3 March 2023

Budget 2023 – Is transfer pricing going to be the next SARS focus area? (Part 2)

Johannesburg, Tuesday, 21 February 2023 - Following the global public outcry around 2012, and the highlighting of certain Multinational Enterprises’ (MNEs’) tax avoidance structures, the G20 Group of Finance Ministers, which includes South Africa, briefed the The Organisation for Economic Cooperation and Development (OECD) to consult and come up with an action plan to put an end to international tax avoidance schemes. Although not a member of the OECD, South Africa has observer status and adopted most of the recommendations set out in the OECD 15 Base erosion and profit shifting (BEPS) Actions Plan (“BEPS 1.0”). Then, more recently, South Africa also became a member of the OECD’s Inclusive Framework on BEPS, including a commitment to support the “BEPS 2.0” initiative. But how did we get there?

It would appear that reference to “BEPS” was first included as part of South Africa’s National Budget documentation in 2013. Attempts to specifically address base erosion included the introduction of a withholding tax on services (subsequently withdrawn), and debt restrictions because the risk was identified as “[E]excessive debt issued to connected person creditors is of concern if the creditor is exempt from tax on the interest, because connected persons can often use debt and equity interchangeably without serious economic consequence.

Section 23M limits interest deductions in respect of debt owed to persons not subject to tax and have been subject to various changes since 2013.

In 2014. specific mention is made of the Davis Tax Committee and highlights that this committee “is looking into the effect of base erosion and profit shifting on the domestic tax base, the manner in which the tax system responds to increased cross-border activity and aggressive tax planning by multinational corporations. This includes consideration of transfer pricing, e-commerce, “treaty shopping” to reduce tax liability and the use of debt and hybrid instruments.”

BEPS is highlighted again in the 2015 National Budget documentation where government makes it clear that the limitations introduced in respect of cross-border interest payments (refer to section 23M above) are not enough. Changes would be implemented in respect of transfer pricing documentation and reporting, as well as a focus on controlled foreign companies (CFCs) and the digital economy. Last mentioned was of course in line with the OECD’s BEPS project that was launched in 2013.

The changes to the Controlled Foreign Corporation (CFC) legislation included the re-insertion of the diversionary rules since transfer pricing provisions did not address BEPS risks sufficiently:

these rules were removed because transfer pricing rules could be applied as an alternative. However, CFC rules have proven less effective in immediately addressing profit shifting by South African resident companies. Although transfer pricing rules can be applied in these circumstances, the CFC diversionary rules are more effective in taxing profits from these transactions.”

A significant focus on BEPS and transfer pricing can be seen in the 2016 National Budget where the following three areas of concern were specifically identified:

  1. Unacceptable transfer pricing practices due to manipulation of the value and nature of cross-border transactions,
  2. Treaty shopping, and
  3. Excessive interest deductions due to highly geared financing structures

It was made clear that South Africa would participate in the global BEPS project to address these areas of concern. Looking back, South Africa kept its word. It has and continues to participate in the global arena to address BEPS. Steps already taken by South Africa at that time included the requirement to prepare and submit country-by-country reports to the South African Revenue Service (SARS) from 2018 onwards. Furthermore, important transfer pricing documentation requirements were published in the Government Gazette of 28 October 2016.

The 2017 National Budget documentation set out South Africa’s position in respect of the 15 Action Items of the OECD’s BEPS project. It furthermore confirmed that SARS will continue to develop the skills and capacity needed to enforce legislation. It will strengthen its efforts to curb tax avoidance and evasion, and address transfer pricing – a component of illicit financial flows.”

In 2018 and 2019, the South African government confirmed that BEPS remained on its agenda. As part of the 2019 Budget, reference was made to the extension of the transfer pricing scope to transactions between ‘associated enterprises’. It might have taken three years, but this extended scope has since become law.

The 2020 National Budget documentation included the proposal “to restrict net interest expense deductions to 30 per cent of earnings for years of assessment commencing on or after 1 January 2021”, all in line with the OECD BEPS action steps, while the 2021 National Budget process included tweaks to the CFC diversionary rules.

Even though there was no significant ‘focus’ on any new transfer pricing/BEPS measures from 2017 to 2020 as part of the National Budget process, the SARS Commissioner stated that:

[T]ransfer pricing remains a major concern across the globe and South Africa is no exception.

Significant revenue leaves South Africa every year in the form of intra-group services linked to multinational enterprises (MNEs). Through such transfer pricing some MNEs engage in aggressive tax planning to create a disconnect between the local activities which give rise to profits and then declare these profits in tax jurisdiction with lower tax rates.

There is a risk that these payments will continue to reduce the sovereign tax base of South Africa to the extent that they are not services that a third party would contract for and / or do not reflect an arm’s length price for the services that have been rendered. The next step will be risk-profiling cases, including an automated transfer pricing risk assessment, selecting cases for in depth auditing and taking criminal action against taxpayers that have failed to comply with our request for information.”

In 2022, government confirmed South Africa’s support for the OECD’s two-pillar solution. More recently, in a response document to the Annexure C submissions made late in 2022 by South Africa’s tax stakeholders, National Treasury stated that, as a developing country, South Africa would not follow a “first mover” approach, but rather await the EU members’ responses and implementation of an EU Directive, or other broad implementation by developed countries.

Pillar One and Pillar Two

The second part of the BEPS initiative, which is aimed at finding a solution to address tax challenges arising from the digitalisation of the economy (also referred to as Pillar One and Pillar Two), found overwhelming support by countries around the world when, on 8 October 2021, 137 countries agreed on the approach to be followed.

On that day, the group signed a statement regarding the key aspects of the Pillar One and Pillar Two Initiative. Notably, many African countries signed the statement, however, Kenya and Nigeria were part of the four counties that did not join the statement at the time. There have since been several models and blueprints regarding how the solutions should work, but because consent was not achieved in several areas (for example the European Union failed to find agreement for a long time) the initiative has been delayed. However, there is still momentum internationally and many milestones have been achieved.

Pillar One concerns profit allocation and nexus rules for certain MNE Groups, that is groups with worldwide revenues in excess of 20 billion Euros and profitability before tax of at least 10%. The purpose of the profit allocation rules is to ensure that a certain portion of the group’s residual profit is taxed in the end market jurisdictions where goods or services are used or consumed, irrespective of a physical presence in that jurisdiction. The allocation of taxing rights to the market jurisdiction would be achieved by applying a specific allocation mechanism. Certain simplification measures are also being considered and, in fact, currently highly debated, regarding marketing and distribution activities in market jurisdictions.

Pillar Two is designed to provide rules granting jurisdictions additional taxing rights focusing on a global minimum income tax rate of 15%. These proposed rules include an income inclusion rule, which imposes a top-up tax on a parent company in respect of a subsidiary’s income. In addition, another rule, which is to support the income inclusion rule, provides for a denial of deductions or an adjustment to the extent that a group entity is not subject to tax under the income inclusion rule. Furthermore, it is proposed that a treaty based subject to tax rule will apply to certain related party payments as a further support. While Pillar Two will apply to MNEs with consolidated group revenue in excess of 750 million Euros - that is the threshold for country-by-country reporting under BEPS Action 13 of the 15 BEPS Action Plan, there will be several exclusions and simplifications.

The focus on transfer pricing, elsewhere and in South Africa, has been increasing. However, since the 2022 Budget Speech, there have been very important developments affecting South African taxpayers with transfer pricing transactions, many of which are still ongoing. It will be interesting to see if the Minister will announce South Africa’s stance and the steps to be taken to ensure enforcement of the new rules implemented, or if this will be a “surprise”.

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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