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PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999 9.8.4 Example
A, a South African manufacturer of mining equipment, acquired B, a company located in Namibia. B has an established distribution network in Namibia and the rest of Africa and has good contacts at mines in the region. A would not have been able to sell its product without involving B’s contacts. Before the acquisition of the B, A and the company considered entering into a joint venture agreement and were negotiating a pro t split of 40 per cent for A and 60 per cent for B.
Application of the pro t split method
There are no comparables which would allow the application of the CUP, resale price or cost plus methods. Based on the negotiations before the acquisition of B by A, it was decided to apply the pro t split method to arrive at arm’s length prices. Because of the importance of B’s contacts and distribution network, and the other factors taken into account during the negotiation phase, it was decided that the transfer price at which the product should be sold to the B should be set at a level that will result in a 40:60 pro t split if the relevant factors remain unchanged.
10 Documentation
10.1 The Act
10.1.1 Sections 74, 74A, 74B, 74C, 74D and 75 of the Act deal comprehensively with the information and documents of the taxpayer and the access of SARS to such information and documents, as well as the supporting documentation required when submitting returns. These provisions are also applicable to transfer pricing investigations. In addition, section 69 of the Act also enables the Commissioner to require any person to furnish the information he may require.
10.1.2 The Commissioner, for the purpose of obtaining full information in respect of the income of a taxpayer or of any part thereof, may require the taxpayer or any other person to produce for examination by the Commissioner, or by any person appointed by him, at such time and place as may be determined by the Commissioner, any ‘documents’ or ‘information’ (as de ned in section 74 (1)) which the Commissioner may require. If any document is not in one of the of cial languages, the Commissioner may, by written notice, require the taxpayer to, at his own expense, produce a translation in one of the of cial languages, prepared and certi ed by a sworn translator or another person approved by the Commissioner.
10.1.3 Section 75 (1) (f) requires all records (namely ledgers, cash-books, journals, cheque-books, bank statements, deposit slips, paid cheques, invoices, stock lists, all other books of account and data created by means of a computer relating to any trade carried on by the taxpayer), as well as recorded details from which the taxpayer’s returns were prepared, for assessment of taxes, to be retained for a period of four years from the date on which the return relevant to the last entry in any of the above-mentioned records was received by the Commissioner.
10.1.4 The purpose of this section of the Practice Note is to cover the broad issues relating to the types and extent of documentation which taxpayers are advised to keep, to be able to demonstrate how their methods and prices satisfy the arm’s length principle.
10.2 The need for documentation
10.2.1 Although there is no explicit statutory requirement to prepare and maintain transfer pricing documentation, it is in the taxpayer’s best interest to document how transfer prices have been determined, since adequate documentation is the best way to demonstrate that transfer prices are consistent with the arm’s length principle, as required by section 31.
10.2.2 A taxpayer electing not to prepare transfer pricing documentation is at risk on two counts. Firstly, it is more likely that the Commissioner will examine a taxpayer’s transfer pricing in detail if the taxpayer has not prepared proper documentation. Secondly, if the Commissioner, as a result of this examination, substitutes an alternative arm’s length amount for the one adopted by the taxpayer, the lack of adequate documentation will make it dif cult for the taxpayer to rebut that substitution, either directly to the Commissioner or in the Courts.
10.2.3 Also, if taxpayers have not maintained appropriate records, the process of checking compliance with the arm’s length principle becomes far more dif cult and the Commissioner’s of cials are forced to rely on less evidence on which to apply a method, thus requiring a greater degree of judgment.
10.2.4 In addition there are practical reasons why taxpayers would be well advised to keep contemporaneous (at or close to the time the transaction occurs) documentation. The income tax return for companies (IT 14) requires taxpayers to supply certain speci c information regarding transactions entered into between connected persons. It is not possible for a taxpayer to comply with these requirements if the taxpayer has not addressed the question of whether its dealings comply with the arm’s length principle.
10.2.5 Thus, if a taxpayer can demonstrate that it has developed a sound transfer pricing policy in terms of which transfer prices are determined in accordance with the arm’s length principle by documenting the policies and procedures for determining those prices, the Commissioner is more likely to conclude that its transfer pricing practices are acceptable and the risk of possible adjustments will be diminished.
10.2.6 On the other hand, preparing documentation is time-consuming and expensive. It will therefore not be expected of taxpayers to go to such lengths that the compliance costs related to the preparation of documentation are disproportionate to the nature, scope and complexity of the international agreements entered into by taxpayers with connected persons.
10.3 Documentation guidelines
10.3.1 The documentation guidelines set out below broadly follow Chapter V of the OECD Guidelines. According to paragraph 5.4 of the OECD Guidelines, the taxpayer’s process of considering whether transfer pricing is
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