Page 156 - SAIT Compendium 2016 Volume2

PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999
arm’s length prices for the transfer of goods or services between connected persons in terms of transactions as
envisaged in section 31 of the Act.
11.2 The availability of information
11.2.1 In the light of the dif culties which may be encountered in obtaining information on uncontrolled transactions in South Africa, the Commissioner will accept the use of foreign country comparables (e.g., data from the Australian, United Kingdom and United States markets) in taxpayers’ transfer pricing analyses. However, taxpayers using such comparables would be expected to assess the expected impact of geographic differences and other factors on the price.
11.2.2 For example, data may be available to indicate that the gross margin paid to distributors of a particular product in the United Kingdom is 20 per cent. This does not mean that 20 per cent will necessarily be an appropriate gross margin for South African distributors. There are a number of factors which may indicate an alternative gross margin to be more appropriate. For example:
(a) Consumer preferences may result in different retail prices for a product in the two countries. This raises the question of which party to the transaction should capture any premium in price.
(b) Higher transport costs may be associated with one of the markets. The relative gross margins may be affected by who bears this cost.
(c) The relative competitiveness of the distribution industries in South Africa and the United Kingdom may differ. This could result in lower gross margins being paid in the more competitive market.
(d) There may be differences in accounting standards that, if not adjusted for, could distort the relative margins of the parties being compared.
11.2.3 Thus, while foreign comparables may be useful, taxpayers will need to exercise caution to ensure that appropriate adjustments re ect differences between the South African and foreign markets.
11.3 Determining the party to be evaluated in a controlled transaction
11.3.1 From a South African perspective, the focus should be primarily on functions performed by the South African member, as the basis for determining and applying an appropriate pricing method.
11.3.2 However, there may be instances where, based on a taxpayer’s circumstances and the information available, it would be appropriate for the foreign party to a transaction to be evaluated in determining the most reliable measure of the arm’s length price. This would be the case where the foreign party does not own intangible property, or does not perform any unique functions. For example, if the other party were a contract distributor, the obvious choice of method, based on the activities of that distributor, would seem to be the resale price method. In such instances the taxpayer will need to consider its ability to obtain reliable information about comparable transactions from which to determine an arm’s length price.
11.3.3 From the Commissioner’s perspective, the important point is that a pragmatic approach is required. In determining which party to a transaction should be used as the party to be evaluated, taxpayers should seek a practical solution that leads to a reliable determination of the arm’s length amount.
11.3.4 However, taxpayers should be aware that the Commissioner would generally prefer using the South African party as the party to be evaluated, in appraising whether a taxpayer’s transfer prices are arm’s length. It is, therefore, important that if a taxpayer uses a foreign party as the party to be evaluated, the price determined is also considered in relation to the South African operations, to ensure that it results in an appropriate return for those operations.
11.4 Determination of an arm’s length range
11.4.1 As transfer pricing is not an exact science, the application of the most appropriate method or methods will often result in a range of justi able transfer prices.
11.4.2 An arm’s length range is arrived at by applying a transfer pricing method to multiple comparable data, or from applying different transfer pricing methods. Deciding on the price within a range would involve a degree of judgment.
11.4.3 A number of considerations should be taken into account when determining an arm’s length range. The arm’s length range would be determined using only comparable uncontrolled dealings that have been, or will be, adjusted to a level of comparability similar to the controlled dealings.
11.4.4 Where a single method is applied, it should be capable of being applied with similar accuracy and reliability to each element of data constituting the range, having regard to all the factors relevant to comparability.
11.4.5 Where there is substantial divergence between the data in the range, it is doubtful whether all the data in the range are truly arm’s length outcomes. In such cases any adjustments made for material differences in comparability, as well as the method itself, should be reviewed.
11.4.6 There would be more con dence in ranges that are established by the use of different methods if those ranges, when compared, re ect common results.
11.4.7 A high level of comparability is required in order to apply a traditional transaction method (CUP, CP, and RP methods). When using these methods, an outcome that falls within a properly constructed arm’s length range should be regarded as being arm’s length, if the data used to construct the range is truly comparable. However, if the transaction falls outside the arm’s length range, it is a matter of judgment as to where in the range the adjustment should be effected. The Commissioner concurs with the view of the OECD that the adjustment should re ect the point in the range that best accounts for the facts and circumstances of the controlled transaction. However, in the absence of persuasive evidence for the selection of a particular point in the range, the Commissioner may select the mid-point in the range.
11.4.8 When applying a method other than a traditional transaction method, arm’s length ranges will be evaluated thoroughly. The approximations used in applying these other methods which rely on broader measures of comparability can result in extensive ranges, some of which may not be suf ciently accurate to permit the general statement that any point in the range may be regarded as arm’s length.
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