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Relief from transfer pricing for CFCs
The current South African transfer pricing (TP) provisions contained in section 31 of the Income Tax Act came into effect on 1 April 2012 and are applicable for years of assessment commencing on or after that date. Taxand South Africa takes a look at relief from TP for controlled foreign companies (CFCs).
Where a South African company makes an interest-free shareholder loan to its CFC with no fixed date of repayment, the provisions of section 31 would apply to the South African company and the South African company will be required to calculate its taxable income as if the shareholder loan had been entered into on terms and conditions that would have existed between independent persons dealing on an arm’s length basis. The South African company would therefore be required to make a primary adjustment by including in its taxable income interest at a rate equal to an arms’ length interest rate on the shareholder loan to the CFC. The South African company would further be required to make the secondary adjustment by including in its taxable income an amount of interest calculated at an arms’ length interest rate on the deemed loan until it is repaid.
However because of the application of section 31 to such interest-free shareholder loans, the South African company will be subject to income tax on the notional primary and secondary adjustments, whilst the CFC will not be allowed a deduction for the primary and secondary adjustments. The net result is a potential double taxation which reduces the international competitiveness of South African multinationals.
In order to facilitate the expansion and global competitiveness of South African multinationals in other countries it was proposed that transfer pricing provisions will not apply to certain cross-border financial assistance transactions (eg shareholder loans).
To this end section 31(6) was introduced by the Taxation Laws Amendment Act, where any transaction, operation, scheme, agreement or understanding that comprises the granting of “financial assistance” by a person that is a resident to a CFC in relation to that resident, section 31 must not be applied in calculating the taxable income or tax payable by that resident in respect of any amount received by or accrued to that resident in terms of that transaction, operation, scheme, agreement or understanding if:
- That CFC has a “foreign business establishment” as defined in section 9D(1)
- The aggregate amount of tax payable to all spheres of government of any country other than South Africa by that CFC in respect of any “foreign tax year” of that CFC during which that transaction, operation, scheme, agreement, or understanding exists is at least 75% of the amount of normal tax that would have been payable in respect of any taxable income of that CFC had that CFC been a resident for that foreign tax year: provided that the aggregate amount of tax so payable must be determined
- After taking into account any applicable double taxation agreement and any credit, rebate or other right of recovery of tax from any sphere of government of any country other than South Africa
- After disregarding any loss in respect of a year other than that foreign tax year or from a company other than that CFC
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Also published in Thomson Reuters' Taxnet Pro, 12 June 2014
The reason for the allowance of relief from TP provisions in the case of high-taxed CFCs is because the high-taxed nature of a CFC provides little overall net worldwide tax savings, if the interest is understated and therefore provides very little possibility for tax avoidance. Multinationals should investigate this relief further to ascertain if it would apply to their specifc situation.