Worldwide transfer pricing reference guide 2014

South Africa
Taxing authority and tax law
Taxing 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 had previously authorized the tax authority to adjust the consideration for goods or services to an arm’s length price for the
purpose of computing the South African taxable income of a person.
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 to 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. Therefore, the application of transfer
pricing provisions has been widened. Two key changes affecting financial assistance arrangements and thin capitalization have also been
incorporated under the new legislation. The first is the inclusion of financial arrangements between South African branches of foreign
companies and another foreign company in the group. The second, perhaps a more radical change, is the move from a debt to equity
ratio test for assessing thin capitalization, to an arm’s length test to determine an appropriate level of debt and interest rate to
be charged.
Relevant regulations and rulings
There are no specific regulations or rulings. However, guidance on the application of §31 is currently contained in Practice Note 7
(6 August 1999) and in the addendum to the Practice Note 7 (29 September 2005). On 22 March 2013, a draft Interpretation Note
(draft IN) was published by SARS. The draft IN provides an indication of the analysis and documentation that SARS would expect to see
in relation to cross border financial assistance and thin capitalization. The final IN is binding only for SARS, and not for taxpayers and
courts.
SARS has also contributed to the UN Practical Manual on Transfer Pricing for Developing Countries.
OECD Guidelines treatment
Although South Africa is not a member of the OECD, SARS accepts the OECD Guidelines and has largely based its practice on them.
By the same token, SARS recognizes the five methods accepted by the OECD Guidelines. New changes to the legislation will ensure better
alignment with the OECD Guidelines and with the approach adopted by the OECD member countries.
Priorities/pricing methods
SARS accepts the methods prescribed by the OECD; i.e., CUP, Resale Price, 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 it is substantiated. SARS may require adjustments to
be made to foreign comparable company results used for benchmarking the results of the South African entity, so as to compensate
for the differences in risks assumed by entities operating in a different jurisdiction. We note that SARS has a preference for comparable
companies from emerging markets.
Transfer pricing penalties
For years of assessment commencing on or after 1 April 2012, any transfer pricing adjustment will be deemed a loan, on which interest
at an arm’s length rate should be charged. The proposed change allows for a secondary adjustment on the South African taxpayer’s
taxable income in the form of interest on the deemed loan amount. The amount would also be deemed as a loan until a point in time
where the pricing is corrected or the difference in pricing between the two related parties is settled through the repatriation of funds or
through a possible mutual agreement procedure (MAP). 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).
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