Taxing authority and tax law
Tax authority: Commissioner of the South African Revenue Services (SARS)
Tax law: Section 31 of the Income Tax Act 58 of 1962 (the Act) contains the main legislative provisions concerning transfer pricing.
Section 31 authorizes the tax authority to adjust the consideration for goods or services to an arm’s length price for the purposes of computing the South African taxable income of a person.
For years of assessment commencing on or after 1 October 2011 the legislation has changed, allowing the tax authority to adjust any term or condition imposed in any part of a transactions, scheme or arrangement, thus widening the application of the section.
Relevant regulations and rulings
There are no specific regulations or rulings; however, guidance on the application of §31 is contained in Practice Notes Number 2 (14 May 1996) and 7 (6 August 1999). The legislation currently prohibits the tax authority from issuing an advanced ruling on a transfer pricing matter.
OECD guidelines treatment
Although South Africa is not a member of the OECD, the tax authority accepts the OECD guidelines and has largely based Practice Note 7 on these Guidelines. By the same token, the tax authority recognizes the five methods accepted by the OECD.
Priorities/pricing methods
The tax authority accepts the methods prescribed by the OECD, i.e., CUP, RPM, Cost Plus, TNMM and Profit Split; and has indicated that it will subscribe to the OECD view on accepting a best method approach as long as this is substantiated. The tax authority may require that adjustments be made to foreign comparable company results used to benchmarking the results of the South African entity, to compensate for differences in risks assumed by entities operating in a different jurisdiction.
Transfer pricing penalties
Any adjustments made by the tax authority under §31 are deemed to be dividends, and the Secondary Tax on Companies (STC) at a rate of 10% will be levied which is non-discretionary. There are no other specific penalties for transfer pricing, but general penalty rules are applicable, which could reach 200% of the additional tax resulting from an adjustment (in the event of default, omission, incorrect disclosure or misrepresentation).
Penalty relief
Where taxpayers have made conscientious efforts to establish transfer prices that comply with the arm’s length principle, and have prepared documentation to evidence such compliance, the tax authority is likely to take the view that the taxpayer’s transfer pricing practices represent a lower tax risk. Accordingly, the preparation of sound and consistent transfer pricing practices may reduce the possibility of an audit and, therefore, reduce the likelihood of incurring penalties.
Documentation requirements
Section 31 is discretionary therefore initially the burden rests with the tax authority (although this changes with effect from years commencing on or after 1 October 2011). Once the tax authority has arrived at a view, the taxpayer has the burden of proof to demonstrate that its prices are arm’s length. Under the new legislation (effective 1 October 2011), this burden initially rests with the taxpayer. The best way to discharge the burden of proof is by developing a transfer pricing policy, determining the arm’s length amount and voluntarily producing documentation to evidence the analysis undertaken. Having said this, the tax authority would expect taxpayers to have created, referred to and retained transfer pricing documentation in accordance with prudent business management principles (i.e., the principles that would govern the process of evaluating a business decision at a similar level of complexity and importance).
No specific documentation requirements exist however there is an inherent requirement in that the tax authority is of the view that by not preparing documentation, a company is not adequately monitoring the policies in place and cannot support that they result in an arm’s length outcome.
Documentation deadlines
Transfer pricing documentation should be prepared not later than the date of submission of a tax return affected by the intercompany transactions. Tax returns are due 12 months after a company’s financial year-end with no further extension.
Statute of limitations on transfer pricing assessments
The statute of limitations is three years from the date of assessment. Section 79 of the Act provides that an assessment will prescribe three years from the date of issue. However where the tax authority is of the view there was fraud, misrepresentation or non-disclosure of material facts, this will not apply.
Return disclosures/related-party disclosures
Very limited disclosure at present around whether related party transactions occurred, some limited questions on their nature, notably around lending arrangements and management services, a question on the existence of documentation and a question asking if the transactions occurred at arm’s length.
Audit risk/transfer pricing scrutiny
The tax authority follows a risk matrix in assessing the level of transfer pricing risk. This follows two steps, an initial review of the information lodged with the tax return and possibly from a questionnaire issued, followed by a more thorough investigation into the documentation and results. If risk is found to exist they will then proceed into a desk and possibly a field audit. The last couple of years have seen some significant assessments being raised.
APA opportunity
Currently South Africa does not have an APA program although it is being considered. The legislation also currently prohibits the tax authority from providing an advanced ruling on a transfer pricing matter.
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