Page 144 - SAIT Compendium 2016 Volume2

PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999 1.2.5 Transfer prices: Transfer prices are the prices at which an entity transfers goods and services to connected
persons.
2 Introduction
2.1 The term transfer pricing describes the process by which entities set the prices at which they transfer goods or services between each other.
2.2 The transfer prices adopted by a multinational have a direct bearing on the proportional pro t it derives in each country in which it operates. If a non-market value (inadequate or excessive consideration) is paid for the transfer of goods or services between the members of a multinational, the income calculated for each of those members will be inconsistent with their relative economic contributions. This distortion will impact on the tax revenues of the relevant tax jurisdictions in which they operate.
2.3 For example, if a member of a multinational sells to a connected person resident in a speci c country at a price which exceeds the market price, the pro t which the multinational earns in that country is reduced. Similarly if the member of a multinational sells to a connected person resident in a country at a reduced price, the pro t the multinational earns in that country is increased.
2.4 Since South Africa’s re-emergence in the international market, there has been a marked expansion of international trade and commerce, with wide-ranging changes in volume and complexity. An increasing proportion of this international activity is carried on between members of multinationals. As the globalisation of business activity continues to accelerate, protecting the South African tax base is vital to South Africa’s wealth and development.
2.5 Exchange controls have historically provided some protection against the more signi cant manipulation of transfer prices to transfer pro ts to lower tax jurisdictions. In anticipation of the relaxation of exchange controls and the envisaged adverse effect on the South African tax base, section 31 was introduced into the Act in 1995.
2.6 Section 31 enables the Commissioner to adjust the consideration in respect of a supply or acquisition of goods or services in terms of an international agreement between connected persons. The Commissioner may adjust the consideration, for tax purposes, if the actual price is either less or greater than the price that would have been set if the supply or acquisition of goods or services had occurred between independent parties on an arm’s length basis. The Commissioner may use the amount so determined, in the determination of the taxable income of either of the parties to the transaction.
2.7 The section, therefore, provides a mechanism by which the Commissioner adopts the internationally accepted ‘arm’s length principle’ for taxation purposes as the basis for ensuring that the South African scus receives its fair share of tax. This is achieved by adjusting the consideration in the determination of taxable income based on the conditions which would have existed between unconnected persons under comparable circumstances.
2.8 The objective of this practice note is to provide taxpayers with guidelines about the procedures to be followed in the determination of arm’s length prices, taking into account the South African business environment. It also sets out the Commissioner’s views on documentation and other practical issues that are relevant in setting and reviewing transfer pricing in international agreements.
3 The Commissioner’s Approach to the Practice Note
3.1 This Practice Note has been drafted as a practical guide and is not intended to be a prescriptive or an exhaustive discussion of every transfer pricing issue that might arise. Each case will be decided on its own merits, taking into account the taxpayer’s business strategies and commercial judgment.
3.2 Status of the OECD Guidelines
3.2.1 Because of the international importance of the OECD Guidelines, this Practice Note is based on, inter alia,
those guidelines. Although South Africa is not a member country of the OECD, the OECD Guidelines are acknowledged as an important, in uential document that re ects unanimous agreement amongst the member countries, reached after an extensive process of consultation with industry and tax practitioners in many countries. The OECD Guidelines are also followed by many countries which are not OECD members and are therefore becoming a globally accepted standard.
3.2.2 The OECD has issued a report entitled ‘Harmful Tax Competition – An emerging global issue’.
In this report, the failure to adhere to international transfer pricing principles is identi ed as a contributing factor to the proliferation of harmful preferential tax regimes. A tax authority’s view on appropriate arm’s length prices, if they impact on how an enterprise conducts its cross-border activity, can directly affect the competitive position of that enterprise. Following the OECD Guidelines will thus promote tax equality and reduce the possibility of South Africa contributing to the establishment of a harmful preferential tax regime.
3.2.3 The OECD Guidelines should be followed in the absence of speci c guidance in terms of this Practice Note, the provisions of section 31 or the tax treaties entered into by South Africa.
4 Section 31 of the Act
4.1 Section 31 was introduced into the Act with effect from 19 July 1995 to counter transfer pricing practices which may have adverse tax implications for the South African scus. This section consists of a combination of transfer pricing and thin capitalisation provisions. The measures to combat transfer pricing schemes are in essence contained in section 31 (1) and (2). The provisions of section 31 (3) are more speci cally aimed at countering thin capitalisation schemes.
4.2 Section 31 (1) de nes the terms used in this section. Section 31 (2) empowers the Commissioner to adjust the consideration (for the purposes of the Act and the calculation of taxable income) in respect of international agreements to re ect an arm’s length price for the goods or services supplied in terms of that international agreement.
4.3 The Commissioner may exercise his discretion in the following circumstances in relation to cross border transactions:
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SAIT CompendIum oF TAx LegISLATIon VoLume 2