Good Financial Governance and Extractives

Tax Compliance in the Extractive Sector

Base erosion and profit shifting (BEPS) to countries with low tax rates by multinational resource enterprises is having a negative impact on domestic resource mobilisation in developing countries. The resulting loss of tax revenue is putting increasing pressure on public budgets and limiting the options available to these countries to finance their own development and the achievement of the SDGs. Inter-company transfer pricing is often used in this context to manipulate the tax base. To strengthen the capacities of tax authorities in partner countries with active extractive sectors, the Extractives and Development sector programme has developed the Toolkit for Transfer pricing risk assessment for the African mining industry.

Although not illegal in itself, transfer pricing mechanisms can be used by firms for tax avoidance purposes and thus to the detriment of the state. Transfer pricing is the setting of prices for goods and services that are sold between the various divisions of a company and are therefore not purchased from third parties. This is particularly common in enterprises comprising several legal entities. Where transfer pricing practices are misused for tax avoidance purposes, profits can be shifted between individual entities of an enterprise, often to entities in regions with low tax rates. The country in which the profit was actually generated therefore loses out on revenue that could play an important role in its development.

In the case of the extractive sector, the responsible tax authorities in developing countries often lack the sector-specific expertise required to identify and mitigate transfer pricing risks. Effective risk assessment mechanisms can consequently play a very important role in developing countries with limited audit resources. To determine whether illegal transfer pricing practices have been used, tax authorities need information that enables them to distinguish between abusive practices on the one hand, and standard industry practice on the other.

The Toolkit for Transfer Pricing Risk Assessment for the African mining industry addresses this challenge by offering user-friendly, straightforward, step-by-step guidance on how to determine whether high-risk transactions in the extractive sector should be subject to transfer pricing audits. It also sets out the exact information required by the tax authorities for investigating and assessing transfer pricing issues. The toolkit is intended to be used primarily by tax authorities in resource-rich developing countries and helps them to develop sector-specific expertise with a view to identifying and counteracting transfer pricing risks in the extractive sector. It can be dowloaded here (English and French).

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