Download What is transfer pricing?

South African Mining
Development Association
Submission to the Portfolio Committee on Trade and
Industry re: Transfer Pricing and Transformation within the
Mining Industry
25 March 2015
1
What is transfer pricing?
• The term ‘transfer pricing’ is used to describe arrangements involving the
transfer of goods or services, at an artificial price, (usually lower) in order
to transfer income from one business to an associated business in a
different tax jurisdiction which is often lower
• Some producer companies sell the companies commodities to its
marketing divisions at lower than market related prices.
• This results in the exportation of profits to the tax haven off shore
accounts and the declaration of low profits and the payment of low tax in
the country where the commodity is being produced and exported from.
In this case a loss to South Africa
• As Transfer Pricing regulating are tightened in South Africa, more
sophisticated forms are developed, such as abuse of Advanced Pricing
Agreements
2
Some ways to Transfer Price
• Under reporting of commodity prices, in favour of contract pricing or
recommended pricing;
• Non-reporting of full range of products sold;
• Inflated expenditure used to reduce profits locally;
• Thin-capitalisation;
• Transfer between two South African based companies which are
connected but the transfer is towards the company carrying an assessed
loss which is used to reduce prices; and
• Exchange rate misreporting
3
Impact on the mining Sector
• Outflows exceed local spend significantly;
• Pleading poverty;
• Projects committed to are underfunded because of a perceived loss of
profitability;
• Commitments are scaled back and delayed;
• BBBEEE partners to mining companies are robbed of profits and so
dividend which would go towards paying re-paying loans and funding
products leading to cancelled BBBEEE deals.
4
South Africa is losing roughly R147-billion a year to
the illegal movement of money out of the country.
(Source: Global Financial Integrity GFI)
•
Out of 151 countries, South Africa loses, on average, the 12th highest amount of
money through illicit financial outflows. In 2012 alone, South Africa ranked 9th,
losing $29.13-billion, according to (GFI)
•
This is according to a report by international monitoring organisation, Global
Financial Integrity (GFI), which released a new report on illegal capital flight this
week. The report tracks illegal outflows from 2003 to 2012. (source:www.mg.co.za)
•
“This form of illegal capital flight, or, illicit financial flows, involves the movement
of money out of the country in which it is generated, robbing countries of the
economic benefits of money generated” – source (GFI).
•
“Companies do this to purposefully hide profits generated or money illegally
earned from their record books” – source (GFI)
5
South Africa lost approximately R400bn between
2008 and 2012 through transfer pricing according to
the Alternative Information Development Centre
(AIDC).
•
Director of Western Platinum Sales Mohamed Seedat appeared to make several
contradictions during cross examination, revealing that Lonmin had paid R1.2
billion to a company based in Bermuda. Source: The Marikana Commission of Inquiry,
21 September 2014
6
Former President Thabo Mbeki said that “More than
$50 billion (R582 billion) left the continent annually–
money that could be used for development”. Source:
www.citypress.co.za
“The problem is that private companies or large
companies are able to mobilise much better skills with
regards to lawyers, accountants, banking people and all
that, so they could bring all that expertise to bear in the
court cases” – Thabo Mbeki
7
“Honourable Members, we are also taking further
steps to combat financial leakages which deprive our
economy of billions of rand through erosion of the tax
base, profit shifting and illicit money flows.”
“Action has to be taken to close tax evasion loopholes
such as transfer pricing, and profit shifting strategies by
SA corporates. I ask that South Africa continue its
support for the recent G20 decisions in this regard and
the implementation of actions in support of
transparency and sharing of information. South Africa
must similarly stand firm in the SADC against tax
havens.” - Finance Minister Nhlanhla Nene – 2015
Budget Speech
8
The impairment of the direct and indirect contribution
of the mining industry to the economy because of
Transfer Pricing
The Mining Sector has a Direct and Indirect contribution to the whole economy as
demonstrated by a few of the many sectors of the economy below:
• 17% of GDP (direct and indirect);
• 38% of merchandise exports (primary and beneficiated mineral exports)
• 19% of private sector investment
• 11.9% of total investment in the economy
• 50% of volume of Transnet’s rail and ports
• 16% of formal sector employment (direct and indirect)
• 94% of electricity generation via coal power plants
• 40% of electricity demand
• 37% of country’s liquid fuels via coal
•
Accounts for R78-billion spent in wages and salaries.
•
NB - The above figures of the direct and indirect mining contribution to the South
African Economy are artificial and misleading because the genuine figures have been
eroded through transfer pricing.
The whole economy is therefore denied the opportunity of sustainable growth.
Rapid Economic Transformation Is Sabotaged Through Transfer Pricing.
An Erosion Of The National Development Plan Through Transfer Pricing.
•
•
•
9
E-Tolls - a result of Transfer Pricing:
Transfer Pricing creates Erosion of Capital and lack of Funding
for Road Infrastructure:
•
Abolish Transfer Pricing and address SA National Roads Agency Limited's (Sanral) R150 billion
roads infrastructure and maintenance backlog.
•
The Sanral's debt of R41bn could be put in jeopardy by motorists' non-payment for e-tolls,
according to spokesperson Vusi Mona. (Dec 2013).
SOLUTION – Abolish Tax Erosion / Abolish Transfer Pricing and Create sustainable Infrastructure10
Load Shedding a result of Transfer Pricing
Transfer Pricing = Erosion of Capital which should pay for
Electricity Generation:
ECONOMIC
DOWNTURN
NEGATIVE CREDIT
RATING
Eskom will have to raise "additional debt in the region of R50bn, over and above its original plan of
R200bn".
"Eskom is facing significant challenges that threaten its sustainability," according to National Treasury.
SOLUTION – FIX ESKOM AND COLLECT THE REQUIRED FUNDS BY ABOLISHING TRANSFER PRICING
11
Transfer Pricing = Cripples the ability to address Infrastructure
and Transport Needs:
SAA, requires funding of R50 billion to stay afloat, according Public
Enterprises Minister Lynne Brown.
“We are looking at guarantees for funding for SAA, They have to meet conditions of the
open market.” The funds would come from private investors as loans or bonds and be
backed by the Treasury - Public Enterprises Minister Lynne Brown
•
SOLUTION - Minister Lynne Brown Please Advocate for the of Abolishment
Transfer Pricing to raise the funds required for SAA.
•
Avoid raising funds in a negative credit rating economic enviroment
12
Transfer Pricing = Cripples the ability to build Educational
Institutions:
“Acting CEO at NSFAS Nathan Johnstone, in 2013 said the number of students
they are able to fund is significantly less than the number of students who need
financial aid”.
Higher Education Minister Blade Nzimande told Parliament in 2012 that R147-billion could
accommodate all university students at all universities in the country, (source:www.mg.co.za)
SOLUTION – Ministers of Education Please Advocate for the of Abolishment
Transfer Pricing to raise the funds required for Sustainable Education
13
Transfer Pricing = Cripples the ability to build Hospitals and
Deliver Health Care:
The bulk of health-sector funding comes from the South Africa's National Treasury.
The health budget for 2012/13 was R121-billion, which was aimed at improving
hospitals and strengthening public health ahead of the National Health Insurance
scheme. (Source: http://www.southafrica.info/about/health/health.htm#.VL5HOkeUeSo#ixzz3PMayrMa3)
South Africa has a Shortage of doctors, medical staff, clinics and hospitals.
SOLUTION - Minister Dr. Aaron Motsoaledi Please Advocate for the of Abolishment
Transfer Pricing to raise the funds required for Health.
14
The Role of Audit & Tax Firms and Finance & Audit Committees
of Boards in Transfer Pricing:
• Do Audit Firms pay attention to Transfer Pricing when issuing clean
audits?
• Audit Companies should ensure Transfer Pricing does not happen.
• Audit Companies please ensure that Board Members, (especially the
Finance & Audit Committees) adhere to non Transfer Pricing Rules.
15
The Role of Finance Institutions and Banks in Transfer Pricing:
• Do Finance Institutions and Banks pay attention to Transfer Pricing when
managing funds and supplying credit?
• Finance Institutions and Banks should not do financial transactions with
organizations that are involved in Transfer Pricing.
16
The Role of Commercial Law Firms in Transfer Pricing:
• Do Commercial Law Firms pay attention to Transfer Pricing when
structuring deals and drafting contracts?
• Commercial Law Firms when advising clients should insist on
structuring legal agreements that adhere to non Transfer Pricing Rules.
17
The Socio Economic and Political effects of
transfer pricing:
• Transfer Pricing creates disgruntled communities that embark on service
delivery protests
• Disgruntled workers embarking on labour unrest
• Disgruntled political parties demanding Nationalisation
• Disgruntled BBBEE investors losing faith in the economic justice system
because the economic emancipation of the majority of the South
Africans have been betrayed by those foreign investors who guilty of the
disregard of the South African Laws (MPRDA and the DTI’s BBBEE Act).
• South Africans are disgruntled because there has been no penalization of
those investors that are in breach of the Mining Charter Requirements
(Section 100 (2)(b) of the MPRDA) and are practicing Transfer Pricing.
• Negative credit rating
• Negative investor confidence
18
From The Resource Curse and Economic Apartheid Model to
Transformation and Sustainable Mining Model:
From Exploited Mining Model
Hostels
Economic Rape as a Weapon of war
Conflict Diamonds the Root of all Evil
19
To
Sustainable Mining Model
DISGRUNTLED WORKERS AND DISGRUNTLED COMMUNITIES:
CHARTER NON COMPLIANCY, TRANSFER PRICING, SERVICE
DELIVERY PROTESTS, MARIKANA
20
From The Resource Curse and Economic Apartheid Model to
Transformation and Sustainable Mining Model:
Ghost Towns in Kimberly and
the Namaqualand
Environmental Hazards
21
The Final Effects of Transfer Pricing thus far:
• Neo- Colonialism continues to exist through the foreign
ownership of the South African economy even after the
political emancipation of the majority of South Africans
being reached
• Within 21 years of our Democracy it is only government that
has thus far made meaningful contributions towards
addressing the Social and Economic inequalities.
• Charter Non-Compliancy And Transfer Pricing is a direct
sabotage of the National Development Plan that has to be
achieved by 2030 (In 15 years time)
22
Transformation of minerals industry: Section 100.(2)
(a) of the MPRDA
100. (2) (a) To ensure the attainment of Government’s
objectives of redressing historical, social and economic
inequalities as stated in the Constitution, the Minister must
within six months from the date on which this Act takes effect
develop a broad-based socio-economic empowerment Charter
that will set the framework, targets and time-table for effecting
the entry of historically disadvantaged South Africans into the
mining industry, and allow such South Africans to benefit from
the exploitation of mining and mineral resources.
23
Elements of the Mining Charter
Ownership - 26% equity participation by May 2014
• Effective ownership is a requisite instrument to effect meaningful
integration of HDSA into the mainstream economy. In order to achieve a
substantial change in radical and gender disparities prevalent in
ownership of mining assets, and thus pave the way for meaningful
participation of HDSA for attainment of sustainable growth of the mining
industry, stakeholders commit to:
– Achieve a minimum target of 26 percent ownership to enable meaningful
economic participation of HDSA by 2014:
24
OWNERSHIP SCORECARD FOR THE BROAD-BASED SOCIOECONOMIC EMPOWEREMENT CHARTER FOR THE SOUTH
AFRICAN MINING INDUSTRY
ELEMENT
DESCRIPTION
MEASURE
COMPLIANCE
TARGET BY 2014
PROGRESS ACHIEVED BY
2010
Reporting
Ownership
Has the company reported the level
of
Documentary proof of
compliance with the Charter for the
Calendar year
receipt from the
department
Minimum target for effective HDSA
ownership
Meaningful economic
participation
Full shareholder rights
Annually
26%
March
2011
2011
2012
2013
March March March
2012
2013
2014
Weighting
2014
March
2015
Y/N
Y/N
26%
25
Elements of the Mining Charter
Procurement and Enterprise development
•
Local procurement is attributable to competitiveness and transformation,
captures economic value, presents opportunities to extend economic growth that
allows for creation of decent jobs and widens scope for market access of south
African Capital Goods and services. In order to achieve this, the mining industry
must procure from BEE entities in accordance with the following criteria:
– Procure a minimum of 40% of capital goods from BEE entities by 2014;
– Ensure that multinational suppliers of capital goods annually contribute to a minimum
of 0,5% of annual income generated from local mining companies towards socioeconomic development of local communities into a social development fund from
2010;
– Procure 70% of services and 50% of consumer goods from BEE entities by 2014
26
Procurement and Enterprise development
Element of the Mining Charter
SCORECARD FOR THE BROAD-BASED SOCIO-ECONOMIC EMPOWEREMENT CHARTER FOR THE
SOUTH AFRICAN MINING INDUSTRY
ELEMENT
DESCRIPTION
MEASURE
COMPLIANCE
TARGET BY
2014
PROGRESS ACHIEVED
BY
2010 2011 2012 2013
Has the company reported the
level of
Reporting
Procurement
& Enterprise
Development
Multinational suppliers
contribution to
the social fund
2014
Documentary proof of
compliance with the Charter for
receipt from the
the
Calendar year
department
Procurement spent from BEE
entity
Weightin
g
Capital goods
Services
Consumable goods
Annual spend on
procurement from
multinational
suppliers
Annually
March March March March
2011
2012 2013 2014
March
2015
Y/N
40%
70%
5%
5%
50%
2%
0.5% of
3%
procurement
value
27
Beneficiation
Elements of the Mining Charter
Beneficiation seeks to translate comparative advantage in
mineral resources endowment into competitive advantage as
fulcrum to enhance industrialization in line with State
development priorities. In this regard, mining companies must
facilitate local beneficiation of mineral commodities by
adhereing to the provision of Section 26 of the MPRDA and the
Mineral beneficiation Strategy.
28
SCORECARD FOR THE BROAD-BASED SOCIO-ECONOMIC
EMPOWEREMENT CHARTER FOR THE SOUTH AFRICAN
MINING INDUSTRY
ELEMENT
DESCRIPTION
MEASURE
COMPLIANCE
TARGET BY
2014
PROGRESS ACHIEVED BY
2010
Beneficiation
2011
2012 2013
Weightin
g
2014
Contribution of a mining company Additional production Section 26 of the
The beneficiation strategy and its
towards beneficiation (this
volume contributory to
MPRDA
modalities of implementation outline the
measure is
(percentage
beneficiation requirements per
effective from 2012)
local value addition
above
commodity
beyond the base-line
baseline )
-
extracted in South Africa.
29
STEEL VALUE CHAIN (IRON ORE, MANGANESE, NICKEL, VANADIUM & CHROME
30
GEOLOGICAL OVERVIEW OF SOUTH
AFRICA
31
MINING VALUE CURVE
32
CASE STUDY IN MINING
33
Current Structure of Case Study
Commodities from the
Mines sold to Foreign
Trading Company at Market
Price less 7%
BBBEE Company X
(SA Based)
30% (BEE)
40% (BEE)
Mine A
Mine B
70%
South African
Companies
60%
International Company Y
(SA Subsidiary)
International Company Z2
(Foreign Trading Company)
Does Marketing / Trading for the Mines
100%
100%
International Company Z1
(Foreign Holding Company)
International
Companies owns
the South African
Subsidiary and the
Marketing / Trading
Company (NO BEE)
34
Current Structure of Case Study
Company Z1
(Foreign Holding Company)
•
100%
Company Z2
(Foreign Marketing/Trading
Company)
•
100%
Company Y
(SA Subsidiary of Company Z1)
Commodities from the
Mines sold to Foreign
Trading Company at
Market Price less 7%
•
•
•
60%
70%
Mine A
30%
Mine B
•
40%
•
BBBEE Company X
(SA Based)
A foreign Investor (Company Z1) invested in two mines in South
Africa – Mine A and Mine B. The Foreign Investor created a local
subsidiary (Company Y) in which the shares were held. The Foreign
Investor also created an offshore Trading Company (Company Z2)
to market the commodities from the two mines (Mine A and B).
A BBBEE Company (Company X) became the BEE partner through
purchasing of shares in Mine A and B. The BBBEEE company is not
a shareholder in the Trading Company which is owned by the
Foreign Company alone (this trading company is the company that
does the transfer pricing).
Mine A and Mine B produce the same mineral.
The mineral produced are priced by International buyers/traders
and sellers at a South African harbour on a Free on Board (FOB)
basis – thereby determining the “Spot Export Market Price” of the
commodity.
The Foreign Owned Trading Company (Company Z2) structured a
marketing agreement with the two mines forcing them to sell
their product at a 7% discount to the “Spot Export Market Price”.
By so doing the BBBEE company was forced to sell its commodity
to its foreign Partner for 7% less than the market value eg. If the
price of the commodity was R100 then the income was only R93
for the BBBEEE and not R100.
The Trading Company (Company Z2) justified the payment of the
7% as a marketing commission payable for marketing and trading
services rendered.
35
Transfer Pricing Audit Conducted by BBBEE Company
•
•
•
•
•
•
•
•
•
•
•
This Marketing Arrangement left the mine with minimal profits most of the time.
Over and above a discounted sale of commodity to its own Foreign Trading Company by its own mines,
the Foreign Investor often sells the commodity to the end user at a higher price than the “Spot Market
Price”.
Transfer Pricing occurs through the discounted price and the additional higher price.
The lack of profit from the Mines made it impossible for the BBBEE Company X to repay its loans for
acquiring the shares and by 2014 does not have 26% ownership through unencumbered net value as per
Sec 100(2)(b) of the MPRDA and the Elements of Mining Charter and the Mining Scorecard by 2014.
Despite the fact that the foreign company has been in breach of the Mining Charter there has been no
legislative penalties imposed on this foreign company. Eg. Sec 47 or 98 or any other relevant section of
the MPRDA etc.
A marketing audit was commissioned by the BBBEEE company to investigate this disproportionate
income arrangement caused through transfer pricing.
The final audit report was accepted as correct by the Foreign Holding Company (Company Z1) and
Foreign Trading Company (Company Z2).
Despite the fact that the report found that the Foreign Company should have only discounted the price
at between 2% - 3% and not 7% thereby achieving an extra-ordinary profit of 4% , the Foreign Company
continued with this practice
eg. R100/t less 7% discount = R93/t but should have been R100/t less 3% discount = R97/t resulting in a
R4/t extra-ordinary profit for the Foreign Trading Company.
If the discount of the sale of the commodity to the Foreign Trading Company was between 2% - 3%, this
would be able to cover all fixed and variable cost, including a reasonable returns associated with the risk
of the activities conducted by the Foreign Trading Company.
The calculation for this case study was therefore based on a profit differential of 4% in favour of the
Foreign trading Company owned by the Foreign Partner.
36
Potential Transfer Price Impact
Platinum
If Mine A and B produced 5% of the
Platinum Market
If all producers were doing transfer pricing
(100% of the Platinum Market)
7% Transfer Price
3% Transfer Price
Extra-ordinary
Profits (4%)
R212m per annum
(US$1350 x R10 x
0.225mil ounces x7%)
R91m per annum
(US$1350 x R10 x
0.225mil ounces x 3%)
R121m per annum
R4.24bil per annum
(R212m/5%)
R1.82bil per annum
(R112m/5%)
R2.42bil per annum
(R121m/5%)
Potential tax loss for SARS
Coal
If Mine A and B produced 5% of the Coal
Market
If all producers were doing transfer pricing
(100% of the Coal Market)
Potential tax loss for SARS
R677m per annum
7% Transfer Price
3% Transfer Price
Extra-ordinary
Profits (4%)
R262m per annum
(US$75 x R10 x 5mil x7%)
R112m per annum
(US$75 x R10 x 5mil x 3%)
R150m per annum
R5.25 bil per annum
(R262m/5%)
R1.8bil per annum
(R112m/5%)
R3bil per annum
(R150m/5%)
R616m per annum
37
Recommendation
•
•
•
•
•
•
•
•
•
•
We welcome the fact that the Minister of Finance has established a commission under Judge Dennis Davis
that will investigate the extent, type and impact of commodity price manipulation in the country.
We welcome the opportunity to share the transfer pricing challenges of mining sector with the
commission.
The role of local and foreign marketing agents and their impact on the mining sector will be researched,
better understood through the due diligence process on transfer pricing.
The role and benefits of companies with primary listing off-shore must be researched and reviewed;
The detrimental impact on BBBEE ownership, Beneficiation, procurement and all the other elements of
the mining charter must investigated.
The alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice has not been made despite
the fact that the Mining Charter has a 2014 deadline to comply with.
We suggest that the immediate alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice
must be done as it is long overdue to address transfer pricing and charter non-compliance by producers.
Section26 (3) of the MPRDA states that any person who intends to beneficiate any mineral mined in the
Republic outside the Republic may only do so after written notice and in consultation with the Minister.
Section26 (3) of the MPRDA can be used to assist government in determining the true value of the
commodities being transferred to the end user/consumer/beneficiator.
Companies that have been in breach of the 2014 Mining Charter deadline should be penalized under the
relevant clauses of the Mineral and Petroleum Resources Development Act.
38