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Cross-Border Business Restructurings In The Context Of A Revised Section 31

01 October 2011   (0 Comments)
Posted by: Author: Carel Cornelissen
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Cross-Border Business Restructurings In The Context Of A Revised Section 31
As a general point of departure, it should be re-emphasised that taxpayers are free to structure their affairs in the most tax-efficient manner, provided it is substantiated by sound commercial reasoning. However, the overriding principle to consider when embarking on a cross-border business restructuring is the South African transfer pricing legislation.This requires that transactions between connected persons with a cross-border nexus should be conducted at arm’s length.This principle applies regardless of whether independent parties would enter into similar business restructurings. To this end, section 31 is used by the South African Revenue Service (SARS) to apply the internationally accepted arm’s-length principle.
Although not a member of the Organisation for Economic Co-operation and Development (OECD),South Africa subscribes to the OECD Model Tax Convention and guidelines, by adopting an internationally accepted method of determining the allocation of profits among a group of companies. This complies with the requirements of Article 9 of the OECD Model Tax Convention.This is further supported by acknowledging the importance and influence of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as amended (OECD Guidelines) in Practice Note 7: Determination of the taxable income of certain persons from international transactions (issued 6 August 1999) (Practice Note 7).

Practice Note 7 currently serves as a practical guide to the application of the South African transfer pricing provisions.It is not intended to be a prescriptive or an exhaustive discussion of every transfer pricing issue that may arise. It is important to remember that the practice note does not form part of the income tax legislation and, should it come to the interpretation and extent of section 31, a court of law may come to different conclusions than those drawn by SARS.
In the absence of specific guidance by Practice Note 7, the provisions of section 31 or a particular double taxation treaty entered into by South Africa, OECD Guidelines should be adhered to.Section 31 has recently been amended, with a newly worded section coming into operation on 1 October 2011 and applying in respect of years of assessment commencing on or after that date. Clause 62(1) of the Draft Taxation Laws Amendment Bill, 2011 proposes yet another amendment to section 31, which if enacted, will come into operation on 1 April 2012 and apply in respect of years of assessment commencing on or after that date.
The amendment to section 31, it is said, aligns South African transfer pricing and thin capitalisation rules with the OECD and United Nations Model Tax Conventions.In achieving this, the South African thin capitalisation rules (which ran parallel to the transfer pricing rules) will be seen as a mere extension of the transfer pricing rules, which is in line with international practice.
In terms of the new regime, the focus on the supply of goods and/or services is substituted with that of a more holistic review of transactions, operations, schemes, agreements or understandings undertaken for the benefit of connected persons with a cross-border nexus.It therefore widens the application of the transfer pricing rules considerably. 
Whereas SARS may have, for income tax purposes, adjusted the pricing for the supply or acquisition of goods or services to reflect what they regard as an arm’s-length price in respect of a specific transaction, the focus has now shifted to an adjustment of the overall taxable income.In the case of cross-border business restructuring, where, for example, a South African full-fledged distributor is changed into a commissionaire or a low-risk distributor, it may result in a transfer pricing adjustment for South African income tax purposes.Typically, consideration will be given to whether the terms of any revised or renegotiated agreement are comparable with those of independent parties acting at arm’s length and, where any rights were disposed of in the process, whether compensation is required.It must also be considered whether a purported allocation of risks and functions, both pre- and post-restructuring, is not only consistent with the economic substance of the transaction, but also based on a sound commercial rationale. 

Where it is argued that the objective of the business restructuring is aligned to the business strategy of the multinational group as a whole, SARS will nevertheless consider if the transaction is based on an arm’s-length price, whether comparable with independent party transactions or not.For example, where it is argued that the South African taxpayer’s profit will be reduced temporarily with the view of earning higher profits in the long term, SARS will typically consider whether:
•Independent parties acting at arm’s length would similarly have been prepared to sacrifice profitability for a corresponding period under the economic circumstances and competitive conditions prevalent at the time.
•The conduct of the parties is consistent with the professed business strategy.
•The nature of the relationship between the parties to the controlled transaction justifies that the taxpayer bears the costs of the business strategy.
•There is a plausible expectation that the business strategy will produce a return sufficient to justify its costs, within a period of time that would be acceptable in an arm’s length arrangement.

In addition to a transfer pricing adjustment, the resultant exportation of assets and/or termination of rights may give rise to a liability for capital gains tax, Secondary Tax on Companies, donations tax and a withholding tax.The transaction should also be compliant with exchange control regulations.
Source: By Carel Cornelissen (TaxTALK)


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