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PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999
and new product development, degree of diversi cation, risk aversion and other factors which have bearing upon
the daily conduct of business.
8.5.2 Business strategies could also include market penetration schemes. A taxpayer seeking to penetrate a new
market or to expand (or defend) its market share
might temporarily charge a lower price for its product than the price for otherwise comparable products in that market. Alternatively, it might temporarily incur higher costs (perhaps because of start-up costs or increased marketing efforts) and hence achieve lower pro t levels than other taxpayers operating in the same market.
8.5.3 The important issue is how one should appraise whether a business strategy that temporarily decreases pro ts in return for higher long-term pro ts is consistent with the arm’s length principle. The relevant question here is whether a party operating at arm’s length would have been prepared to sacri ce pro tability for a similar period under such economic circumstances and competitive conditions.
8.5.4 The Commissioner may consider a number of factors in evaluating a taxpayer’s claim of following a strategy that temporarily reduces pro ts in return for higher long-term pro ts, for example, whether:
(a) the conduct of the parties is consistent with the professed business strategy;
(b) the nature of the relationship between the parties to the controlled transaction justi es that the taxpayer
bears the costs of the business strategy;
(c) there is a plausible expectation that the business strategy will produce a return suf cient to justify its costs,
within a period of time that would be acceptable in an arm’s length arrangement.
9 Acceptable Methods for Determining an Arm’s Length Price
9.1 Introduction
9.1.1 Neither section 31 nor the tax treaties entered into by South Africa prescribe any particular methodology for the purpose of ascertaining an arm’s length consideration. Given that there is no prescribed legislative preference, the Commissioner would generally seek to use the methods that have been set out below.
9.1.2 The most appropriate method in a given case will depend on the facts and circumstances of the case and the extent and reliability of data on which to base a comparability analysis. It should always be the intention to select the method that produces the highest degree of comparability.
9.1.3 The choice of the most appropriate method should therefore be based on a practical weighting of the evidence, having regard to:
(a) the nature of the activities being examined,
(b) the availability, quality and reliability of the data,
(c) the nature and extent of any assumptions, and
(d) the degree of comparability that exists between the controlled and uncontrolled transactions where the
difference would affect conditions in the arm’s length dealings being examined.
9.1.4 In cases where there are no comparables or there is insuf cient information to determine an arm’s length outcome, the method to be used should be a method that produces a reasonable estimate of an arm’s length
outcome. Such estimate must be based on the facts in hand.
9.1.5 The application of the principles set out in this Practice Note may require the exercise of judgment. After the
identi cation of an independent benchmark or benchmarks against which the pricing of a multinational is to be compared, it needs to be established to what extent the functions of the members of a multinational are similar to or differ from those of the independent benchmark(s). An element of judgment is required to determine the extent to which these similarities or differences have a material effect on the transfer price adopted by the multinational.
9.1.6 As a general rule, the most reliable method will be the one that requires fewer and more reliable adjustments to be made. Taxpayers will not be required to undertake an intricate analysis of all the methodologies, but should have a sound basis for using the selected methodology. This could entail providing reasons why secondary methods are not appropriate.
9.1.7 This section of the Practice Note considers the principles underlying each of the various transfer pricing methods. An understanding of these principles is useful for identifying the limitations of each method and applying the methods in practice.
9.2 The principle [sic[ methods referred to in the OECD Guidelines
9.2.1 Several transfer pricing methods have been developed in international practice for determining and appraising a taxpayer’s transfer prices. These methods are based on measuring a multinational’s pricing strategies against a benchmark of the pricing behaviour of independent entities in uncontrolled transactions.
9.2.2 The standard transfer pricing methods recognised by the OECD Guidelines, are: (a) the comparable uncontrolled price method (CUP method);
(b) the resale price method (RP method);
(c) the cost plus method (CP method);
(d) the transactional net margin method (TNMM); and
(e) the pro t split method.
9.2.3 The CUP, RP and CP methods are known as the traditional transaction methods and the TNMM and pro t split
method are referred to as transactional pro t methods.
9.2.4 The Commissioner endorses the CUP, RP, CP, TNMM and pro t split methods as acceptable transfer pricing
methods, the most appropriate of these depending on the particular situation and the extent of reliable data to
enable its proper application.
9.3 The hierarchy of methods
9.3.1 Section 31 does not impose a hierarchy for the transfer pricing methods. However, there is in effect a hierarchy, in that certain methods may provide a more reliable result than others, depending on the quality of available data and the taxpayer’s circumstances.
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