Authored by Billy Joubert: Senior Associate Director | Transfer Pricing, Deloitte Africa Tax & Legal
Transfer pricing (TP) is an area which has been changing rapidly in recent years. This as a result of the ongoing focus of the Organisation for Economic Co-operation and Development (OECD) on base erosion and profit shifting (BEPS). Indeed, the burden associated with TP compliance is significant and is set to become more so with the imminent introduction of Pillar Two rules. Compliance for South African taxpayers, which form part of a multinational enterprise (MNE), has become increasingly arduous with compulsory preparation and submissions of transfer pricing local files and master files (for MNEs with cross-border related party transactions above certain thresholds) and also of the country-by-country (CbC) report for significant SA based MNEs.
As a consequence of these changes MNEs have to accept that they are subject to a much greater degree of transparency when it comes to their worldwide group. The CbC report enables tax administrations to establish exactly where the group is making its profits – and the extent of such profits. The introduction of the Pillar Two minimum global tax regime, and of the broader BEPS initiatives, may further contribute to this trend.
Access to the CbC report equips tax authorities to mine the group’s financial information and identify potential areas of vulnerability. Indeed, the OECD has issued a comprehensive handbook to enable tax administrations to use the CbC report to effectively determine areas of risk. This includes identifying 19 specific “Potential tax risk indicators”.
So far, we have not seen any queries from the South African Revenue Service (SARS) arising explicitly from information obtained from the CbC report of a group. However, this is the expectation. There is also technology available which allows information to be mined automatically and generates reports highlighting areas which could justify further investigation. This would be low hanging fruit for SARS and other tax administrations.
An exciting recent development is the promulgation, in December 2023, of the South African advance pricing agreement (APA) legislation. Further details of how the APA programme will work will be contained in regulations still to be issued and the effective date of the APA programme will be determined by the SARS Commissioner via public notice. The APA programme is designed to mitigate TP risk by providing taxpayers with the opportunity to obtain certainty via an agreement with the relevant tax authorities in advance of embarking on significant large-scale international transactions. There is considerable excitement about this programme and it is expected to be a significant area of focus going forward.
Another trend is that TP continues to be a focus area for SARS and other tax authorities across Africa. Thus far, TP disputes have generally been settled via the alternative dispute resolution (ADR) process.
However, we have seen a persistent and significant trend of taxpayers and SARS battling to reach a settled solution via the ADR process. Expectation gaps of possible settlement options that the parties feel they can live with are sometimes just too wide. Therefore, taxpayers are increasingly pursuing other options – including litigation or proceedings via the mutual agreement procedure (MAP) process in terms of tax treaties. Until recently, TP court cases have been unheard of in South Africa. How will these unfold in court? That remains to be seen. Yet we are aware of several matters that are likely to proceed to court, – some imminent. We are also aware of several recent and imminent MAP proceedings, some of them being multilateral MAPs.
All of this means that TP specialists, both in-house specialists and practitioners, need to focus simultaneously on the past, the present and the future. The past often remains with us because TP disputes always relate to previous years, sometimes up to seven or eight years in arrears. We have recently seen new disputes arising which relate to financial years as far back as 2016. This often indicates significant exposure in subsequent years if the transactions, and associated TP policies, have remain unchanged.
Where such cases proceed to court there can be significant challenges with gathering evidence, and obtaining witnesses who can reliably testify to events dating that far back.
We are also forced to live in the present as the everyday issues remain, and there is also the increasing compliance burden outlined above. We have often seen MNEs implementing significant operational or structural changes that greatly affect their TP situation but only thinking about TP once the new transactions need to be included in the local files. Since TP documentation is prepared significantly in arrears, under this scenario any exposures resulting from such changes are crystalised by the time a TP lens is used. This risk can only be mitigated by ensuring that in-house tax specialists are aware of such developments within the group and are responding in real time – including obtaining specialist advice where required.
The upcoming implementation of an APA regime will require us to cast our minds into the future. SARS has chosen to go the route of allowing bi-lateral APAs first and then implement unilateral APAs. The negotiation of bi-lateral, or multilateral, APAs requires the involvement of multiple tax authorities. They therefore typically take extended periods to negotiate and reach an agreement. This means that MNEs will need to do significant advance planning to take advantage of the APA regime.
In summary, the trends which we foresee affecting the TP environment include the following: