The introduction of the new South African transfer pricing rules, which took effect from April 1 2012, and the repeatedly delayed publication of the SARS Interpretation Note, have ensured that transfer pricing has been a hot topic of discussion over the last few months.

The introduction of the new transfer pricing rules has caused considerable speculation as to SARS ’s view on the application of the transfer pricing principles to intragroup financing transactions in general, and thin capitalisation in particular. The speculation surrounding SARS’s approach to transfer pricing in future will only subside once the new interpretation note on transfer pricing has been published. In the meantime, we make reference to SARS’s recently issued Five-Year Strategic Plan for the period 2012/13 to 2016/17, setting out SARS’s mandate, vision, values and core outcomes, as well as its five-year strategy to achieve these core outcomes.

Independent of the more practical guidance to be provided in the interpretation note, though, it is important to understand that transfer pricing is one of SARS’s main strategic focus areas for the next few years. Therefore, transfer pricing must be on the radar screen of any tax director who is responsible for a company involved in intragroup cross-border transactions.

In terms of the strategic plan, transfer pricing has been identified as one of the main strategic risks currently faced by SARS, due to the growing presence of multinational corporations in South Africa, the emergence of large local original players and the position of South Africa as an investment conduit into Africa.

As South Africa, with its corporate tax rate of 28%, is a relatively high-tax jurisdiction compared to some of its global competitors, SARS is concerned that multinational corporations, with their ability to potentially shift profits from high-tax jurisdictions to low-tax jurisdictions, could shift a substantial portion of their tax base out of South Africa to lower-tax jurisdictions. Such jurisdictions include Mauritius, Switzerland and even the UK, where the corporate tax rate has been reduced to 24% as of April 1 2012.

Considering statistics which show that nearly 70% of worldwide trade is currently conducted within multinational companies, SARS’s concern in this regard is more than understandable. It is in this context that one has to consider SARS’s additional comment that the current OECD and UN transfer pricing frameworks are seen to favour developed countries, even though SARS provides no further explanation for this statement.

In order to address the compliance problems which SARS has been encountering with regard to transfer pricing, the strategic plan sets out a seven-step approach to be undertaken. The seven steps can be summarised as follows:

  • Ensuring that the new format of the company tax return provides the detail required by SARS ’s transfer pricing unit by submitting input to the new reporting standard (xBRL) rollout;

  • The development of a South African database containing information on South African companies, their goods and services, thereby enabling SARS to perform local benchmarking for transfer pricing purposes;

  • The continued use by SARS of third-party data, including information obtained from the South African Reserve Bank, to validate information declared by taxpayers;

  • The exploration of the possibility of offering bilateral and multilateral advanced transfer pricing agreements (APAs);

  • The adoption of the use of multiple data;

  • The introduction of statutory documentation and disclosure requirements; and

  • The strengthening of the transfer pricing capability within SARS through intensive practical training courses and exploring secondment options to and from other tax jurisdictions, such as India.

Most of the steps above are in line with those undertaken by tax authorities in other jurisdictions and are, as such, not necessarily controversial. However, two of the steps could be of concern to South African taxpayers. The first is the proposed development of an internal database of local companies and their goods and services.

While the development of a South African/Pan African database for transfer pricing purposes should be welcomed by all tax authorities, advisors and taxpayers, the problem with the proposed approach is that the database appears to be an internal SARS database. Such a database will effectively result in SARS being able to use so-called “secret comparables”, ie comparables to which taxpayers and/or their advisors will not have any access, for benchmarking purposes.

The second step of concern is the potential influence which the Indian tax authorities might have on SARS. As anyone practising in the area of transfer pricing will know, the Indian tax authorities have consistently been extremely aggressive over the past few years when it comes to transfer pricing, as well as other tax areas, often ignoring generally accepted international principles, such as the OECD Guidelines. While we have understanding for SARS’s concern that the current international transfer pricing framework might favour developed countries, as well as their desire to align themselves with other BRIC countries from a political perspective, we would urge SARS not to blindly copy the Indian approach.

Considering the difference in size of the two economies, and South Africa’s dependence on foreign direct investment, an aggressive approach similar to the one taken by the Indian tax authorities could result in serious damage to be inflicted on South Africa as an investment destination.

While the overall size of the Indian market might be big enough to lure foreign investors, despite the aggressive approach taken by its tax authorities, we are doubtful whether the same would apply to South Africa – a substantially smaller and less strategically important market.

Originally published in LEGAL TIMES, Friday July 13 | 2012

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