Global Tax Alert (News and views from Transfer Pricing) | 31 May 2013

South Africa transfer pricing related disclosure requirements in the new ITR14

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The South African Revenue Services (SARS) introduced an enhanced Income Tax Return for Companies (ITR14) on 4 May 2013. In the new ITR14, taxpayers have to provide information on the value of certain transactions and financial ratios that are mentioned as risks harbors in the draft interpretation note on thin capitalization dated 22 March 20131 (draft IN). Taxpayers are also asked for supporting information on transfer pricing that assists SARS to determine the taxpayer’s risk position in relation to transfer pricing.

Value of certain intercompany transactions

In the new ITR14, the taxpayer needs to answer whether or not the company entered into an affected transaction as defined in section 31 of the Income Tax Act in circumstances where the company received/earned foreign income or incurred foreign expenditure. If the taxpayer responds affirmatively, the company needs to report the Rand amounts of:

Foreign income received/earned (received or receivable)

Foreign expenditure incurred (paid or payable)

  • Sale of goods
  • Purchase of goods
  • Commission
  • Commission
  • Interest
  • Interest
  • Royalties or license fees
  • Royalties or license fees
  • Admin, secretarial fees, rentals
  • Admin, secretarial fees, rentals
  • Insurance premiums
  • Guarantee fee
  • Other finance charges
  • Insurance premiums
  • Research and development fees
  • Other finance charges
  • Other income
  • Research and development fees
  • Other expenses

These amounts need to be segregated as follows:

  • Total aggregate value of transactions with domestic transaction partners (third parties and related parties)
  • Total aggregate value of transactions with related parties based outside South Africa
  • Total aggregate value of transactions with third parties based outside South Africa

Thin capitalization

Unlike PN2,2 the draft IN does not provide for any safe harbor ratios. It identifies certain financial ratios – among other factors – that can be used to determine whether or not the financial assistance received from related parties meets the arm’s length principle. The ratios listed are debt/EBITDA (earnings before interest, taxes, depreciation and amortization) ratio, interest cover ratio and the debt/equity ratio.

Although the draft IN on financial assistance is not finalized yet, taxpayers are already asked to specify:

  • The financial assistance in relation to fixed capital ratio;
  • The debt in relation to EBITDA interest paid ratio; and
  • The EBITDA in relation to interest paid ratio.

In contrast to the draft IN, National Treasury and SARS issued a media statement for public comment on 29 April 2013 discussing a “safe harbor” in relation to financial assistance. The safe harbor proposed in this media statement is as follows:

  • The interest deduction is limited to 30 percent of taxable income (with no adjustment for other interest received, accrued, interest paid or incurred); and
  • The interest rate on the debt may not exceed the foreign equivalent of the South African prime rate (denominated in a foreign currency) or the South African prime rate (denominated in Rand).
  • The interest rate risk harbor in the draft IN is higher than in the media statement by adding a spread of two percentage points.

Transfer pricing supporting information

The new ITR14 asks for supporting information as follows:

  • Does the company have transfer pricing documentation that supports the pricing policy applied to each transaction between the company and the foreign connected person during the year of assessment as being at arm’s length?
  • Did the company conduct any outbound transaction, operation, scheme, agreement for no consideration with a connected person that is tax resident outside South Africa?
  • Did the company transact with a connected person that is tax resident in a tax haven/low tax jurisdiction?
  • Did the company make a year-end adjustment to achieve a guaranteed profit margin?

Impact

It is evident from the increased request for information that the SARS continues to intensify its

activity in reviewing and auditing taxpayers’ transfer pricing. The information obtained via the new ITR14 is a useful source of information to select taxpayers for transfer pricing reviews. This follows an international trend. The OECD issued a “Draft Handbook on Transfer Pricing Risk Assessment” for public consultation on 30 April 2013. The handbook describes the level of information that tax authorities should request to select taxpayers for review/audit.

Taxpayers need to assess whether their ERP systems allow them to generate reliable data to complete the new ITR14 or what steps need to be taken to obtain this information.

Although there is no statutory transfer pricing documentation requirement in South Africa, the new ITR14 asks whether or not the taxpayer has transfer pricing documentation in place that supports an arm’s length transfer pricing policy applied to each transaction between the company and foreign connected persons during the year of assessment. In practice, this question on the ITR14 creates the need to prepare transfer pricing documentation prior to the submission of the tax return so the taxpayer can answer the question with “yes.” It also reflects that the burden of proof that the transfer pricing meets the arm’s length principle is with the taxpayer effective 1 April 2012.

In line with global trends, there is an increased focus on taxpayers’ dealings with related parties and the associated transfer pricing risk. Taxpayers in South Africa have to be prepared for more transfer pricing reviews and audits in the future.

Endnotes

1. Section 31 Income Tax Act No 58 of 1962, Determination of the taxable income of certain persons from international transactions: thin capitalisation.

2. Practice Note: No 2, Income Tax: Determination of taxable income where financial assistance has been granted by a non-resident of the Republic to a resident of the Republic, dated 14 May 1996.

For additional information with respect to this Alert, please contact the following:

EY Advisory Services Ltd, Johannesburg, South Africa
  • Cornelia Wolff
    +27 11 77 2 3157
    cornelia.wolff@za.ey.com
  • Karen Miller
    +27 21 44 3 0281
    karen.miller@za.ey.com
  • Johan Kruger
    +27 11 77 2 3036
    johan.kruger@za.ey.com
EY (China) Advisory Services Limited, Pan African Tax Desk, Beijing
  • Rendani Neluvhalani
    +86 10 5815 2831
    rendani.neluvhalani@cn.ey.com
Ernst & Young LLP, Pan African Tax Desk, New York
  • Dele Olaogun
    +1 212 773 2546
    dele.olaogun@ey.com
Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London
  • Leon Steenkamp
    +44 20 7951 1976
    lsteenkamp@uk.ey.com

EYG no. CM3489