Transfer pricing rules for South African domestic intergroup transactions
23 May 2013
Posted by: Author: Tarryn Spearman (Grant Thornton)
Source: Tarryn Spearman (Grant Thornton)
The United Kingdom introduced transfer pricing rules nearly 50 years ago and regularly updates legislation to stay abreast of global trends set by large multinational enterprises that consistently challenge tax authorities through the perceived employment of complex corporate structures and intergroup profit shifting in an effort to minimise the consolidated group tax liability.
Transfer pricing developments in the UK
South Africa, like many other countries, bases certain of their efforts to establish and implement domestic taxation rules and regulations on the experience of the UK. In the past, South Africa has mirrored the UK in developing and enacting of many income tax provisions and it will be interesting to see whether this will be the case with transfer pricing.
As an OECD member country, UK Income Tax Legislation on transfer pricing reflects and enforces the arm’s length principle. The transfer pricing legislation is based on a self-assessment system which requires all companies to self-assess whether their intergroup transactions occur at arm’s length.
Initially, transfer pricing rules were implemented in the UK only in respect of cross-border intergroup transactions. In April 2004, UK transfer pricing legislation was amended to address deficiencies in the introductory legislation which failed to counter a range of UK tax planning structures that allowed companies to shift profits domestically to benefit from assessed tax losses. Transfer pricing legislation now includes domestic transactions, providing the UK with one of the most robust and effective transfer pricing regulation systems.
South Africa’s situation
In the 2010 Budget Speech, Finance Minister Pravin Gordhan said, "Steps will be taken against several sophisticated tax avoidance arrangements and the use of transfer pricing and cross-border mismatches.” This indicated that South Africa had become very aware of the misuse of transfer pricing by companies and the ensuing loss to the fiscus.
The revision of Section 31 of the Income Tax Act 58 of 1962 to align South Africa’s legislation with the OECD Model Tax Convention was one of the major steps taken to address this issue. The revised legislation makes arm’s length transactions compulsory for all international dealings between connected persons.
The discretion and duty to adjust arm’s length prices no longer rests with the Commissioner, but instead, like the UK’s self-assessment, it is the taxpayer’s responsibility to determine arm’s length transfer prices.
Currently, section 31 doesn’t apply to domestic transfer pricing. However, with the revision of transfer pricing rules, section 80A was incorporated into the Act. This section relates to impermissible tax avoidance arrangements and its anti-avoidance rules require all transactions (including domestic transactions) to be conducted at arm’s length. Section 80A therefore indirectly makes provision for domestic mispricing.
However, in a recent Johannesburg Tax Court case (no. 12262), a taxpayer succeeded in charging a South African subsidiary company service fees which were challenged by SARS on the basis that they were excessive in the circumstances and thus, there is much doubt as to whether section 80 is an effective means of regulating domestic transfer pricing.
In his judgment, Judge Willis stated, "…taking advantage of an accumulated assessed tax loss is not an inherent wrong. On the contrary, advantages presented by losses can influence strategic decisions which can save companies and turn them around to obvious benefit of employees and the revenue services, among others.”
This illustrates that the applicability of the arm’s length principle to domestic transfer pricing is very subjective and open to interpretation by the courts.
Seeking help from India
To address the inherent transfer pricing legislation weaknesses, SARS has sought guidance from Indian Revenue Authorities who have experienced much success in the realm of international transfer pricing.
To strengthen SARS’ ability to perform efficient transfer pricing audits and draft guidance in this respect, many employees are being seconded to India. In addition to the UK influence, South Africa is therefore likely to adopt Indian transfer pricing principles which are known to be quite aggressive.
Like the UK, India has also taken steps to address domestic mispricing issues. In the 2011/2012 financial year the Indian tax revenue net was cast wider and deeper by including "Specified Domestic Transactions” in the purview of transfer pricing.
Domestic taxpayers with specified domestic transactions in excess of RS50 million in the new financial year are required to maintain extensive documentation to verify that their domestic intra-group dealings are arm’s lengths and comply with the rules relating to international transactions.
How is your business affected?
SARS has expressed that transfer pricing is a key focus area. Further, with the recent developments in respect of the taxation effects of company reorganisations, the future adoption of domestic transfer pricing provisions by SARS has been specifically referred to.
In the light of this as well as the influence of both UK principles historically and India’s guidance discussed above, it remains to be seen whether South Africa will go ahead and enact specific rules relating to domestic transfer pricing to strengthen the current transfer pricing legislation.
Taxpayers must be prudent in ensuring that all connected party transactions are justifiable in the light of emphasis placed on arm’s length.