Transfer pricing (TP) rules have existed for several decades internationally. In South Africa we have had TP legislation since 1995 and a detailed TP Practice Note – based on the Organisation for Economic Co-operation and Development (OECD) TP Guidelines – since 1999. TP rules have continued to evolve – with updated OECD Guidelines having been released in 2010 and 2017 and expected in January 2022.
Yet the South African Revenue Service (SARS) Practice Note 7 (the TP practice Note) is still in force, except for the rules relating to mandatory record keeping which were passed in 2016. The balance of the Practice Note continues to apply, despite having been superseded to a significant extent by fundamental changes in the OECD Guidelines. SARS Practice Note 2 (the thin capitalisation practice note) was also issued in 1999. However, that was effectively made redundant by changes in our TP legislation and it was subsequently withdrawn and has never been replaced. Although SARS issued a Draft Interpretation Note on thin capitalisation several years ago, it has not been finalised.
Changes to TP rules, over the past few years, impose a much greater compliance burden on taxpayers. In line with OECD guidance, the preparation and annual submission of TP documentation is now compulsory for South African taxpayers with significant (or relatively significant) cross-border transactions with related parties. In many cases this includes both an entity specific local file and a group-wide standard master file. Significant multinational enterprises (MNEs) are also required to prepare a country-by-country (CbC) report, which may be required to be submitted to SARS by South African based MNEs and are then shared by SARS with other revenue authorities where the group has a presence. For significant foreign based MNEs with a South Africa (SA) presence, the reverse scenario generally applies.
SA has generally been an early adopter of these rules which impose a greater reporting and compliance burden on taxpayers. The implementation of these rules has been effected by ensuring that the necessary domestic enabling regulations and international treaties are put in place timeously.
However, where SARS has been less responsive is in providing guidance to taxpayers which could assist them in navigating the pitfalls and areas of uncertainty associated with such a complex area as TP. More specifically:
SARS is working on an updated TP Interpretation Note and had an engagement with the South African Institute of Chartered Accountants TP Sub-committee during 2021 to discuss this. Following which, the members of the sub-committee submitted written recommendations to SARS. However, it is not clear when a draft of the Interpretation Note can be expected.
A significant challenge with issuing a new Interpretation Note now is that, for impacted larger MNEs, the way in which TP works globally is about to be turned on its head. Therefore, there is a real risk (perhaps a likelihood) that a new Interpretation Note will very quickly become obsolete or, at the very least, incomplete.
Whereas TP rules have evolved gradually for many years, there are certain very fundamental changes which are being worked on by the OECD and which are associated with tax challenges associated with the digitalisation of the global economy. These are primarily embodied in the so called “Two-Pillar Solution”. The threshold for Pillar One to apply (global group turnover above 20 billion Euros – reducing in future to 10 billion Euros) is much higher than for Pillar Two (group turnover of 750 million Euros). Therefore, practically speaking, far more MNEs will be affected by Pillar Two than by Pillar One.
Pillar One will enable revenue authorities to tax certain revenues realised in market jurisdictions – being those countries around the world into which a multinational enterprise makes its sales without creating a taxable permanent establishment in-country currently. This measure is intended, amongst other things, to replace digital services taxes. Therefore, it is envisaged that a multilateral convention (MLC) will be signed by all participating countries which undertakes, amongst other things, to remove all existing digital services taxes. It is also envisaged that the MLC will be signed by participating countries during 2022.
Pillar Two will, amongst other things, enable the revenue authority in the country where the parent of an MNE is located to impose top-up tax on profits which have been undertaxed elsewhere in the group (i.e. taxed at a rate of less than 15%).
It is envisaged by the OECD that both Pillar One and Pillar Two will become effective in 2023 - so time is short. The implementation of both pillars involves a combination of international agreements and, more than likely, significant changes to domestic laws. For example, in South Africa the interaction between Pillar Two and our controlled foreign company (CFC) rules will need to be examined and the CFC rules amended as necessary.
There will be other areas which require consideration. For example, the trigger in our domestic laws which gives the South African fiscus the right to tax income of foreign tax residents in our source rules; foreigners are taxed here on South African sourced income. Yet the principles of our source rules exist in our common law and evolved long before Pillar One was even dreamed of. We will therefore need to suitably amend our tax rules and treaties through enabling legislation and the MLC to make sure that we cast our net widely enough to capture the income of foreign residents which will potentially become taxable under Pillar One.
These are just two examples of how our domestic tax laws and treaties will need to be amended to keep up with the changes.
An area where SARS has been successful in maintaining momentum is with the proposed establishment of an Advance Pricing Agreement (APA) programme. APAs are agreements that revenue authorities concluded with taxpayers in respect of future transactions regarding the pricing of such transactions. Such an agreement can be exceptionally valuable for taxpayers since it can eliminate the TP risk associated with the pricing of significant transactions for an agreed period. SARS issued a discussion paper on the possible implementation of an APA programme in late 2020. Having received comments on that paper and after further consideration, in late 2021 it issued a document entitled “Proposed Model for Establishing an Advance Pricing Agreement”. SARS has invited comment to be submitted on that paper by end January 2022.
That paper includes certain draft legislation as an annexure. It also outlines a proposed high-level process flow which tracks an end-to-end process from APA pre-application through negotiation to termination or renewal of the APA. The wording of that process flow seems to envisage only bilateral APAs (i.e. between revenue authorities of more than one country and the respective taxpayers) and not unilateral ones (between SARS and the SA taxpayer only), presumably as bilateral APAs are covered in the OECD’s peer review reports on the dispute resolution mechanisms available per country. It also makes it clear that certain key aspects of the APA system - such as which persons are eligible to apply to SARS for an APA and the minimum value of the affected transactions – will be managed by public notice in the Government Gazette. These aspects are therefore not clear at this stage.
SARS is to be commended on maintaining the momentum of putting an APA process in place. This would certainly be a value-adding step for taxpayers (and prospective investors into our economy). If it is intended only to have a bilateral APA programme, then SARS should consider extending the scope of the advance tax ruling (ATR) process to include TP matters. TP is currently expressly excluded from the ATR process. This should assist taxpayers (and SARS) in avoiding costly TP disputes.
Presumably, the reason for excluding TP from the ATR process so far is that TP is considered to be a very complex area requiring significant technical resources and SARS was not confident that it had the capacity to handle ATR applications relating to TP. However, the implementation of the APA process involves resourcing a team with sufficient technical skill to manage the APA process. Therefore, perhaps these additional resources may enable SARS to consider extending the ATR programme to TP matters.
In summary, it is clear that SARS faces considerable challenges in keeping pace with the changes in the global tax environment. The pace of change has increased dramatically and the effectiveness with which SARS responds is an important factor in South Africa’s effectiveness both in optimising tax collections and offering a globally up-to-date tax system to investors.