As the world becomes increasingly globalised, the idea of multinational corporations being limited to large global conglomerates is a thing of the past. It is no longer uncommon for small and medium-sized enterprises (SMEs) to extend their reach into markets other than their home jurisdiction to benefit from greater economies of scale, especially where their home jurisdiction participates in a customs union, such as the Caribbean Single Market and Economy (CSME).
Where a multinational corporation has a subsidiary in a low tax or zero tax jurisdiction, then as it does business with that subsidiary, one of the unintended or intended by-products may be the lowering of its tax liability in its home jurisdiction. For illustration, if a Jamaican company, JamCo, sets up subsidiaries throughout the Caribbean, including incorporating SluInc, an international business company in the tax haven of St. Lucia, it may opt to pay 1% tax in St. Lucia on the profits of SluInc. As Jamaica and St. Lucia are both parties to Caricom’s double taxation treaty which provides that income shall be taxable only by the Member State in which the income arises, then if by various transactions, profits are shifted from JamCo to SluInc then those profits will be taxed at 1% in St. Lucia only. This would be in place of the 25% corporate tax rate applicable in Jamaica if the profits remained with JamCo.
This type of structuring may be considered a tax avoidance measure. Tax avoidance refers to taking lawful measures to minimise one’s tax liabilities. It is not synonymous with tax evasion, which is unlawful. In order to counteract such tax avoidance measures, Parliament has recently amended Jamaica’s Income Tax Act to specify transfer pricing rules applicable to transactions between connected persons, such as JamCo and SluInc in the example above. Transfer pricing refers to the pricing of transactions between such related or connected parties. The aim of the legislation is to prevent artificial or distorted transfer prices by obliging connected persons to price their transactions at arm’s length.
This arm’s length principle is in fact not new—it existed in the Income Tax Act, 1970 as section 17. Prior to the 2015 amendment, however, it was the Commissioner General who bore the burden of determining whether or not connected party transactions were in accordance with the arm’s length principle. Now, the burden has shifted to taxpayer’s to advise the Commissioner General of the basis used to arrive at a transfer price. This will, of course, result in increased administrative burden on taxpayers and greater exposure to liability as there are penalties that may be imposed for non-compliance.
The transfer pricing provisions will apply to taxpayers that are resident in Jamaica and conduct transactions with connected persons locally or abroad. They will also apply to those transactions that are carried out with persons (whether connected or not) that are resident in a tax haven.
Who are related or connected parties (for the purposes of transfer pricing)?
According to section 2(2) of the Income Tax Act a “connected person” in relation to “Person A” includes (among others):
- Any person acting together with Person A to secure or exercise control of a body corporate;
- Any person acting on the directions of Person A to secure or exercise control of a body corporate;
- Bodies corporate of which Person A has control;
- Bodies corporate of which Person A and persons connected with him or her together have control;
- Where Person A is a body corporate, then (i) bodies corporate under the control of the same person who has control of Person A; (ii) bodies corporate under the control of persons (other than individuals) connected with the person who has control of Person A; etc.
Effects of the Legislation
The key changes brought by the legislation are that taxpayers engaging in transactions with connected persons or persons located in a tax haven will now need to employ one of the transfer pricing methodologies to arrive at an arm’s length price. If the taxpayer fails to apply the arm’s length principle, the TAJ is empowered to adjust the price. Alternatively, the taxpayer may negotiate an Advance Pricing Agreement with the Tax Administration of Jamaica (TAJ) to agree a pre-determined arm’s length price.
Affected taxpayers will now also have to file an annual transfer pricing information schedule called the “Related Party Transaction Schedule” together with their usual Annual Income Tax Return. If the taxpayer fails to certify that transactions have been carried out with connected parties or provides an incomplete certificate or return, penalty provisions will apply, but such provisions are only effective from the 2016 year of assessment.
Moreover, if the affected taxpayer’s gross annual revenue equals or exceeds J$500 million, it will also be required to maintain transfer pricing documentation to prove its arm’s length pricing.
These new requirements will no doubt have the effect of increasing the administrative burden of taxpayers. They will also result in increased costs to taxpayers for engaging in related party transactions, as the transfer pricing methodologies to be used when setting transfer prices often involve complex comparability analyses that will likely require the professional input of an accountant or tax specialist.
Despite its burdensome nature, however, the new transfer pricing regime appears to be in keeping with international best practices and, if successful, should assist Jamaica with improving its revenue generation from taxes.
René Gayle is an Associate at Myers, Fletcher & Gordon and is a member of the firm’s Commercial Law Department. René may be contacted via email@example.com or www.myersfletcher.com. This article is for general information purposes only and does not constitute legal advice.