SOUTH AFRICAN TRANSFER PRICING RULES & AVOIDING TRANSFER PRICING DISPUTES

Transfer pricing is a complex, but interesting area, in which our firm are specialists. We are currently representing a multinational corporation in a massive transfer pricing dispute with SARS and are well positioned to assist in transfer pricing studies for clients.

TRANSFER PRICING
Transfer pricing is concerned with the cost at which goods and services are supplied between cross border related companies. It is often used as a method by multinational corporations to shift profits out of high-tax countries.

Companies normally provide its goods or services in exchange for a fair market value price. However, in light of the relationship between them, different branches (subsidiaries) of a multinational corporation might not necessarily provide goods and services at a fair market value price. When this happens, such branches will have a low profit margin, which ultimately affects the taxation of profit. The revenue authority where the branch with a low profit margin is located, will not get its fair share of taxes.

SARS could at best only show the court that the Final Demand was generated. The court found however that the actual delivery of the Final Demand to the taxpayer is required to show compliance, whether the delivery is physical or electronic. Since SARS could not prove delivery of the Final Demand, the court held that the TPA Notice to the taxpayer’s bank was thus null and void.

Over the years, countries have developed transfer pricing rules to ensure that it gets its fair share of taxes. This article deals with the transfer pricing rules in South Africa and how to avoid a transfer pricing dispute with SARS.

TRANSFER PRICING RULES IN SOUTH AFRICA:
Transfer pricing rules in South Africa may be found in section 31 of the Income Tax Act 58 of 1962 (“ITA”), Practice Note 7 (“PN7”) and the Organisation for Economic Co-Operation and Development (“OECD”) Guidelines known as the OECD Guidelines.

PN7 serves as a practical guide and is not intended to be a prescriptive or exhaustive discussion of every transfer pricing issue that may arise. PN7 makes it clear that each case is to be decided on its own merits, considering the taxpayer’s business strategies and commercial judgment.

Although South Africa is not a member country of the OECD, PN7 is based on the OECD Guidelines, which should be followed in the absence of any specific guidance in PN7, the provisions of section 31 or any tax treaties entered into by South Africa.

SECTION 31 OF THE ITA:
Section 31(2) of the ITA provides that if two connected persons entered an affected transaction which contains a term or condition which differs from that which would have existed had the parties been independent, dealing at arm’s length and the term or condition results in a tax benefit for a party to the transaction, the benefiting party must make a transfer pricing adjustment to its taxable income as if the transaction had been concluded between independent parties dealing at arm’s length.

Simply put, this means that the party benefiting from the transaction which does not reflect the fair market value, must adjust its taxable income as if the transaction did reflect the fair market value.

ARM'S LENGTH PRINCIPLE:
The arm’s length principle, which is accepted internationally, has also been adopted by South Africa. A transaction will be considered as at arm’s length when it has the substantive financial characteristic of a transaction between independent parties, where each party strives to get the utmost possible benefit from the transaction.

For a taxpayer to adjust its taxable income in accordance with section 31(2), it should determine what would be considered as an at arm’s length transaction in its particular and unique circumstances. In this regard, the problem to be resolved is essentially how multinational corporations should determine an arm’s length price.

The determination of an arm’s length consideration is not an exact science but requires judgment on the part of both the taxpayer and SARS. Each case should be approached with due regard to the unique business and market realities applicable.

An arm’s length price may be determined by consulting various methods. SARS has endorsed the comparable uncontrolled price method (CUP method), the resale price method (RP method), the cost-plus method (CP method), the transactional net margin method (TNMM method) and the profit split method as acceptable transfer pricing methods. The most appropriate method depends on the particular situation and the extent of reliable data to enable its proper application.

Although section 31 of the ITA does not impose a hierarchy of methods, SARS prefers the traditional methods, which is the CUP, RP and CP methods. Of these methods, the CUP method is most preferred.

“WHAT WE HOPE EVER TO DO WITH EASE, WE MUST FIRST LEARN TO DO WITH DILIGENCE.” SAMUEL JOHNSON

WHAT CAN COMPANIES DO TO AVOID A TRANSFER PRICING DISPUTE WITH SARS? The most important thing a company can do to avoid a transfer pricing dispute with SARS is to document how transfer prices have been determined. Adequate documentation is the best way to demonstrate that transfer prices are consistent with the arm’s length principle. If the taxpayer did not maintain appropriate records, it becomes much more difficult for SARS officials to check compliance. Although there is no statutory requirement in South Africa to prepare and maintain transfer pricing records, PN7 provides that it is in the taxpayer’s best interest to do so.

CONCLUSION: Transfer pricing disputes with SARS can take years to resolve. We therefore recommend that you get a professional on board to assist with your transfer pricing documentation, as well as represent you in any ongoing transfer pricing audits and disputes.

Intellectual property disclaimer:
The contents of any article published by Pieterse Sellner Erasmus should not be construed as professional legal advice.