Exchange Control: New rules for royalties and fees paid to non-residents

Previously, South African prior exchange control (EXCON) rules required prior approval for these transactions. Such approval was obtained via Authorised Dealers at local commercial banks.  

The new rules apply in addition to the following types of payment:

• Payments for services rendered by non-resident individuals (including associated costs such as airfares and accommodation)
• Advance payments and down payments relating to future royalties or fees payable
• Percentage-based fees which are allowed if they are normal in the trade concerned

These new rules are described in the circular as being part of a continuous effort to reduce red tape. It is noted that these types of payment are covered by the transfer pricing rules in South Africa’s tax legislation. Therefore, the following principle is emphasised: “It should be noted that transactions involving related parties must be concluded at arm’s length and at fair and market related prices.”

From the perspective of multinational enterprises (MNEs) with South African operations – or based in South Africa – any measure which reduces red tape is obviously going to be welcomed.

It is important to note that transfer pricing rules globally have become increasingly stringent over several years, placing a significantly higher compliance burden on MNEs. The Organisation for Economic Co-operation and Development (OECD) is leading developments in this area. MNEs are currently grappling with the realities of implementing and achieving compliance with the new Pillar Two rules.

South Africa’s transfer pricing rules and compliance requirements are based on, and closely follow, the OECD models and guidance. They therefore represent global best practice in this area. While compliance with these rules can be onerous and expensive (and is becoming increasingly more so), foreign based MNEs would be familiar with them.

Unlike transfer pricing rules, which have become largely universal and standardised internationally, foreign exchange rules (such as our EXCON regulations) vary significantly across countries and are less widely implemented. These foreign exchange rules are likely viewed as local red tape by prospective investors. Therefore, any initiative to reduce such administrative burden would be considered an investor-friendly measure.

However, it is important to note that while the payment of royalties and management fees to foreign related parties may no longer require prior EXCON approval, they continue to be subject to EXCON rules – including the general requirement that they must be at arm’s length. The Circular further stipulates significant EXCON compliance obligations placed on both the company making these payments and the Authorised Dealers processing the payments. These obligations include:

• Senior management of the applicant company must confirm that the company maintains compliant transfer pricing documentation. It seems reasonable to assume that the SARB would require such documentation to cover the transactions in question. Furthermore, it will need to be clarified who qualifies as senior management in this context.
• The payments must be reported by the Authorised Dealer concerned on SARB’s FinSurv Reporting System.
• The Authorised Dealer must submit a return to the Financial Surveillance Department on a quarterly basis providing certain prescribed information regarding all related party agreements considered by the Authorised Dealer during the period stated.
• Authorised Dealers are required to view a copy of the agreement entered into in respect of the relevant payment. They should also review and invoice from the relevant non-resident party (in other words, the intended recipient of the payment) verifying the purpose and the amount involved.
• For recurring royalty payments, the applicant must submit an annual letter, on an annual basis, confirming the amount or percentage of such royalties transferred over a 12-month period.

There are certain specific additional rules covering ad hoc services between related parties and extensions and/or addendums to agreements.

The burden of red tape might have been reduced but it has by no means been eliminated. It also seems likely that, because taxpayers will be able to make payments of royalties and intra-group management fees without specific prior approval, the South African Revenue Service will, going forward, focus more intensely on these payments. This probably applies even more so to royalties – since this category of payment has been specifically identified by the OECD as one which can be used to achieve base erosion and profit shifting.

A final point is to note that the new rules, in so far as they apply to royalties, do not apply to those associated with a process of manufacture. There is a separate application process to the Department of Trade Industry and Competition (DTIC) for the approval of such royalties. The DTIC has confirmed that the separate application process for these royalties continues to apply.