August 17 2012
South Africa's transfer pricing and thin capitalisation regime, as contained in Section 31 of the Income Tax Act (58/1961), has undergone some extensive changes over the past two years.
In respect of transfer pricing, the focus had always been on the supply of goods and services between certain connected persons, usually a resident and a non-resident. Where the price for such goods or services was not at arm's length, the South African Revenue Service could adjust the consideration paid so that the parties would be taxed as if they did deal at arm's length. A secondary adjustment also entailed a deemed distribution of a dividend in respect of which the now-repealed secondary tax on companies would have had to be accounted for.
Thin capitalisation had always been dealt with as something separate from transfer pricing. The principle was that where a non-resident granted financial assistance to a resident, the South African Revenue Service could deny the resident a deduction in respect of excessive interest or finance costs paid to the non-resident. Any such excessive amount was also deemed to be a dividend declared by the resident. However, thin capitalisation was subject to the so-called safe-harbour rule: where the debt-to-equity ratio of the resident was less than or equal to three to one deductions would not be denied.
With effect from April 1 2012, transfer pricing now focuses not only on the supply of goods or services, but also on any cross-border "transaction, scheme, agreement or understanding" between or for the benefit of certain parties, usually a resident and a non-resident (but it also applies to certain other parties), where one or both of the parties gain a tax benefit.
Another change is that instead of the South African Revenue Service simply being empowered to adjust the price concerned for tax purposes, the parties are required to calculate their own tax as if the price had been at arm's length. This is not only in respect of price but also in respect of any term or condition of the transaction, scheme, agreement or understanding.
Thin capitalisation is no longer treated as separate from transfer pricing, but has been incorporated into the transfer pricing rules and is now treated as an extension of the transfer pricing provisions. The transfer pricing provisions are sufficiently wide to include the provision of financial assistance, and therefore, if a party derives an undue tax benefit - such as excessive interest deductions from such financial assistance - the arm's-length principle will apply and the parties will have to calculate their taxes accordingly. The rule now additionally incorporates the making available of intellectual property. A secondary adjustment mechanism was also introduced. In terms of this mechanism, the amount of any difference in price (ie, the amount of the adjustment) will be regarded as a loan extended by the resident party to the other party, which itself will be subject to the transfer pricing rules. In other words, the terms of the loan will have to be at arm's length, including the charging of interest. The resident will therefore be treated as having interest accruing to it in respect of the deemed loan, until such time as the other party pays the amount of the loan to the resident. If the non-resident pays the amount to the resident within the same year of assessment in respect of which the adjustment is made, no deemed interest will accrue to the resident.
The transfer pricing rules apply not only to income tax but also to other taxes, such as dividends tax and possibly donations tax.
There are certain exclusions from the transfer pricing provisions for headquarter companies.
In the draft Taxation Laws Amendment Bill 2012, it is proposed that the transfer pricing provisions should not apply in respect of loans or intellectual property where the holder is a South African company and the debtor or licensee is a controlled foreign company in relation to that South African company. The controlled foreign company must also be highly taxed and have a foreign business establishment. The controlled foreign company will be considered highly taxed if it has an effective tax rate of 75% of the applicable South African tax rate.
It is expected that the South African Revenue Service will take a more aggressive stance in respect of transfer pricing, especially given the fact that the new provisions are wide and geared towards eliminating undue tax benefits.
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