Budget 2023 – Is transfer pricing going to be the next SARS focus area? (Part 1)
Johannesburg, Tuesday 21 February 2023 - Once again, we are close to the next Budget Speech and all eyes in South Africa will be on the Minister of Finance. Mastering the ship through the storm that South Africa has been experiencing over the past few years has been incredibly difficult and it is not going to get easier, at least for now. The struggling economy has resulted in less activity, yet the South African Revenue Service (SARS) has been able to exceed expectations regarding its revenue budget. However, it is clear that new sources of revenue collection will need to be discovered, and tougher transfer pricing enforcement may be one of them.
What has changed?
For years, the SARS Commissioner has been suggesting that transfer pricing will be a focus area for SARS enforcement. Multinational Entities (MNEs) with a presence in South Africa, which have been said to have shifted profits to no- or low-tax jurisdictions, have been on SARS’ radar for many years, but little to no success in the area has been reported.
This may change, and recent legislative proposals, SARS guidance, and international developments at the Organisation of Economic Cooperation and Development (OECD) also suggest this. In South Africa, new SARS guidelines regarding the transfer pricing treatment of intra-group loans and a significantly broadened transfer pricing law have progressed. At the global level, however, progress has continued around negotiations regarding further rules to avoid base erosion and profit shifting by certain MNE taxpayers, as well as the discussion of a global minimum tax. South Africa is involved in these negotiations, and it is expected that some sort of agreement will soon be reached.
Intra-group loan guidance
Since South Africa introduced general transfer pricing legislation in 1995, intra-group financial assistance transactions have received special attention.
Initially, the law required that the interest rate of a cross-border loan between connected persons should be at arm’s length. In addition, thin capitalisation rules provided that the debt-to-equity ratio in respect of foreign inbound loans should also be at an acceptable level. Guidance in this regard was released in 1996 in the form of Practice Note 2. For the years of assessment commencing on or after 1 April 2012, however, the transfer pricing law was overhauled and a much broader approach for assessing whether or not an intra-group loan is at arm’s length was introduced.
The new law resulted in uncertainty, and a soon-published SARS draft interpretation note did not change the position. It was only in 2019 that SARS, with retroactive effect for years of assessment commencing on or after 1 April 2012, withdrew Practice Note 2. However, the 2013 draft interpretation note was not finalised. In 2020, the OECD then published its Financial Transactions Report, which was much broader than the 2013 SARS draft guidance and resulted in more uncertainty as to how SARS would view intra-group loans.
In 2022 the OECD formally introduced intra-group financial assistance guidance, as set out in the Financial Transactions Report, into the OECD Guidelines. This was the first time in history that the OECD took a position on the matter. While South Africa is not a member of the OECD it has observer status, and South Africa is also a member of the Inclusive Framework. Therefore, the financial transactions guidance should be relevant to South Africa. At around the same time, SARS then issued another draft interpretation note regarding the transfer pricing treatment of intra-group loans from a South African perspective, seemingly aligning with the OECD, although the 2022 draft interpretation note was somewhat more restricted to intra-group loans.
What is remarkable, and at the same time seems to indicate that SARS will soon focus much more on intra-group financial loans (particularly inbound loans) is that within less than a year from publishing the 2022 draft interpretation note, SARS released for the first time since 1996, final guidance regarding the transfer pricing treatment of intra-group loans. It will be interesting to see if the Minister, in the 2023 Budget Address, will provide further detail as to whether or not, and if so in what manner, SARS will focus more on intra-group loan transactions with South African members of an MNE Group.
Broadening of the South African transfer pricing law
Historically, the South African transfer pricing law focused, broadly speaking, on cross-border transactions, operations, etc. between connected persons. The term “connected person” is quite broad and defined in section 1 of the Income Tax Act, 58 of 1962, as amended.
However, in 2019, draft legislation was published adding the concept of “associated enterprises” to the transfer pricing legislation. Following several comments from the tax practitioner community, the effective date for the introduction of the “associated enterprises” concept in South Africa was postponed to allow for guidance to be published by SARS. SARS then released a Draft Interpretation Note containing guidance on the concept in 2022, and shortly thereafter the effective date was set for years of assessment commencing on or after 1 January 2023.
The “associated enterprises” concept stems from the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention on Income and Capital Gains, Article 9, and is designed to address situations where related parties transact. The term in the OECD Model Tax Convention is meant to give an overarching concept from an international tax perspective but leaves the clarification of when two persons are “related” to the domestic law. The SARS guidance should clarify the term for South African purposes. However, the concept is extremely wide, and it therefore significantly broadens the ambit of the South African transfer pricing law.
The OECD Model Tax Convention effectively states that if one entity (the broader term “enterprise” is used in the convention) directly or indirectly participates in the management, control or capital of a foreign entity, then transfer pricing rules would apply in respect of transactions between these entities. In addition, if two persons directly or indirectly participate in the management, control or capital of an entity in one country and in another entity in another country, then these two entities would be considered related for transfer pricing purposes.
SARS, in the draft Interpretation Note then states that the term “management” is broad and in terms of an example suggests that “persons may be viewed as participating in the management of an entity if they participate in the appointment, dismissal or reassignment of the entity’s key management personnel, or if they share resources, or if direction in entering into significant transactions, operations, schemes, agreements or understandings exists.” SARS then illustrates in terms of Example 1 how broad the concept could be applied. Example 2 in the draft Interpretation Note seems to address a very specific scenario, and Example 3 focuses on Dual Listed Companies.
In summary, taxpayers should note that, as indicated, the concept of “associated enterprises” as it is now included in the South African transfer pricing rules is very broad. The SARS guidance states that a taxpayer would first need to ascertain whether the party to a cross-border transaction etc. is a connected person, as defined, and if not, in a second step it would need to be tested if that other person does perhaps qualify as “associated enterprise”.
In practice, because the burden to discharge the onus that a taxpayer entered into a cross-border intragroup transaction at arm’s length is with that taxpayer, taxpayers will need to prepare and maintain detailed analyses to support that the “associated enterprises” concept does not apply to a cross-border transaction, etc with another person.
Written by: Christian Wiesener, Chairperson of the SAICA Transfer Pricing Committee and Associate Director, Transfer Pricing at KPMG and Janien Jonker, member of the SAICA Transfer Pricing Committee.
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