Sun | Jan 20, 2019

Everald Dewar | Transfer pricing - the tax that stole Christmas

Published:Wednesday | January 13, 2016 | 12:00 AMEverald Dewar
Everald Dewar

The Grinch is a bitter, bad-tempered, cave-dwelling, green monster with a heart "two sizes too small". He was annoyed at, and decided to stop, Christmas.

No one knew the reason the Grinch hated Christmas; perhaps he was thinking as a Chancellor of the Exchequer. Well-according to another printed media's front-page editorial, the finance minister acted similar to the Grinch in promulgating the amendment to the Income Tax Act right in the festive season.

The new rules were described as an 'illegal and unconstitutional legislation'. But that reaction may be rather late in the day, in bringing into view some of the serious tax measures that have been promulgated over the last three years. This amendment pales in comparison with the passage of the 2013 amendments to the Revenue Administration Act.

This writer was in the gallery at Gordon House during the debate on that bill in the Senate and got the impression that the members of the Upper House have, in general, almost little concern for the effects of the fiscal measures put to them and which they were prepared to pass into law.

But putting aside the notion that the amendment is unconstitutional, or whether 'Dr Phillips is recklessly betraying the cause of Jamaican businesses', let us look first at what ill the amendment is trying to cure.

In 1968, a case came before the Tax Court. Two parties who own catering concessions at Jamaica's two international airports, formed a third company to act as a management company and to receive management fees. Six years after formation, the third company went into liquidation and wanted to distribute its capital, including the accumulated management fees, as capital gains (not subject to income tax). The court ruled that "the management agreements were a sham and that the transaction were fictitious and artificial. The agreement was also artificial in that they did not constitute genuine commercial transactions but were, in fact, links in a chain of artificial devices".

As in this case, there are instances where a supposed commercial contract appears to have legal effect only to save taxes. Make no mistake, there was always a provision where the commissioner general of Tax Administration Jamaica (TAJ) had the power to challenge such arrangements and to disregard a transaction which, in his opinion, is artificial or fictitious. It is this provision that was amended, giving it more teeth.

Now, the tax authorities cannot dictate the terms or adequacy of compensation or award to be placed on goods or services between parties to a contact. However, in circumstances where 'transactions' are between connected persons, then the question of arm's length or market value arises.



The word 'transaction' means that some sort of arrangement exists between two or more persons, and accordingly, regard must be had not only to the transaction itself but to all surrounding circumstances, including the relationship between the parties, which in the case of a company would include its directors and shareholders.

There will be a declaration or certification on tax returns on whether any provision has been made for dealings with associates other than those that would have existed between independent parties. If so, assuming it brings an 'advantage' to the taxpayer, the tax computation must be adjusted accordingly. This is needed especially in cross-border cases, where transfer prices are greater than arm's-length transactions.

Looking at the new transfer-pricing rules, taxpayers are going to be required to operate the law against themselves and to certify that they have done so.

It is self-evident that the new transfer-pricing rules may require taxpayers to pay tax on profits, which they never received. The taxpayer who offers goods and services to a connected business on favourable terms may require adjustments and, in extreme circumstances, tax may be payable on entirely hypothetical profits.

Records must be kept that have no commercial purpose whatsoever other than to ensure transfer-pricing matters have been attended. We are yet to ascertain what will be the penalty position if the TAJ disagrees with an incorrect certificate. This could be considered neglectful or, in a worst-case scenario, court fines and confinement can be imposed.

The legislation will apply to business organisations that have turnover of $500 million or more.


Everald Dewar is senior taxation manager at BDO Chartered Accountants in Kingston.