Page 145 - SAIT Compendium 2016 Volume2

PN 7/1999
4.3.1
Income Tax acT: PracTIce noTes PN 7/1999
Where the acquirer of the goods or services is a connected person in relation to the supplier of those goods or services (including the supply of goods and services to or by a permanent establishment which either such acquirer or supplier has in South Africa or which either such acquirer or supplier has outside South Africa); and
4.3.2
4.4 Although the Act grants the Commissioner the power to adjust the consideration in respect of a transaction,
the goods or services are supplied at a price other (greater or less) than the arm’s length price.
the reality is that numerous transactions in respect of the same goods or services are entered into between the connected persons. In practice the Commissioner will exercise his discretion in respect of all transactions entered into in respect of a product or service during any period. Such period could be a year or number of years of assessment.
4.5 In terms of section 3 (4) of the Act, the Commissioner’s decision is subject to objection and appeal.
5 Financial Transactions
5.1 The de nition of services, as contained in section 31, includes nancial transactions and would thus apply to non-arm’s length interest, discounts and other payments for the use of money.
5.2 The consideration for the use of funds obtained from, or made available to, a connected person may be unacceptable to the Commissioner for reasons other than a high debt : xed capital ratio or a high rate of interest envisaged in SARS Practice Note 2. For example, the amount of the loan or terms of the agreement may not re ect what would have been agreed if the persons had been unconnected and dealing entirely at arm’s length. The Commissioner may, therefore, apply the provisions of section 31 to adjust or ignore such non-arm’s length transactions for tax purposes.
5.3 The guidelines set out in this Practice Note will apply to all types of nancial transactions between connected persons in terms of international agreements.
6 Tax Treaties
6.1 Article 7 of the OECD ‘Model Tax Convention on Income and on Capital’ provides inter alia for the attribution of pro ts to a permanent establishment of an enterprise. Furthermore, Article 9 of the OECD Model Tax Convention stipulates that the arm’s length principle must be applied to commercial and nancial relations between associated companies residing in the contracting states. These principles are embodied in each of South Africa’s tax treaties. Tax treaties cannot impose tax liability, they merely allocate existing tax liabilities between countries.
6.2 The ‘business pro ts’ and ‘associated enterprises’ articles in the tax treaties do not indicate priorities as to the methods to be used to determine the attribution of pro ts or an arm’s length price. Therefore, the Commissioner holds the view that the treaties do not restrict or limit the application of Section 31 of the Act, regardless of the method selected to determine an arm’s length consideration. The Commissioner also takes the view that no inconsistency exists between domestic law and the tax treaties, as both embody the arm’s length principle.
6.3 Paragraph 2 of Article 9 of the OECD Model Tax Convention provides that a contracting state must make an appropriate adjustment to the amount of tax it levies on pro ts, if the other contracting state has made an adjustment to the pro ts of a related enterprise. Furthermore, the competent authorities of the contracting states may consult each other over the transfer pricing adjustments. Although South Africa’s treaties generally incorporate such adjusting mechanisms, the wording of the relevant article in the treaties may not oblige South Africa to make a corresponding adjustment in all cases.
6.4 Although the provisions of section 31 of the Act are applicable to persons, which are separate legal entities, the contents of this Practice Note will also apply to determine the arm’s length consideration for income tax purposes of cross-border transactions conducted by—
• a person with a connected person;
• a person’s head of ce with a branch of such person; or
• a person’s branch with another branch of such person,
in the application of the tax treaties entered into by South Africa.
7 The Arm’s Length Principle
7.1 The rst and overriding principle is that transactions between connected persons are to be conducted at arm’s length. This simply means that the transaction should have the substantive nancial characteristics of a transaction between independent parties, where each party will strive to get the utmost possible bene t from the transaction.
7.2 Paragraph 1 of Article 9 of the OECD Model Tax Convention deals with the arm’s length principle as follows: ‘[When] conditions are made or imposed between ... two [associated] enterprises in their commercial or nancial relations which differ from those which would have been made between independent enterprises, then any pro ts which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the pro ts of that enterprise and taxed accordingly.’.
7.3 The problem to be resolved is how a multinational should determine what price would have arisen if transactions between its members were subject to market forces. The solution advanced by the arm’s length principle is that a comparable transaction between independent parties (an uncontrolled transaction) should be used as a benchmark against which to appraise the multinational’s prices (the controlled transaction). Any difference between the two transactions can then be identi ed and adjusted. An arm’s length price that will re ect the economic contributions made by the parties to the transaction can be determined for the controlled transaction.
7.4 South Africa has adopted the arm’s length principle, which is the international norm. The Commissioner is of the opinion that application of this internationally accepted principle will minimise the potential for double taxation.
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