Page 150 - SAIT Compendium 2016 Volume2

PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999 9.4.4 Example
A South African enterprise, A, manufactures crocodile leather shoes and travel bags. The shoes are sold to a French subsidiary, B, which sells the shoes to unconnected exclusive boutiques. The credit terms to B are 90 days. A also sells the shoes to two independent distributors in France, C and D. The credit terms to the independent parties are 30 days. C sells the shoes directly to end-users and D sells the shoes to expensive shoe shops in Oxford and Bond Street in London. A also sells the travel bags to an independent distributor in France.
Possible CUPs:
The travel bags sold to the independent distributor in France will not constitute a CUP because the product is not similar to shoes and the price is not comparable.
The shoes sold to C would also not qualify as a CUP because the level of the market is different. B is at a higher level in the distribution chain than C and it is unlikely to be possible to quantify this difference and make reliable adjustments.
The shoes sold to D may be a valid CUP if the Paris and London markets are comparable. It will, however, be necessary to adjust the price for the difference in credit terms.
9.5 The Resale Price method
9.5.1 Description
The resale price method is based on the price at which a product, which has been purchased from a connected enterprise, is resold to an independent enterprise. The resale price is then reduced by an appropriate gross margin, to cover the reseller’s selling and other operating costs, and to provide an appropriate pro t, depending on functions performed, assets used and risks assumed by the reseller. The balance may be regarded as the arm’s length price before other adjustments in respect of, for example, customs duties.
9.5.2 Application
The resale price margin of the reseller in the controlled transaction may be determined by reference to the resale price margin that the entity obtains on items purchased and sold in comparable uncontrolled transactions, as well as by reference to the resale price margin obtained by one independent party selling to another.
Functional comparability is very important and it is essential that the functions performed by the independent entity are comparable to the functions performed by the member of the multinational selling to an independent enterprise. There should be no differences, which have a material effect on the price, for which reasonably accurate adjustments cannot be made.
In applying the resale price method, fewer adjustments are normally required for product comparability than under the CUP method. Minor product differences are less likely to have an effect on pro t margins than on prices, as pro t margins for similar functions tend to be equal, but prices for different products will be equal only to the extent that products are substitutes for one another. For example, a distributor performs the same function to sell toasters and blenders and is therefore likely to require the same pro t margin, but blenders are not comparable in price to toasters.
Although broader product differences can be allowed in the resale price method, product similarity may still be important when applying this method, for example when high value intangibles are involved. All the other factors affecting comparability will have to be considered when applying the resale price method.
The resale price method focuses only on the external sale price to third parties and the gross margin required to reward the function performed by the reseller. These factors are not overly sensitive to differences between the cost structure of a member of a multinational and an independent rm. Thus, if the member of the multinational operates a more ef cient distributorship than the independent rm, this will result in a higher net pro t percentage when the resale price method is used, and will not in uence the gross pro t percentage.
The resale price method is most appropriate where the reseller does not add substantially to the value of the
product or does not posses valuable marketing intangibles.
9.5.3 Practical problems
(a) The biggest problem is to determine an arm’s length resale price gross margin. It is usually very dif cult to nd a transaction between independent enterprises that is similar to a controlled transaction and where differences do not have a material effect on the margin.
(b) Accounting policies also play an important role and appropriate adjustments should be made to ensure that the same types of costs are included for the comparison. The items of cost taken into account to arrive at a gross margin may differ from company to company.
(c) The application of this method sometimes requires access to segregated product data. Whilst this information may be available in respect of the controlled party being examined, it will usually not be available in respect of uncontrolled entities used as benchmarks.
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