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Tax Authority Amendments Aimed At Tackling Base Erosion And Transfer Pricing


Nghiinomenwa-vali Erastus
In calculating how much tax a company pays, the tax authority has adopted new rules to limit companies’ interest payments to foreign-owned parents outside Namibia if their debt is three times more than their equity.
This is according to the Income Tax Act’s recent amendments which were gazetted at the end of December 2022.
The fixed ratio rule will compel an entity to deduct interest expense up to a specified proportion of debt and equity, so that their profit remains subject to tax in the country.
This is to prevent companies from reducing their taxable income and eroding the country’s tax base by shifting their profits outside the country through interest expenses.
This comes two years after Southern Africa Resource Watch criticised the country’s weak and self-destructing anti-avoidance policies, which allow companies to accumulate debt in comparison to equity.
This creates opportunities for base erosion and profit shifting (BEPS), requiring policymakers to ensure profits are taxed where economic activities take place and value is created.
BEPS refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax according to the Organisation for Economic Development Corporation (OEDC).
Multinational companies have been hesitant to pay taxes in developing nations where they collect billions in taxes.
The finance ministry has also facilitated the Income Tax Act amendment that will now put a cap on interest payments from local companies to their parents or foreign subsidiaries, with interest of no less than 25% of the dividends, profits, or capital as payments due to financial assistance received.
This was previously only applied by the Bank of Namibia for exchange control purposes.
At any time during a year of assessment, a deduction will also be disallowed for any interest paid to the non-resident investor in respect of the financial assistance granted.
The maximum amount that the entity is allowed to deduct for tax purposes is compared with the entity’s actual net interest expense.
Net interest expense above the maximum allowable amount is disallowed.
Interest payment expenses worry the treasurer as it is noted internationally that multinational groups may achieve favourable tax results by adjusting the amount of debt in a group entity.
OEDC says the use of third-party and related party interest is one of the most simple profit-shifting techniques available in international tax planning.
It has been noted that the developing countries’ higher reliance on corporate income tax means they suffer from BEPS disproportionately, OEDC added.
The effect of thin capitalisation, according to various studies, is that it inflates tax-deductible interest payments beyond what is economically normal.
BEPS risks in this area may arise in three basic scenarios. It has been noted.
First, the groups place higher levels of third-party debt in high-tax countries.
Secondly, groups use intragroup loans to generate interest deductions in excess of the group’s actual third-party interest expense.
Lastly, groups use third-party or intragroup financing to fund the generation of tax-exempt income.
The interest payment is tax-deductible, meaning it gets to be deducted before NamRa claims its shares/taxes.
If the interest payments are a big chunk it lowers how much the government will earn in taxes from that specific company.
As a result, companies that are financed through high-interest loans from the holding company offshore erode the tax base for Namibia.
The country uses debt to equity ratio of 3:1 in determining whether a Namibian company is adequately capitalised.
“This ratio is not efficient, it is too high compared to other mining jurisdictions such as Canada and Australia,” Southern Africa Resource Watch wrote in their Mineral Insight 2021 assessment.
The Resources Watch explained that the ratio being used is not efficient, it is too high compared to other mining jurisdictions such as Canada and Australia where the debt-to-equity ratio is far lower at 1.5:1.
South Africa adopted an earnings-stripping approach that limits the number of deductibles as a share of earnings before taxable income (United Nations Economic Commission for Africa, 2017).
The Resources Watch advised using efficient ratio such as the one used in Canada and Australia, and effective policing of the transfer pricing and thin capitalisation legislation should enable Namibia to generate additional funds from the extractive sector.
The organisation highlighted the country’s thin capitalisation tool is unusually high, that is the debt to equity capital ratio in the financing of a company by its offshore or associated company.
The Southern Africa Resource Watch wrote the country “seems to be a serious lack of technical and business savvy to understand and negotiate business deals that have maximum benefits for the country”.
As a result, the Resources Watch stated companies financed through high-interest loans from the holding companies offshore can use the loophole to erode the tax base for Namibia.
Their 2021 assessment found that the country has excessive leveraging by multinational companies in the sector that causes major domestic tax base erosion.
The incentives given to foreign mining companies to attract foreign direct investment (FDI) into the sector do not make economic sense.
“Companies that pay taxes may continually record losses because they are selling unprocessed ore to sister companies at a discount,” the Resources Watch found in 2021.
The fixed ratio rule limits an entity’s net deductions for interest and payments economically equivalent to a well-leveraged company.
According to OECD, the rules which limit interest expense by reference to a fixed ratio are relatively easy to apply and link the level of interest expense to a measure of an entity’s economic activity.
These rules are currently applied by several countries.
However, the OECD has noted how existing rules are designed is not always the most effective way to tackle base erosion and profit shifting.
The majority of countries apply fixed ratio rules link interest deductibility to the level of equity in an entity, typically through thin capitalisation rules based on a debt/equity test.
The main advantage of such a test is that it is relatively easy for tax administrations to obtain relevant information on the level of debt and equity in an entity and it also provides a reasonable level of certainty to groups in planning their financing. Email: erastus@thevillager.com.na

Nghiinomenwa-vali Erastus

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