Page 149 - SAIT Compendium 2016 Volume2

PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999
9.3.2 The Commissioner acknowledges that the suitability and reliability of a method will depend on the facts and circumstances of each case. The most reliable method will be the one that requires fewer and more reliable adjustments.
9.3.3 It is essential to have an understanding of the commercial and economic reality underlying any particular transaction before beginning with a search for, and close examination of comparable transactions between unrelated enterprises in an application of the traditional arm’s length methods.
9.3.4 As a general rule, the traditional transaction methods are preferred. Of these methods the CUP method is preferred, as it looks directly to the product or service transferred and is relatively insensitive to the speci c functions which are performed by the entities being compared.
9.3.5 The RP and CP methods look at valuing the functions performed. Because these methods examine gross margins, operating expenses are excluded and therefore the impact of relative cost structures should not be material.
9.3.6 In practice, the traditional methods may not be able to be applied, because of information constraints, particularly the lack of comparable uncontrolled transactions or published data on gross margins. Hence it may be necessary to resort to the transactional pro ts methods.
9.3.7 Of the transactional pro ts methods, the TNMM is reasonably objective because comparables are applied. Essentially, this is either the RP or CP with varying levels of operating expenses incorporated into the calculations.
9.3.8 In theory the TNMM is inferior to the RP or CP methods where suf cient information is available to apply all three methods, because comparing operating expenses requires a similar structure of business to be truly reliable. This presents a more dif cult threshold than functional comparability.
9.3.9 Where a taxpayer has considered a number of methods, it may be appropriate to document the reasons for discarding some of those methods. The availability of data is likely to be very important in a taxpayer’s choice of method. South Africa is a small market and under certain circumstances this means reliable comparables may be dif cult for taxpayers to locate. Approaches to address this problem are set out in paragraphs 11.2, 11.3 and 12.5 of this Practice Note.
9.4 The CUP method
9.4.1 Description
In applying the CUP method, a direct comparison is drawn between the price charged for a speci c product in a controlled transaction and the price charged for a closely comparable product in an uncontrolled transaction, in comparable circumstances. It therefore primarily focuses on the goods being transferred or service being rendered, but also takes into account broader business functions and economic circumstances.
Differences between the two prices may indicate the existence of non-arm’s length conditions and that the price
in the controlled transaction may need to be substituted for the price in the uncontrolled transaction.
9.4.2 Application
The CUP method is the most direct and reliable way to apply the arm’s length principle where it is possible to locate comparable uncontrolled transactions. A comparable uncontrolled price can be determined by reference to similar products or services transferred under similar circumstances by the taxpayer to an independent party (internal comparable) or by reference to similar products or services transferred under similar circumstances by one independent party to another (external comparable).
The two transactions being compared will only be truly comparable if there are no differences between the two transactions that will have a material effect on the price, or if reasonably accurate adjustments can be made to eliminate the effect of differences that may materially affect the price.
It is important to keep in mind that two transactions will not be comparable merely because the product or service transferred is comparable. Regard should also be had to the effect on price of broader business functions and economic circumstances other than just the product comparability.
Listed below are examples of where adjustments may be necessary when comparable products or services are transferred between independent parties or the taxpayer and an independent third party:
(a) terms of a transactions may differ (for example, credit terms)
(b) volumes transferred may differ signi cantly e.g. sell 10 tonnes to an independent party vs. 1000 tonnes to a
connected person
(c) sell FOB to a connected person and at CIF to an independent party Certain adjustments could be very dif cult to effect, such as differences in— (a) the quality of the products
(b) geographic markets
(c) market levels
(d) amount and type of intangible property involved
9.4.3 Practical problems
(a) It is usually very dif cult to nd a transaction between independent enterprises which is suf ciently similar to a controlled transaction, without differences which have a material effect on price.
(b) Where differences exist between the controlled and uncontrolled transactions, or between the enterprises undertaking those transactions, it may be dif cult or impossible to determine reasonably accurate adjustments to eliminate the effect on price.
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