For many years our transfer pricing (TP) and thin capitalisation rules have remained essentially unchanged. However, certain fairly fundamental changes have been made to the TP legislation. These changes become effective on 1 October this year. In addition, SARS is currently revisiting the practice note which deals with inbound financial assistance to a South African company from a foreign related party.
The wording of the new TP legislation is already a ‘done deal’. Treasury has considered – and in many cases rejected – submissions regarding this legislation. In its submission Deloitte raised a concern that the new legislation is too far reaching. Essentially it applies automatically if there is a relationship between the parties which differs from one that would be likely to exist between unrelated parties.
We pointed out that relationships within multi-national enterprises (MNEs) are frequently different from those which apply between unrelated parties. For example, limited risk arrangements – which represent unremarkable TP planning within MNEs – seldom occur between unrelated parties. As the OECD has pointed out, one of the reasons for the continued existence of MNEs is that they are able to achieve cross border synergies and efficiencies which independent enterprises cannot. This is done largely through having arrangements which are not available to independent parties.
Treasury was not persuaded by this submission and the legislation is now a (future) reality.
We will therefore we watching the Budget Speech (and supporting information) carefully for guidance regarding the implications of this new legislation. For example, what should a taxpayer do if it is party to such a limited risk arrangement? What happens if there are no examples of similar arrangements between unrelated parties? Does this automatically mean a TP adjustment?
It seems unlikely that SARS will simply throw existing TP arrangements out of the window. ‘Artificial’ arrangements are a reality within MNEs and, if SA wishes to be a respected member of the world’s economic community, then it needs to (and certainly will) continue to respect international practice in the area of TP.
It must be emphasised that, despite our reservations, our new TP rules have been based on OECD guidance. Therefore it is probably appropriate to look to the OECD for further guidance regarding how they should be implemented.
What the OECD has emphasised is that, from a TP point of view, the underlying economic substance needs to be consistent with the specific transaction under consideration. As regards limited risk arrangements, this is likely to mean that an entity which earns additional return by virtue of such an arrangement needs not only to carry the financial consequences of the risk, but should also be the party which actively manages the risk. Therefore it is possible that, going forward, it will not be sufficient merely for a SA limited risk entity to have a guaranteed operating profit. In addition, it will be necessary to show that the SA entity does not manage the risks which have been limited by agreement, but that these are managed by the foreign entity which purports to be carrying them. Therefore the functional and risk analysis of the TP policy of such an entity will probably require careful consideration.
A further significant change is that, under the new legislation, SARS’ discretion has been removed. In other words, the TP rules apply automatically if the conditions are fulfilled. This will have significant implications as regards the timing of the liability for STC or dividend tax and interest associated with TP adjustments.
It is possible that the transfer pricing practice note will be amended to provide guidance in relation to these issues.
We have been told by SARS that the new financial assistance practice note (replacing SARS Practice Note 2) will also have fundamental changes. These might extend as far as the current thin capitalisation regime (including the long established 3:1 debt:equity ratio). The implications of the withholding tax on interest, currently envisaged to come into operation in 2013, will need to be carefully considered as part of the exercise of preparing the new practice note.
Full details of these various issues are unlikely to become clear through the Budget process. However, we do expect some guidance as to when such information is likely to become available. For example, when will the financial assistance practice note be released? And will there be a new (or significantly revised) TP practice note?
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