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PN 7/1999 Income Tax acT: PracTIce noTes PN 7/1999 2.3.3 allocation of the consideration between the enterprises, when a pro t split method is applicable.
3 Step 3: Application of the pricing method or methods
3.1 Once a pricing method (or methods) has been chosen, the preliminary functional analysis prepared in step 1 can be extended to re ect that choice of method.
3.2 If a pricing method involving external benchmarking with independent enterprises is being used, the functional analysis assists in determining the comparability of the multinational’s dealings with uncontrolled dealings of the independent parties. The main purpose of this is to establish the degree of comparability. It is, therefore, not necessary to value the functions, assets and risks of each of the enterprises separately. However, it is essential to ensure that, if there are differences in the signi cance of the functions, assets and risks to each of the businesses, these differences are taken into account.
3.3 The functional analysis can be performed with varying levels of detail and can serve a variety of purposes. The analysis may be applied on a product, a divisional basis for individual transactions, or on all levels up to corporate group level. The scope of the analysis will be determined by the nature, value and complexity of the matters covered by international dealings. It will also be determined by the nature of the taxpayer’s business activities, including the strategies that the enterprise pursues and the features of its products or services.
4 Step 4: Arriving at the arm’s length amount and introducing processes to support the chosen method
4.1 The taxpayer will be required to document and demonstrate how its data has been used in the application of its chosen pricing method to determine an arm’s length amount.
4.2 Adherence to the process up to this stage should result in a taxpayer having an objective, documented and considered review of the available material and possible choices for arriving at an arm’s length outcome. However, the nature of the arm’s length principle is such that there are a number of practical problems in its application. Transfer pricing will always require an element of judgment and taxpayers and the Commissioner need to bear this in mind in undertaking their transfer pricing analysis.
4.3 It should also be noted that transfer pricing does not end with the initial analysis. Taxpayers will need to implement appropriate processes to:
4.3.1 ensure the availability of data for subsequent review analyses; and
4.3.2 allow for changes in the choice and application of a pricing method, to re ect changes in their
circumstances or market conditions, or if the process followed does not result in a commercially realistic outcome.
ADDENDUM TO SARS PRACTICE NOTE 7 DATED 6 AUGUST 1999
SUBMISSION OF TRANSFER PRICING POLICY DOCUMENT
It has been brought to SARS’ attention that taxpayers are being advised that they must submit a copy of their transfer pricing policy document with their annual return of income. Where taxpayers have not prepared such a policy document, they are advised that they are obliged to draft one for submission with their return to prevent a material non-disclosure
that is an offence and will result in the return remaining open inde nitely for revision by SARS.
SARS wishes to clarify its position on this matter and provide taxpayers with some guidance on how to approach it.
SARS Practice Note 7 dated 6 August 1999 dealing with transfer pricing states the following in paragraph 10.2: ‘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.’
SARS hereby con rms that its policy remains that there is no statutory requirement that taxpayers compile a formal transfer pricing policy document. The requirement for submission of a formal transfer pricing policy document in terms
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