Most recently, the Egyptian tax authorities introduced legislative changes within the Unified Tax Procedures Law imposing high penalties for the late/non-submission of transfer pricing documentation. The boost in transfer pricing capabilities is also driving an increase in the number of transfer pricing audits, in standalone form and within corporate tax audits.
This has resulted in an environment that is challenging for businesses, with local tax teams being expected to build documentation to secure protection against penalties and stand strong in an audit that has become more likely to occur.
With transfer pricing documentation deadlines around the corner, businesses with a presence in Egypt are gearing up to prepare. This article contains some insights for companies whose local tax teams are somewhat new to the local documentation process and would benefit from some guidance on how to manage the task.
Simply put, the task is composed of detailed information gathering, which sits at the forefront of the process, followed by qualitative and quantitative analysis for the ultimate production of a report which proactively defends a company's intercompany pricing. The process is usually governed by transfer pricing advisers working to guide company tax and finance teams with the interpretation, presentation and analysis of information.
Inspired by live conversations with clients, the following is a checklist of the most common information categories that are frequently addressed when preparing for a new transfer pricing compliance season:
The checklist considers the following per category:
The identification of intercompany commercial or financial relations is the starting point of transfer pricing documentation. Identification is further linked to the accurate delineation of transactions within a functional analysis; however, this commences with identification and a description along broad lines. This would include information such as:
Once transactions have been identified, it is most efficient to start the local documentation process with knowledge of whether these transactions have already been documented (i.e., described and analysed against the arm’s length principle) within the global organisation.
There is often documentation that is available at group level for transactions that are similar to those occurring locally. These may be found in modular form, which is common within large organisations engaging in centralised documentation approaches, or simply found with other group companies engaging in similar transactions with the parent or with other group members.
The documentation process is most efficient when local tax teams understand what is available at group level before interacting with transfer pricing advisers. This is important to ensure consistency across the group and increases the cost effectiveness of the local documentation process. Local verification of available documentation is best practice, and can occur at different levels, to ensure local documentation is reflective of reality.
The Egyptian transfer pricing guidelines indicate that taxpayers are expected to represent sufficient evidence of the credibility of their transfer pricing policies. Accordingly, local tax teams should be prepared to explain their transfer pricing policy as applied to the transactions being documented. For example, in the case of central cost charges, details of the transfer pricing policy may include the framework of direct and indirect cost allocation, allocation keys used, and mark-ups applied.
Local tax teams do not always have a full understanding of their group's transfer pricing policies. This often causes difficulties with defending policies, creates barriers to consistent local documentation, and sometimes leads to incorrect implementation of these policies.
It is considered best practice for local tax teams to build a well-rounded understanding of their company's global transfer pricing policy and how this policy is applied to their local entity, including deviations or anomalies for certain transactions.
The transfer pricing disclosure within the company corporate tax return is a good information source; however, it is a common error that the values included in the return transfer pricing disclosure are related-party balances copied from financial statements. It is crucial that the values used in the return disclosure and the local file are transactional values for the year and not overall related-party balances. The use of balances may heavily impact the calculation of potential penalties.
For example, when balances result in amounts which exceed transactional values for a given financial year, penalties for late/non-submission of documentation (3% of aggregate transaction values) become inflated due to being calculated with reference to an inflated base. Companies then face an added burden of proving that disclosed figures were inaccurate. Similarly, when balances result in amounts which are less than transactional values for a given financial year, companies may face a penalty with regard to the undisclosed amounts (1% of the undisclosed transaction value).
Local tax teams are most likely expected to produce segmented financials if the company carries out more than one function; for example, if the company imports raw materials for manufacturing and at the same time imports finished products that are sold in their finished form. In that case, local tax teams will be expected to construct two profit and loss (P&L) statements: a manufacturing P&L and a distribution P&L. The sum of the segmented financial information needs to be reconciled with the total audited financial statements.
Another type of segmentation that will likely be useful during the process is between a related-party business and a third-party business that may exist within the same company. A third-party business operates independently without the effect of any control from a related party; i.e., neither at revenue nor at cost levels. This sort of segmentation is useful to separate (or potentially scope out) a third-party business from documentation, or for the identification of potentially comparable internal uncontrolled transactions.
Local tax teams will need to provide a general background about the business and the industry in which the business operates. In doing so, it is important that companies identify significant events occurring within a business, an industry, or an economy that influenced the pricing of intercompany transactions.
As audits tend to occur years after the fact, it is considered best practice to gather evidence in a timely manner to support the commercial rationale connected to transactions that may appear high risk. For example, losses that were driven by extraordinary events, or unique but commercially viable circumstances, must be accounted for with appropriate evidence. These cases may range from global events such as COVID or macroeconomic circumstances such as currency devaluations, to market penetration strategies and/or start-up costs.
Local tax teams may seek out this type of information from the relevant departments of the local business. There are often cases where evidence will need to be gathered end-to-end across counterparts of the global organisation.
The details of the gathered evidence should be considered and presented on a case-by-case basis and can be based on internal references or external market data.
Comparability analysis lies at the heart of the application of the arm’s length principle. The principle is based on a comparison of the conditions in a controlled transaction with the conditions that would have existed between independent parties participating in a similar transaction under comparable circumstances.
There are two key aspects in this analysis:
The functional analysis determines how each associated entity adds value to a transaction. It focuses on identifying the economically significant activities and functions undertaken, assets utilised or contributed, and risks assumed by the parties to the transactions. It is the base of the economic analysis and benchmarking, helping to:
During the documentation process, local tax teams should therefore be prepared to do the following:
It is a common misconception that external benchmarks are always needed. Broadly, an external benchmark is needed if:
Another common misconception is that one size fits all with benchmarks. It is wise for local tax teams to enquire as to the available benchmarks within the global organisation to understand whether benchmarking analyses can be utilised or leveraged. However, it is often a fact that differences in local practices may lead to the need for commissioning fresh benchmarks.
The following variables commonly drive the decision of whether new benchmarks are needed for an Egyptian company:
Geographical area is not on this list of variables due to the scarcity of local data. This often means that adapting available benchmarking sets to local rules can offer a pragmatic approach for Egyptian companies where possible.
The master file preparation is the responsibility of the ultimate parent of a group. From an Egyptian tax law perspective, it is an integral part of the transfer pricing documentation. Penalties for the late/non-submission of the master file are the same as for the late/non-submission of the local file.
Accordingly, it is crucial for local tax teams to enquire internally with the parent company as to whether a master file is available at the ultimate parent level by the required deadline. The deadline for the submission of the master file in Egypt is consistent with the submission deadline of the ultimate parent country. If no deadline exists, then the master file deadline becomes consistent with the local file deadline.
In the current Egyptian transfer pricing environment, local tax teams are expected to achieve the building of documentation which secures protection against penalties and will stand strong in an audit that has become more likely to occur. This is a challenging task.
In a post-BEPS world, and in this sort of environment, consistency is key. It is important for local tax and finance teams to have a well-rounded understanding of global transfer pricing policies and their implementation with local entities. It is also important for local tax and finance teams to have ownership over the local transfer pricing documentation process; however, it is crucial to consult with parent companies or central transfer pricing teams to achieve an efficient, cost-effective and streamlined process every year.
The local file deadline is two months following the submission of the tax return. It is always recommended that companies kick-start the documentation process two months in advance of the reporting deadline to allow sufficient information-gathering time.
