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Introduction to South Africa transfer pricing
Transfer pricing rules
- South Africa’s (SA) transfer pricing (TP) rules are contained in Section 31 of the Income Tax Act of 58 of 1962 (ITA) and are supported by Practice Note 7, which provides additional guidance to taxpayers on determining an arm’s length consideration in relation to cross border related party transactions. SA TP rules follow the OECD Guidelines.
- SA TP rules apply to SA taxpayers, including SA branches of overseas companies, that have cross-border related party transactions. SA implements a self-assessment regime, i.e., the onus is on the taxpayer to provide the support that it meets its TP obligations or to adjust its tax return accordingly.
- Finally, SA TP rules are only applicable to 'connected persons' as contained in Section 1 of the ITA. Generally, companies that form part of the same group of companies would be considered connected persons for the purposes of SA TP rules, however, the definition is complex and can be widely interpreted. A proposed amendment to Section 31 may see the 'connected persons' definition replaced with the 'associated enterprise' definition for purposes of applying SA TP rules, however, this amendment is yet to be promulgated.
- Although SA is only an observing member country of the OECD, SA’s TP rules follow the OECD Guidelines. The Guidelines should be used for interpretation of the arm’s length principle together with local legislation.
- SA has adopted certain minimum standards proposed under the OECD’s Base Erosion and Profit Shifting (BEPS) recommendations, most notably the documentary requirements proposed by the OECD in BEPS Action 13.
Transfer pricing methods
- The SA Revenue Service (SARS) accepts the traditional and transactional methods prescribed by the OECD Guidelines.
- The most appropriate pricing method should be selected on a transaction by transaction basis, providing the most reliable measure of an arm’s length result in each case.
- All methods as recommended by the OECD Guidelines are considered accepted methods, however, the method used must be in line with the functional and risk profile of the connected parties to the transaction under review. Other methods can also be used if justifiable and appropriate.
- With regard to any preference of method, there is no set hierarchy, as SA legislation currently refers to the 2017 OECD Guidelines. In practice, however, a ‘natural hierarchy’ may be said to favour the comparable uncontrolled price method.
- Section 31 of the ITA essentially requires a self-assessment by the taxpayer where the onus is on the taxpayer to ensure that TP rules are adhered to.
- Certain document retention requirements also apply to taxpayers conducting cross-border related party transactions. These are onerous and go beyond the requirements proposed by the OECD under Action 13 relating to the master file and local file requirements.
- The annual income tax return for corporates (form ITR14) includes a number of TP related questions that need to be responded to by a taxpayer that has entered into cross border related party transactions. The purpose of these questions is to assist SARS with its TP risk assessment and therefore they need to be considered thoroughly and answered correctly. The annual corporate income tax return must be submitted within 12 months from the end of the relevant year of assessment.
Transfer pricing documentation
Preparation of transfer pricing documentation
Master file and local file
- SA has adopted certain minimum standards proposed under the OECD’s BEPS Action 13 with respect to TP documentation.
- Mandatory filing of a BEPS Action 13 compliant master file and local file for a particular year is required by taxpayers that have aggregated cross border related party transactions (without offsetting) exceeding or reasonably expected to exceed ZAR100 million for that year. If this threshold is met, a master file and local file should be prepared and filed with SARS together with the ITR14. The mandatory filing (submission) is effective for years of assessment commencing on or after 1 October 2016.
- In determining whether the ZAR100 million mandatory filing threshold has been met, besides the usual cross border related party transactions (for example sales, purchases, service fees, royalties, and interest), regard must also be given to balance sheet items including (but not limited to) the capital balances of loans, long-outstanding trade balances that could be construed to be financial assistance, and certain types of dividends paid or received
- A taxpayer meeting the threshold must also prepare and retain certain TP related documentation. There are specific additional documentation requirements set out for individual cross-border related party transactions exceeding, or reasonably expected to exceed ZAR5 million.
- Finally, taxpayers that do not meet the ZAR100 million threshold should still be able to support their cross border related party transactions via documentational evidence or a basic TP document. Dependent on a number of factors (including materiality) the latter (TP document) need not meet the local file requirements but should contain sufficient support in relation to the cross border related party transactions.
- TP documentation should be prepared in English.
- The Country-by-Country Reports (CbC Report) must be submitted by the ultimate parent company of a multinational enterprise (MNE) (or the Reporting Entity if not the same as the ultimate parent) that has a consolidated turnover of ZAR10 billion or more (or US$850 million or €750 million). A CbC Report notification must be submitted by SA subsidiaries of a MNE within the CbC Report net.
- If the SA taxpayer is part of a MNE that meets the CbC Report threshold requirements, the CbC Report, master file, and local file filing requirements are applicable to all years of assessment commencing after 1 January 2016.
- SARS has recently extended the administrative penalty under Section 210 of the Tax Administration Act No 28 of 2011 (TAA) for non-compliance relating to the submission of the CbC Report, master file and local file. A taxpayer required to prepare and submit a master file and local file must file the same electronically with SARS in a format consistent with the master file and/or local file format as described by SARS. The master file and/or local file must be prepared and filed with SARS within 12 months from the end of the relevant year of assessment.
- SA resident taxpayers forming part of a MNE with turnover in excess of R10 billion (or the equivalent amount of €750 million or US$850 million), when a group entity files the CbC Report in a country with which SA has a suitable agreement for the automatic exchange of CbC Reports, must notify SARS, in the prescribed format, of certain information relating to the CbC Report, including the identity of the entity that has filed or will file the CbC Report. The notification must be submitted to SARS within 12 months from the end of the relevant fiscal year. Even though the notification information must be completed in the ITR14 corporate income tax return, it is recommended that the notification should also be submitted by email to a dedicated SARS email address. Where the SA resident taxpayer is obligated to file the CbC Report in SA, this must be done within 12 months from the end of the relevant fiscal year.
- Section 29 of the TAA has been extended to include document retention requirements for TP. The requirement for retention of TP documentation was introduced effective 1 October 2016 and applies to years of assessment starting on or after that month. Taxpayers that fall within the threshold limits must retain certain documentation relating to the transactions they enter into with connected persons.
Master and South Africalocal file
- SA taxpayers that are the ultimate parent company of an MNE are required to prepare a master file. The master file includes key information about the Group’s global operations including an overview of the business operations and important information on global TP policies.
- Where the SA taxpayer is not the ultimate parent company of an MNE but such ultimate parent is not obligated in their own jurisdiction to prepare a master file, the SA taxpayer may be obligated to prepare/submit one.
- As mentioned above SA companies are required to file a master file where aggregate cross border related party transactions exceed ZAR100 million applicable to years of assessment commencing on or after 1 October 2016.
- The local file has detailed information and support on the intercompany transactions that the local company engages in with its foreign related parties. The local file is required per legal entity and the information included is in line with the OECD Guidelines prescribed requirements for a local file. Over and above the local file, SA taxpayers with cross-border related party transactions exceeding ZAR100 million per year (whether these are charged out or not) are required to keep significant additional records to support those individual categories of transactions that exceed ZAR5 million. Where a SA MNE is required to file a CbC Report, they will also be required to file a local file as part of the CbC Report submission regardless of the value of the cross border related party transactions for a particular year.
Some risk factors for challenge
- Business restructurings, or changes in TP model
- Persistent losses in an entity that has been characterised as 'limited risk'
- Limited risk manufacturing / distribution models with profit-sharing arrangements
- Intellectual property owned by offshore entities that have DEMPE functions situated in SA
- Thin capitalisation of SA entity
- Licensing payments to low tax jurisdictions
- Inbound service fees that may not pass the benefit test.
- If SARS is of the view that a taxpayer’s TP arrangement is not commensurate with an arm's length consideration, SARS may make a primary TP adjustment in the taxpayer’s tax return to reflect the arm’s length consideration. This will give rise to company tax at 28% on the primary TP adjustment.
- As a further consequence SARS will make a secondary adjustment in the form of a deemed dividend in specie equal to the primary TP adjustment, which is subject to dividend withholding tax at 20%. Since the deemed dividend is punitive by nature, any Double Tax Agreement relief that would normally be applicable to dividends will not be applicable to the secondary TP adjustment.
- Understatement penalties may be applicable to the under-declaration of tax payable as a result of the primary and secondary TP adjustments. Understatement penalties are levied in terms of Section 223 of the TAA at a rate of between 0% and 200%. The applicable rate is dependent on the circumstances that gave rise to the understatement, such as fault, omission, incorrect disclosure or misrepresentation, and also whether the taxpayer has previously been guilty of any of the above.
- An administrative penalty of up to ZAR16,000 can be levied for every month that the documentation remains outstanding. The administrative penalty is based on the assessed loss or taxable income for the preceding year.
Economic analysis and how to demonstrate an arm’s length result
- SARS will expect to see that a search for potential internal comparables has taken place before defaulting to an external database search for comparables.
- There is no legal requirement for local country comparables, however, it is preferable to have comparables that operate in a jurisdiction with a similar risk profile to that of SA.
- Note that where databases are used, the interquartile range is used, and a multiple-year analysis is performed. There is also a preference for the weighted average arm’s length analysis.
- There is no need to conduct a new benchmarking study every year. A new benchmarking study is to be conducted every three years, with an annual financial update.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
- SA does not currently have an APA program. Current legislation prohibits SARS from providing an advanced ruling to determine a price.
- SA does have a mutual agreement procedure (MAP) options available to taxpayers. Guidance in this regard can be found in SARS’ Guide on Mutual Agreement Procedures (Issue 3).
- If the ZAR100 million threshold is exceeded, there are no exemptions from the documentation obligation applicable in SA.
- Certain outbound financial assistance may be exempted from the provision of section 31 of the ITA, provided certain requirements are met.
SARS and taxpayer behaviour
- TP has been a focus area of SARS for the last few years. The likelihood of a general annual tax audit is assessed as medium while the TP forming part of such an audit is high.
- TP methodology is assessed on a case by case basis but is generally challenged within the audit process. Should SARS challenge the methodology, an adjustment is likely.
- SARS has suspended physical interactions with taxpayers (meetings etc.) and has made use of online platforms for any assessments and communication with taxpayers.
- Larger businesses with a gross income greater than ZAR100 million that can show they are incapable of making payment as a consequence of COVID-19, and may defer tax payments without incurring penalties if the business makes an application directly to SARS.
- Smaller businesses may apply for additional deferral of payments without incurring penalties.