Conceptualising the Behaviour of MNEs, Tax Authorities and Tax Consultants in Respect of Transfer Pricing Practices – A Three-Layer Analysis

Tax Enforcement and Dispute Resolution: National and International Challenges

1. Conceptualising the Behaviour of MNEs, Tax Authorities and Tax Consultants in Respect of Transfer Pricing Practices – A Three-Layer Analysis, by Eukeria Wealth, Sharon A. Smulders and Favourate Y. Mpofu, https://doi.org/10.1515/ael-2022-0036.

2. Will Proclaimed Changes to Multinationals’ Taxation Have an Actual Effect and What Will Really Change for Africa?, by Andrea Musselli, https://doi.org/10.1515/ael-2024-0010.

3. Collection of Taxes from Ultimate Beneficiaries: Russian Regulatory Model, by Imeda Tsindeliani, Maria Egorova, Evgeniya Vasilyeva, Inessa Bit-Shabo and Vitaly Kikavets, https://doi.org/10.1515/ael-2020-0149.

4. Transfer Pricing Audit Challenges and Dispute Resolution Effectiveness in Developing Countries with Specific Focus on Zimbabwe, by Favourate Yelesedzani Sebele-Mpofu, Eukeria Mashiri and Patrick Korera, https://doi.org/10.1515/ael-2021-0026.

International Tax Avoidance and the Controlled Foreign Company (CFC) Rule

1. Legal Form or Unfair Substance? A Symposium Around the Controlled Foreign Company (CFC) Rule, by Reuven S. Avi-Yonah and Yuri Biondi, https://doi.org/10.1515/ael-2024-0105.

2. The Relationship between Taxation, Accounting and Legal Forms, by Thomas Kollruss, https://doi.org/10.1515/ael-2019-0076.

3. Why Tax Planning Without Considering Societal Interests is Unfounded, by Ute Schmiel, https://doi.org/10.1515/ael-2021-0115.

4. The (Social) Tasks of Business Tax Research and the Binding Effect of the Statutory Tax Burden Decision, by Thomas Kollruss, https://doi.org/10.1515/ael-2022-0089.

2.1 Aspects of Transfer Pricing (TP) as a Rational Decision

TP as a rational decision entails how economic groups such as taxpayers and tax authorities with their diverse motives and intentions manipulate their position concerning social phenomena (Rouse, 2007). The formal rationality theory by Weber (1968) may be employed as the central theory to solve the TP puzzle. Brunsson (1982) adds that rationality theory involves making decisions where there is at least a choice/two options. He adds that rationality implies ‘playing’ with rules to get the best possible outcomes.

MNEs and tax authorities’ behaviours are influenced by their roles as taxpayers and regulators respectively. They each strive to achieve their unique objectives and interests. Jonge (2012) notes that rational behaviour is a combination of three factors, namely the capacity to use the right resources to accomplish a set goal, the ability to allocate the scarce resources in ways that provide maximum utility, and the ability of the agent to be self-regarding. Self-regarding entails serving one’s well-being, and this is a fundamental attribute of rational players (Jonge, 2012) in a TP setting. Jose (2009) explains that the rationality concept is useful in resolving the decision-making problem. When applied to TP-related problems, these include the complexity of setting transfer prices that are consistent with the host nation’s tax requirements for MNEs, and making appropriate TP adjustments in the case of the tax authorities (Adams & Drtina, 2010). The rationality theory is deployed towards an inquiry into taxpayer behaviour as well as reactions that tax authorities can take to counter the avoidance tendencies of certain taxpayers. Table 1 below summarises three aspects of TP as a rational decision among these two major players.

Faced with options to choose from, rational players carefully calculate the costs and benefits of possible choices and then elect the one which gives them a higher pay-off (Scott, 2000). Scott (2000) says tax-related behaviour is guided by rewards and punishments, and questions why players should choose an action that will benefit others more than themselves. Jose (2009) explains that the rationality concept is useful in resolving the decision-making problem. Considering the thrust of rationality theory, making rational decisions and actions comes at a cost, Jonge (2012) refers to it as the burden of making a rational choice. These may include identifying alternatives and weighing up their costs and benefits. Saunders-Scott (2013) established that increased TP regulation is associated with significant compliance costs for the taxpayer. Eichfelder and Kegels (2012) further note that the compliance costs of taxpayers are not affected by the tax law alone, but by its enforcement through the tax authorities as well. Enforcement of or maximisation of the tax base by tax authorities involves costs such as audit costs. Penalties that come with non-compliance are the determining factor in taxpayer behaviour, according to Kirchler et al. (2008). The same goes with the rewards for compliance, and rational economic actors do not prioritise the interests of others and are, as claimed, exploitative (Scott, 2000). Therefore, tax authorities may decide to strengthen their tax administrative measures without considering the cost implications on the taxpayers, which may stifle voluntary compliance. With this rational decision taken by tax authorities, taxpayers, in turn, engage in tax avoidance and evasion activities without due regard for their actions on the economy, tax revenue mobilisation efforts, and the general public. Both the tax authorities and MNEs ignore the overall economic, social and political costs, thus making decisions, self-serving decisions.

2.2 Dimensions of TP Regulation

TP regulation consists of different dimensions which are embedded in tax administration, enforcement and compliance with TP rules. Governments draft TP legislation, which is enforced by the tax authorities, and these authorities, in the discharge of their duties, can display exploitative tendencies. Similarly, taxpayers are generally antagonistic to the efforts of tax authorities. Jonge (2012) advocates for some sort of win-win situation, which allows one to achieve one’s legacy without sabotaging other actors or players. He also criticises economic actors who improve their situation through interactions that worsen other actors. This is evident in MNEs’ behaviour when they hire tax consultants to design tax avoidance strategies that result in domestic enterprises’ competitive disadvantage while also depriving governments of their national revenue (Oguttu, 2016). MNEs are believed to possess the power and influence to hire and collude with professional accountants in devising sophisticated structures to avoid tax (Mashiri et al., 2021; West, 2018). Some of the exploitative tendencies of MNEs are briefly revealed through certain of their TP strategies such as misinvoicing and the use (or misuse) of management fees (Sebele-Mpofu et al., 2021a; Sikka & Willmott, 2010).

Tax authorities also exhibit exploitative behaviour in several ways such as failing to train their staff, which ultimately compromises their performance, operational effectiveness, and risk management (Brunsson, 1993: 2). Collier and Dykes (2020) point out that the misapplication of the OECD TP guidelines is extensive due to the pervasive problems associated with the ALP. These challenges include the difficulties in applying the principle attributed to the likely contradictory interpretations given by different tax authorities. The other problems involve the worrying effects of the rising and contested concept of value creation as well as the lack of comparable transactions especially concerning intangibles. Buttner and Thiemann (2017) portend that the regulation of TP especially in the developing country context has been largely politicised by international tax technocrats in an effort to shield their self-serving interests. These and other related issues pervert the creation of effective means to fighting corporate tax avoidance, and MNEs continue leveraging the flaws of the existing TP system. Issues of revenue authority capacitation and inadequacies in resources (human, technical and financial) continue to be thorny issues in addressing TP manipulation in developing countries (Sebele-Mpofu et al., 2022). Gupta (2012) established that MNEs continue to shift income to minimise taxes even with increased governmental regulations, while Lohse and Riedel (2012) found stringent TP measures inhibiting tax avoidance. However, Asongu and Nwachukwu (2016) defend the tax avoidance by MNEs arguing that it is justified by Corporate Social Responsibility (CSR), but Sikka and Willmott (2010) refute such claims arguing that such behaviour is exploitative and detrimental to the public good.

Governments through their various institutions find themselves focused on two directions simultaneously. For example, concerning TP, the Ministry of Finance drafts TP legislation to regulate the TP practising transaction to reduce their manipulation and at the same time protect the tax base. On the other hand, in designing these regulations governments want to strike a balance between their revenue mobilisation needs and remaining a preferred destination for investors and thus attracting foreign direct investment (Cooper et al., 2017; Sebele-Mpofu et al., 2021a). In the case of tax authorities, despite their key motive being maximum revenue mobilisation for the country, their aggressiveness is often stifled by political interference and the need to protect the country’s reputation as an investment destination of choice (Sebele-Mpofu et al., 2021b; Readhead, 2017).

From the reviewed studies it is evident that the rational decisions of economic actors concerning TP crystallise themselves in the three dimensions of rationality: legal, implementation, and exploitative rationality, and with varying implications. An aggregated synopsis of the findings and their implications as they relate to the three dimensions of TP regulation is presented in Table 2. The table gives a summary of selected studies from the literature review that show how the three dimensions are evident in the actions of government (through tax authorities and ministries of finance), MNEs, and tax consultants.

In the next section, the TP conceptual framework as informed by the literature review that underpins this study is presented.

2.3 Conceptual Framework

The different views points stemming from the review of the literature were used in the construction of a general conceptual framework to guide TP regulation concerning developing countries. This framework is set out in Figure 1. This framework be further refined to apply not only to the Zimbabwean context but to other developing countries as well. The framework was premised on a three-layered framework, that is, the legal, implementation, and exploitation dimensions. The three rationality perspectives crystallise in the actions of the three different actors. Facilitating factors, which act as enablers of TP decisions, implementation of, influence the decisions and actions of these actors and compliance with TP legislation. Within the overall TP practice, there were countless instances of implementation reality challenges, and rationalistic decisions infused in literature, and these were categorised around the three-layered dimensions. The governments, which are at the top of the hierarchy, face rational decision-making between tightening their tax laws and creating a “pro-business environment” (Hasseldine et al., 2012). Central to this study is the TP practice theory that is based on the compliance or exploitative elements which are influenced by exogenous (tax consultancy advice) or indigenous factors (such as corruption) as shown in Figure 1.

Figure 1:

Conceptual Framework for developing country contexts. Source: Own compilation.

Government is denoted for designing legislation. The literature revealed how developing countries’ governments are faced with the dilemma to align TP rules to national priorities rather than just adopting international guidelines to conform to global expectations. Tax authorities are faced with implementation realities because of the legal and administrative resources (Kabala & Ndulo, 2018; Mashiri, 2018). It has been shown that tax authorities are flooded with both legislative deficiencies and administrative incapacities, which undermine their enforcement abilities. Some of the tax authorities are semi-autonomous if not 100% government controlled, hence affecting the level of objectivity expected in executing tax matters and ensuring fairness and equity. Tax-motivated corruption is also rampant in developing countries. Imam and Jacobs (2007) attribute this to low monetary incentives to tax administrators, which has resulted in tax administrators being the initiators of tax evasion through bribes (Gauthier & Goyette, 2014). As if that is not enough, the invisible hand of tax consultants is arguably very influential in determining the compliance or exploitative decisions of MNEs (Mashiri et al., 2021; Wier, 2020). They engage in a number of possible TP schemes such as round-tripping, mis-invoicing and use of services (Sebele-Mpofu, 2021). While governments are faced with the conundrum of choosing between the arm’s length and the non-arm’s length approaches, MNEs are equally confronted with the dilemma of which TP method to choose that would give them the best tax outcome. This comes at a time when some of the MNEs would have obtained investor’s licences by corrupt means. Because of the drive for foreign investment in developing countries, some government officials use their political muscle to indemnify errant MNEs at the expense of the national pocket. These three prominent actors’ decision-making processes have either had positive or negative repercussions on the fiscus.

3.1 Literature Review Methodology

As outlined earlier, the study integrated a critical literature review and in-depth interviews. Petticrew and Roberts (2008: 19) explain a critical review as a “critical evaluation of the literature according to argument or logic and/or epistemological tradition of the review subject.” The aim is to bring to light novel conceptualisations and perspectives on the research phenomenon, in this case, TP legislation, enforcement, and compliance. TP as a rational decision can be best presented in the summary of studies as given in Table 1 and that focus on three important aspects of TP in developing countries: TP motives, strategies, and challenges. These three aspects better accentuate the three dimensions of tax ruling that were evident from the literature review: legal, implementation, and exploitative dimensions. Therefore, the need for an organised evaluative review of the literature cannot be overemphasised.

3.1.2 Inclusion and Exclusion Decisions

The focus was on original peer-reviewed papers as well as grey literature (conference proceedings and theses). The researchers read all the titles, keywords abstracts, and introductions for the studies’ outputs generated from the database search. The researchers opted to widen the analysis of studies to include the introduction because some titles and abstracts did not provide adequate information on the study. The review methodology process is briefly summarised in the flow chart in Figure 2.

Figure 2:

Flowchart summarising the literature review process. Source: Own compilation.

3.2 Data Collection through Interviews

Data was gathered using in-depth interviews with the drafters of the legislation (MOF), the enforcers of the legislation/tax authority (ZIMRA) as well as the taxpayers who are required to comply with the legislation and who in this case are the MNEs or their tax consultants (TCs). To comprehensively understand the tax behaviour of the economic actors in Zimbabwe, interview questions were centred on Zimbabwe’s TP rules, ZIMRA’s administrative capacity, various TP strategies used by MNEs, and international TP guidelines. To achieve the objectives of the study, the ZIMRA Investigations and International Affairs department was purposefully selected as it is the one responsible for handling TP issues in Zimbabwe. The Revenue and Tax Policy Department in the MOF, which is responsible for the drafting of the TP rules in Zimbabwe and tax consultants, formed part of the research participants. A total of 10 ZIMRA officials, seven tax consultants, and three specialists from the MOF were successfully interviewed. The sample was considered adequate to attain the saturation point as guided by Blaikie (2018) and Mpofu (2021), who advocate for small samples as long as participants are knowledgeable, experienced, and have in-depth knowledge of the subject matter. Although the researchers intended to interview MNEs, the MNEs’ accountants were not as receptive as expected, probably because of their limited knowledge of the subject or their fear of potential victimisation because of the sensitivity of taxation issues.

The navigation of ‘rational’ legislative systems such as TP legislation in an assumed conscious as well as contradictory manner informed the approaches, design, and methods. The initial coding, which distilled the lived experiences, interpretations, and realities of the economic actors (Braun & Clarke, 2014), was recorded as a preliminary point of analysis. Data were analysed using deductive content analysis (Elo & Kyngas, 2008) with the aid of ATLAS. ti 8™. During data analysis legal (rule-based), implementation (which is how the rules play themselves out) and the exploitative dimensions of non-compliance had strongly grounded codes. These codes, together with the literature, were interpreted to form themes and then final assertions. Such themes include MNEs’ attitude towards TP, reactions of tax authorities to MNEs’ TP activities and the adequacy of revenue authority resources in implementing and enforcing TP legislation.

All ethical considerations were observed. Permission letters were sought from the participating organisations, consent from individual participants was also attained, personally identifiable data was kept confidential and member checks were conducted to ensure the trustworthiness of the results. This article reinforces the importance of the legislative and administrative muscles of a tax authority. It moves from abstract and anecdotal evidence presented in the literature review section to an empirical dissection of the TP problem in a developing country context in Section 4.

4.1 Analysis and Discussion of Results

The following sections give a discussion of the findings as guided by the research questions. The discussion is centred on the interview responses to the behaviour of the three economic actors in relation to legal, implementation and exploitation dimensions.

5.1 Strengthen the Legislative Framework

Legislative gaps were evident, providing an opportunity for MNEs to exploit and manipulate tax liabilities. The need for a robust tax legislative system cannot be overemphasized. Zimbabwe should consider incorporating Advance Pricing Agreements (APAs) and country-by-country reporting documentation as recommended by Sebele-Mpofu et al. (2021b).

5.2 Instil Cooperation and a Relationship Based on Mutual Trust, Transparency, and Respect

Purely focusing on taking rational decisions for their respective constituencies, the rational economic actors (MNEs, revenue authorities, and tax consultants) will find themselves at loggerheads yet cooperation is key to both tax legislation enforcement and compliance. The conflicting decisions perpetuate mistrust and the hide-and-seek game, crippling cooperation and voluntary disclosure as well as compliance (Sebele-Mpofu et al., 2022). There is a need to cultivate a spirit of trust, responsibility, ethical conduct, and a synergistic relationship between these key rational economic actors in the tax revenue mobilisation efforts.

5.3 Allocation of Adequate Resources for the Tax Authorities to Execute Their Mandates

Developing countries’ revenue authorities should be allocated with human and financial resources that enable them to fulfil their mandate. Given the elusive nature of intangibles, tax officials need to be trained and equipped in order for them to be able to audit intra-firm transfers of intangible assets. Although not yet adopted, developing countries should assess the applicability of Pillar One and Pillar Two frameworks.

5.4 Increase Transparency and Accountability of Public Officials

Corruption and bribes amongst tax authority officials are found to be rampant in both the literature and the empirical findings from interviews. Governments should employ stringent measures to curb such practices, for instance employing prohibitive penalties for perpetrators, that is for both MNEs and tax officials. The fear of reputational damage, as well as the fines and possibility of prosecution or cancellation of operating licenses for MNEs, could indirectly encourage compliance. Hasseldine et al. (2012) call for the calibration of policies and administrative responses to tax avoidance.

5.5 Intensive Scrutiny of MNEs

The opportunistic behaviour of MNEs is contrary to business ethics and general interest. However, a culture of cooperative compliance should be cultivated, and the onus is upon the government to develop a robust tax system, which enables ZIMRA to discharge its mandate with the necessary legislative support. It is imperative for developing countries to train their tax officers in a way that they are able to manage efficient audits to search for sophisticated profit drivers such as intangible functions. That includes tax authorities such as ZIMRA which should be actively involved in TP audits and scrutinise MNE transactions especially those in the mining sector (Mashiri et al., 2021).

5.6 Regulation of Tax Practitioners

Findings also revealed that it is not only the MNEs that need to be regulated. The call by Hasseldine et al. (2012) for states to regulate tax consultants is critical, as it is evident that other countries are prosecuting accounting firms for misconduct and for selling unacceptable tax avoidance strategies/schemes. For example, South Africa’s KPMG and the Gupta case implicated one of the big four accountancy firms in misconduct (Cropley & Brock, 2017). Most African countries including Zimbabwe do not have such regulations, so they would benefit from introducing them.

5.7 Design Regional/Nation-Specific TP Guidelines

The study also concurs with Oguttu (2016: 20) that the OECD fails to capture the specific needs of the African developing states. Consequently, these latter nations should not adopt prescriptions of international laws and guidelines which are a representation of a few countries (in some cases only developed countries), but rather exercise their sovereignty. This could help in contextualising TP regulation to the needs, risks, and challenges of African national and individual national environments.

Stemming abusive TP through strengthening the legislative framework, capacitating the tax authority, and regulating and monitoring MNE activities as well as the activities of tax consultants should help achieve a nation’s Sustainable Development Goals. Future studies should therefore explore the impact of these measures on revenue collection in developing economies.