With effect from 1 October 2011, South African Transfer Pricing legislation was significantly changed by the implementation of an amended Section 31 to the Income Tax Act 58 of 1962 (”the Act”). The section has now further been amended in terms of the Taxation Laws Amendment Bill 19 of 2011 introduced by the Minister of Finance on 25 October 2011. The revised wording, which is effective from 1 April 2012, has changed the structure of the section but not the fundamental principles which were addressed in the previous amendment to the Act. This article considers Section 31 in the light of the Taxation Laws Amendment Bill 19.
The objective of Transfer Pricing legislation in an international context is to implement anti-avoidance rules within taxation regimes. These rules are established to ensure that arm’s length principles are applied to transactions, operations or schemes that have been entered into between connected persons. The underlying concept is that such transactions, operations or schemes are entered into, applying the same terms and conditions as would have been applied had the transaction been entered into between independent persons.
The objective of the amendments to Section 31 of the Act is to modernise South African transfer pricing and bring it in line with the latest transfer pricing guidelines issued by the Organisation for Economic Cooperation and Development (‘OECD’).
The new section has five subsections. Information for each is addressed below.
Subsection 1 provides two new definitions; those of an “affected transaction” and “financial assistance”.
In summary, an affected transaction constitutes any transaction, operation, scheme, agreement or understanding (‘transaction’) between connected persons where the terms and conditions of such transaction are different from any term or condition that would have existed had those persons been independent persons dealing at arm’s length.
The definition of “financial assistance” is deemed to include the provision of any loan, advance or debt, or security or guarantee.
Subsection 2 contains the most significant change from the previous Section 31.
The subsection first incorporates affected transaction as defined above. It further removes the concept of price which was used in the old section and replaces it with the wording “any term or condition”. Thus the concept of arms length is no longer linked to price but the transaction, operation or scheme is required to be entered into on terms and conditions which would have been applied had the parties involved been independent persons dealing with each other at arm’s length.
Secondly, in the old section the Commissioner for Inland Revenue had the power to adjust the consideration to that which reflected an arm’s length consideration for the goods and services provided. This has been completely removed from the section, with the new section requiring that the taxable income of each person, that is a party to that transaction, that derives the tax benefit be calculated as if that transaction had been entered into on the terms and conditions that would have existed had those persons been independent persons dealing at arm’s length.
It is clear from the new wording that the main focus of South African Transfer Pricing has shifted away from consideration, to one which now rather considers the terms and conditions which have been applied to a transaction.
Subsection 3 deems the difference which arises from the calculation detailed in Subsection 2 to be a loan and such loan in turn constitutes an affected transaction as defined for the purposes of Subsection 2.
Subsection 4 addresses the concept of thin capitalisation. Again, there has been a fundamental shift away from the old Section 31 which applied a fixed capital test when determining whether financial assistance, as defined, was considered excessive. The new section removes this fixed capital test in its entirety and applies the concept of thin capitalisation to the arm’s length principles detailed in subsection 2.
Subsection 5 deals with the impact of Transfer Pricing on Headquarter Companies.
It is, as always, important to note that the onus is on the taxpayer to evidence that a particular transaction, operation or scheme has been entered into on an arm’s length basis.
The implementation of the new Section 31 is intended to bring South Africa’s transfer pricing legislation in line with international norms. What is still unclear, however, is how South African Revenue Services (‘SARS”) intend to apply the legislation in practice. To date, SARS have issued no guidance or interpretations to taxpayers on their intended application of the section. When such guidance will actually be issued is uncertain.
What is clear is that taxpayers must not only ensure that the arm’s length principle is applied at all times but also that they are able to justify, in the form of relevant supporting documentation, that this principle has been applied to all transactions involving connected persons.