Global Tax Alert (News from Transfer Pricing) | 28 February 2014
South Africa aligns secondary transfer pricing adjustment with international standards
Section 31 previously authorized the South African Revenue Service (SARS) 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 taxpayer.
For years of assessment commencing on or after 1 April 2012, the legislation changed, allowing the tax authority to consider whether any term or condition imposed as part of any transaction, operation, scheme, agreement or arrangement differed from the terms and conditions that would have been agreed if the parties to the transaction were independent. Any difference in price between what was charged between the connected persons and what would have been charged between independent parties needs to be adjusted for in the tax return of the taxpayer. This is often referred to as the primary adjustment.
To the extent that the taxpayer has not recovered the difference between the arm's length charge and the actual charge from the foreign related party, a deemed loan will arise. This is often referred to as the secondary adjustment. Deemed interest will accrue on the deemed loan.
The same principles apply for financial assistance/thin capitalization.
It is proposed in the 2014/15 Budget Review that the deemed loan treatment will be removed, and the deemed dividend treatment will be re-instated for transactions between a South African subsidiary and a foreign parent company, which most taxpayers will be familiar with. In case of an adjustment between a South African parent company and its foreign subsidiary the secondary adjustment will be a capital contribution.
The deemed dividend treatment on transfer pricing adjustments of remuneration for goods or services will presumably trigger dividends tax at 15% (similar to the previous section 31 provisions that triggered a deemed dividend subject to secondary tax on companies).
The position is less clear in relation to interest incurred on intercompany loans.
In theory, no dividends tax should be triggered on the non-arm's length portion of the interest provided it is already paid and was subject to 15% interest withholding tax effective as of 1 January 2015. Nonresident lenders will further not be able to rely on potential protection available under a double tax agreement as such protection typically only applies to the arm's length portion of the interest.
However, if the legislature intends a consistent treatment of all transfer pricing adjustments as dividends being subject to dividends tax of 15%, an immediate cash outflow will be triggered for the South African payor. In this case, the legislature should ensure that the non-arm's length portion of the interest is not subject to interest withholding tax when the interest is paid to the lender to avoid a double taxation with withholding tax.
The 2014/15 Budget Speech is silent on the much needed amendments required in terms of the stand-alone thin capitalization provisions of section 23M of the Income Tax Act. One can only trust that the amendments will be taken into account when the 2014 tax amendments are drafted.
The classification of the transfer pricing adjustment as dividends or capital contribution respectively is aligned with the recommendation provided by the European Joint Transfer Pricing Forum.1 The concept of a dividend is well known in the South African law; however a capital contribution is typically limited to trusts. It will be interesting to see how the concept of capital contributions in relation to transfer pricing adjustments will play out in practice.
1. EUROPEAN COMMISSION, 18 January 2013, DOC: JTPF/017/FINAL/2012/EN, EU JOINT TRANSFER PRICING FORUM, Final Report on Secondary Adjustments, Meeting of 25 October 2012.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Advisory Services Ltd, Johannesburg, South Africa
- • Cornelia Wolff
+27 11 772 3157
- • Ide Louw
+27 11 502 0438
EYG no. CM4209