SARS to increase Tax Revenue from Transfer Pricing

In light of the current collection deficit and negative impact of a possible transfer pricing adjustment, any resident company involved in trade with a non-resident company should be mindful of possible transfer pricing issues. In particular it would be prudent for such companies to ensure that their transfer pricing policy are in order to prevent an unnecessary audit been triggered on their company.

SARS is facing a larger than expected budget deficit after the substantial shortfall in collection for the 2009 tax year. Predictions are that SARS may collect up to R80 billion below the requirement. This has placed considerable pressure on SARS. The new Finance Minister, Pravin Gordhan, has hinted at strict measures to be introduced to curtail the increasing budget deficit. The Commissioner for SARS, Mr Oupa Magashula, recently announced that SARS would respond aggressively to the sharp fall in tax income and would implement steps to yield additional revenue. This will specifically include a sharper focus in auditing and the SARS Large Business Centre will concentrate on aggressive tax planning, transfer pricing and offshore arrangements, and employing more experts to unravel these complex tax schemes.

The Commissioner’s indication of an increased focus by the LBC on transfer pricing is not unsurprising considering the historic perceived abuse of transfer pricing provisions and the current market climate. In recent years SARS has increased their efforts in the administration of transfer pricing, and they have been appointing highly qualified and experienced staff from the private sector to regenerate the transfer pricing administration. This places SARS in a position to effectively target transfer pricing in a period when they require additional revenue from all sources, even those considered traditionally unconventional.

Transfer pricing is a broad and complicated field within international tax law and has been rather neglected.

Pivotal to the administration of transfer pricing is the internationally accepted “arm’s length principle” for taxation used as the basis for ensuring that international transactions are conducted at market related prices, thus ensuring that the South African fiscus receives its fair share of tax. In brief, transfer pricing finds its application in an anti-avoidance section of the Income Tax Act which allows the Commissioner to adjust the price paid for goods or services in terms of an international agreement between connected persons. This essentially allows the Commissioner to adjust the actual price if it is lower than market related prices, so that the transaction is regarded to be at arm’s length.

In addition, the Income Tax Act further deems the price of a transaction to be a dividend to the foreign shareholder. Therefore secondary tax on companies (STC), soon to be replaced by the new dividend tax, will be levied on this deemed dividend. The effect of the adjustment on a South African company is:

1. there will be an increase in income tax as a result of the adjustment to revenue; and
2. STC at 10% will have to be paid to SARS despite the fact that the dividend is merely fictional.

No actual cash is received as a result of the adjustment. Therefore the levy of these taxes can lead to a negative impact on a company’s cash flow and may result in a squeeze on liquidity, which can further hamper attempts to access financing, specifically in these harsh trading conditions.

But how will SARS detect all of this? Current tax returns require taxpayers to obtain and maintain transfer pricing policies and to provide a copy of the relevant agreements and the company’s relevant transfer pricing policy.

Often large multinationals adopt an apathetic approach to the validation of their transfer pricing policy in South Africa, because such a policy would normally have been validated by an international audit firm, or scrutinized in a foreign jurisdiction by the relevant Tax and Custom authorities. This incorrectly assumes that the SARS will simply accept their transfer pricing policy. In order to ensure that the Commissioner will not invoke the powers granted to him under of the Income Tax Act, it is imperative that a company establishes whether its transfer pricing policy would pass scrutiny by the SARS.