to tax avoidance schemes, the two have been prepared with very similar tools in order to combat potential erosion of tax base. The most significant difference between the two forms of price corrections is that while both aim to protect tax revenue one is economic fiction and the other one is real.
With transfer pricing adjustments you seek to reallocate the earnings of the related group entities to better reflect reality, while with adjustments of the taxable amount used for calculating VAT you aim to correct a specific transaction. The underlying commodity or service is no longer of any interest and neither is the actual transaction for TP purposes. If you sell goods or services extremely overpriced in the beginning of the year and later you sell goods or services extremely under-priced during the same year and end up correctly reflecting the earnings of each division of the related group entities, there is no need for any transfer pricing adjustments. The tax base will remain intact.
There is also a convergence between TP and VAT adjustments. The convergences are a highly-complicated matter. At first sight, this seems quite clear. Unfortunately, however, determining whether a TP adjustment has VAT consequences, is not always that simple in practice. The circumstances and conditions under which a TP adjustment leads to a VAT adjustment, are very specific and should be checked on a case-by-case basis.
This assertion rather follows from logical deduction and interpretation of the legal provisions rather than expression of certainty. In this respect, some other jurisdictions like the European Union provided non-binding guidelines on the potential VAT consequences of TP adjustments. Based on these guidelines, it is important to identify a specific consideration, a specific supply and, most importantly, a direct link between the supply and the consideration received. If these three elements are present, the TP adjustment will most likely have VAT consequences.
VAT and TP are both areas that are subject to rigorous scrutiny and it is always important to engage experts in this regard. There has been a growing interest around the globe on the effect of TP adjustments on VAT. Yet, despite this growing interest there are hardly any official commentaries or guidelines published by public bodies or tax authorities regarding the treatment of adjustments.
Companies should, however, always consider the VAT consequences of TP adjustments, since there is not a clear set of rules to determine whether or not the TP adjustment will have VAT consequences.
Tapera is the founder of Tax Matrix (Pvt) Ltd and the CEO of Matrix Tax School and he writes in his personal capacity. Meanwhile, Matrix Tax School (Pvt) Limited hosts a webinar short course in Managing Tax Practice (Basic Theory & Practice) every Wednesday and Saturday.
