NEW LAW ABOUT TRANSFER PRICING

Already in April 2006 by Republic of Kazakhstan governmental decision law “About governmental control while using transfer prices” was given for discussions to the Majilis. On July 9th 2008 on birthday of tax agency, head of the country signed new law “About transfer pricing”, which will be in power from January 1st 2009. About the differences between new law and present law, how new law considers interests of every party, we asked to tell us chairman of tax committee Republic of Kazakhstan Ministry of Finance, Mr. Nurlan Rakhmetov.

- Mr. Rakhmetov, what urged tax agency to start development of new law about transfer pricing in 2006? Does it mean that acting law exhausted its potential?
- Actually an idea to develop new law existed well before 2006, but I however, will start from the history of present law. If we remind ourselves 1999 and 2000 then we must remember that world prices for main strategic resources were rapidly growing, but prices of Kazakhstan exporters differentiated from world exporters. It is not secret that most of the export deals were done with off shore zones. For example, if in 2000 average world price of oil equaled to 28 USD per barrel but price of oil that Kazakhstan exporters accepted was 19.9 USD. Thus, we can underline difference of 29.4%. Moreover, there have been differences in other prices as well; in zinc it was equal to 24%. All this underlines that Kazakhstan exporters are using transfer prices, which are different from market prices and this is true, up until approval of existing law. This way our budget did not receive large sums in the ways of taxes and other fees. At that time in order to prevent such practice there have been approved new law “About governmental control while using transfer prices”.
I consider that existing law played its role bringing together world prices and Kazakhstan export prices and decrease overall amount of deals conducted through off shores. There is also another positive moment, our responsible bodies gained enough experience in price determination and this is proved by statistics. However, for many years this law was criticized by foreign investors arguing that it did not comply with international standards. There have been many law suits as well. All this lead to development of new law, now it could serve as strong argument for WTO to accept Kazakhstan as its member. It is understood that such status will provide much more comfortable and stable conditions in access to world markets.

- You have said that existing law played significant positive role in bringing together our exporting and world prices, increase of the government revenue through additional taxes, are there any numbers you could provide?
- Certainly. After existing law has been approved we in hand with customs controls determined additional 3.2 USD billions that have been tax obligatory, thus as a result we received 1.7 USD billions as refund. From this sum 1.6 USD billions have been paid last year and from them 66.3 millions gone into country’s budget. In general, through cooperation of tax and customs bodies it was possible to bring export and world prices close to each other. I have already mentioned that in 2000 average world price for oil was 28 USD per barrel while as our export price was only 19.9 USD per barrel (deviation of 29.4%). However, already in 2006 average world price was 64.9 USD per barrel and our export price was 61.6 so overall deviations was only 5%. Moreover, we can observe similar tendencies in exports of other goods. For example, world price for zinc in 2000 was 1128 USD for one ton; our average price was 852 USD (deviation of 24%). In 2007 when world price reached 3275 USD our average exporting price was 3255 USD, thus deviation was only 0.6%. Another good example – for 2001-2007 indirect effect of indifference of market and export prices added to budget about 5.3 USD billions as corporate income tax only from oil companies. 

- New law has been discussed for more than two years. It is known fact that many business groups were against such law. Main argue was about cancellation of the point allowing 10% deviation of the export price from market price, except for agricultural products. How did you ensure that parliamentarians will agree to cancel this point? Why 10% deviation is still available for agricultural products?
- It is true that discussion of new law have not been easy and gone for very long. Many people have been trying to push their ideas and thoughts; however, we did all the best to achieve our goal – find optimal balance between interests of the government and businesses. In particular, new law does not allow any export price deviation from world prices, except for exporters of agricultural products and here is why. First of all, for development of this law we studied international experience in details. Representatives of the working group visited responsible governmental agencies in Great Britain, China, they have met with experts from Organization for Economical Cooperation and Development (OECD), among members of which, there are such countries as USA, Japan and countries of European Union. You have to notice that many countries are asking recommendations from OECD members while developing legislations for transfer pricing. That is why in many countries not any deviations in prices are allowed and each contract is being controlled. We can sea this in Canada, USA, Australia, Netherlands, etc. This helped us to make decision regarding cancellation of 10% deviation, plus we did not have to force somebody believe us because everybody understand that all goods bought and sold must comply with world prices. Moreover, this is world practice. As for exporters of agricultural products this will be allowed only for short period of time in order to support our local agrarians. Goal is quite clear – increase in competitiveness of domestic food products on international markets. 

- Mr. Rakhmetov, what type of recommendations were given by parliamentarians and representatives of business groups while this legislation was under development. And most important why they have not been accepted?
 - To tell the truth, there have been many recommendations to develop process of transfer pricing. But I would like to mention those that had conceptual character. Thus, for example, there have been recommendations to limit control by applying it only to related together companies, increase acceptable deviation up to 20% and leave financial services without control, use any available sources of information which tax payer could find, and finally increase expenditures that will affect size of price deviation from market price. Regarding all these recommendations working group declined them immediately and unanimously because they will lead to budget losses and movement of capital to foreign countries.  

- Please tell us about main directions of the new law?
- New law is directed towards perfection of control over transfer pricing, we will use new conceptual introductions following the principle, expensive is better, which is used for determination of market price on base of comparison conditions of the agreement between related parties and independent parties. As I have mentioned new law does not accept 10% deviation in order to avoid re-distribution of the profit and outflow of capital. We have tightened control over contract participants which are registered in the government as tax reduction beneficiaries. Especially for transfer pricing new reporting of deal’s monitoring was introduced. Now there will be strict understanding of price ranges, hierarchy of informational sources and we have given an opportunity to sign agreements regarding transfer pricing policies.
All these are actually main differences of the new law, which is much more progressive and complies with today’s requirements.

- You have mentioned introduction of tax reporting regarding deal’s monitoring.
- Reporting on deal’s monitoring was especially introduced for goals of transfer pricing. An idea itself is creation of unified approach of tax payers and tax agencies in understanding of transfer pricing, plus providing an opportunity to construct equal balance in calculation of export and import contract. This will allow making certain conclusions about tax payers from how company filled in necessary report, in details or without them. In addition, new law considers that if companies will be honestly filling in necessary reports they will be detailed enough in order to avoid excessive check-ups and tax agency will consider only those companies which heavily avoid paying taxes and make off shore deals.

- So what about the companies that do make off shore deals? What types of penalties or sanctions are there for such companies in accordance with new law?
- Principal moment – strict rules regarding off shore deals is worldwide practice. Since Kazakhstan is the part of global market we must eliminate such practice, which negatively affects our image. It is not big secret that there are several ways to outflow the capital through off shore zones. Off shore companies themselves could be just part of the chain between Kazakhstan company and foreign partner. This allows manipulating contract price and in the end avoiding taxes. Off shore problem was worst in 1999-2000 when export prices of our enterprises were almost on the level of 1998 crisis even though international markets have been growing.  
In order to solve the problem of capital outflow and avoiding taxes with the help of off shore systems there have been developed acting law about transfer pricing. Income correction in accordance with acting legislation norms was done at any price deviation but differentials have been taken into consideration. That is why I have to underline once more that taxpayers avoiding budgetary payments through off shore deals will be heavily penalized in accordance with new law.  

- Mr. Rakhmetov, are there any lets say “discounts” for such tax payers who corrected their income themselves?
- I will give you short answer – article 73-1 of Tax Code gives such opportunity to tax payers to correct their income themselves, in such case they will not be penalized. 

- Topic of transfer pricing is widely discussed and bring many questions. There are probably many barriers in having full control over transfer pricing? Maybe there are certain legal acts that prevent such control?
- I will try to give you one example with metallurgical company in Kazakhstan. This company realizes its products cheaper than market price with the help of off shore zones and subsidiary business. Fact of transfer pricing is not denied by the taxpayer. However, in the frame of investment contract he has tax discount which is the only base to determine refunded sums as unofficial. There is also court practice which underlines that usage of acting law is correct without dependency on legislation and contracts for natural resource extraction and stability of tax regime.
New law will definitely help us to avoid similar arguments in future, because it allows income correction of those companies that have market price deviations and which have tax discounts.

- Finally last question. Acceptance of such laws always leads to corresponding normative-legal acts. What could we expect?
- Currently we are working on development of order “About approval of Instructions regulating control for transfer pricing in international business operations” there are also governmental acts “About approval of market list of goods”, “About approval of official information resources”. We are planning to work on “Rules for filling in reports regarding transfer pricing”. Of course in such document interests of all parties are being considered.