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Latest Developments in Transfer Pricing Rules
More than a year has passed since the announcement was made in the middle of 2010, that the South African transfer pricing rules would undergo a substantial redrafting process in order to align them with international best practice. In the meantime, the initially envisaged effective date of 1 October 2011 has come and gone and the third updated version of the new section 31 of the Income Tax Act 58 of 1962 has been introduced by the Minister of Finance to Parliament in terms of the Taxation Laws Amendment Bill, 2011, which if promulgated in its current form, will come into operation on 1 April 2012, applying in respect of all financial years commencing on or after that date. Taxand South Africa considers the Taxation Laws Amendment Bill and how it is likely to affect South African taxpayers.
Section 31 of the Act essentially requires that an arm's length, that is, market related, price be paid or charged in respect of the cross-border supply of goods or services between connected persons. Should the Commissioner for the South African Revenue Service be of the opinion that an arm's length price has not been paid or charged, he is entitled to adjust the consideration for the transaction in order for it to reflect an arm's length price, resulting in a potentially higher tax liability for the taxpayer. Furthermore, the excessive portion of the consideration is currently subject to Secondary Tax on Companies at a rate of 10%, since the payment will be regarded as a deemed dividend under section 64(C)(2)(e) of the Act. The Commissioner is also entitled to impose additional tax of up to 200% on the under payment of tax, together with interest.
Taxand South Africa explores the potential new transfer pricing regulations in greater detail
Although the introduction of the arm's length standard to the thin capitalisation rules seems to be commendable, in practice the application of the arm's length principle in the context of thin capitalisation has proven to be extremely difficult, as the factors considered by third party providers of financial assistance are often multi-faceted and not necessarily limited to an analysis of the debt to equity ratio. SARS has acknowledged this and has undertaken to issue an interpretation note in respect of the new transfer pricing rules in general and the application of the arm's length principle to thin capitalisation specifically before 1 April 2012. Based on international precedence and discussions with financial institutions, we would expect that the interpretation note will again provide some form of safe harbour, although in all likelihood not relying on the current debt to equity ratio. Instead, SARS might follow the approach of countries such as Germany or France and limit the interest deduction to a certain percentage of operating income or EBITDA, that is, earnings before interest, tax and depreciation allowances.