Transfer Pricing Filing Obligations

Introduction

In South Africa, transfer pricing is a stated priority for the South African Revenue Service (SARS). Whilst the legislation surrounding transfer pricing is brief, effectively referring to the arm’s length principle, the regulations and guidance are extensive and conform for the most part to international norms. SARS is in the process of revising interpretation notes and practice notes relating to transfer pricing aspects in order to provide additional guidance to taxpayers.

a) Transfer pricing rules

Section 31 of the South African Income Tax Act No. 58 of 1962 governs the application of transfer pricing rules in South Africa. This section is used together with Practice Note 7 to practically apply the arm’s length principle to affected transactions. While South Africa is not a member of the OECD, Practice Note 7 recommends following OECD guidelines if specific guidance is required that is not found within South African legislation.

b) Transfer pricing methods

SARS accepts the methods prescribed by the OECD to the extent they are clearly substantiated by supporting evidence. The methods are: the comparable uncontrolled price (CUP) method, the resale price method (RP), the cost plus method (CP), the transactional net margin method (TNMM), and the profit split method (PS).

1. Comparable uncontrolled price (CUP) method

OECD guidelines state that the comparable uncontrolled price method provides the best evidence of an arm's length price. When using the CUP method, the price of a tangible asset transferred in an intragroup transaction is compared to the price of the same or similar asset transferred in a comparable third party transaction.

2. Resale price method (RP)

The RP method compares the gross profit margin realised by the distributor in connection with the intragroup transaction to the gross margin realised by it or a similar distributor in a comparable third party transaction.

3. Cost plus method (CP)

Using the cost plus method, an arm's length markup on the costs is determined either from the taxpayer's sales of the product or a similar product to third parties in comparable transactions, or from the markup realised by unrelated taxpayers in comparable transactions with third parties. The CP method compares the gross profit margin realised between intercompany transactions and third party transactions.

4. Transactional net margin method (TNMM)

The transactional net margin method (TNMM) can be used to test prices charged for tangible assets, intangible assets and as compensation for related party services. The TNMM compares the net profit margin of a taxpayer arising from a non-arm's length transaction with the net profit margins realised by arm's length parties from similar transactions. As the TNMM relies on a comparison of net margins, a high standard of comparability must be met in order for the TNMM to produce a reasonable estimate of an arm's length result. 

5. Profit split method (PS)

The profit split method may be applied where the operations of two or more non-arm's length parties are highly integrated, making it difficult to evaluate their transactions on an individual basis, and, therefore, preventing the application of the traditional transaction methods. Where the profit split method is applied, a detailed analysis of the functions performed by the parties to the transactions should be completed and well documented. 

c) OCED guidance

As previously mentioned, South Africa is not a member of the OECD. However, Practice Note 7 acknowledges that the OECD guidelines should be followed in the absence of specific guidance in terms of PN7, Section 31, or the double taxation treaties to which South Africa is a party.

d) Reporting requirements 

There is no specific transfer pricing return that needs to be submitted to SARS, however the SARS ITR14 corporate income tax return allows for customisation by way of a questionnaire that helps create a return tailored to a company’s factual declarations. This includes questions relevant to the application of transfer pricing rules.

The ITR14, Master File, Local File and CbCR are all due 12 months after the company’s financial year end. Therefore, it is recommended to submit the transfer pricing document to SARS together with the company’s tax ITR14 tax return.

Transfer pricing documentation

Transfer pricing documentation should be prepared annually in English, with the related benchmarking studies which only need to be updated every 3 years. It is recommended that benchmarking studies be performed on transactions that exceed ZAR 5 million. SARS may request documentation substantiating the transfer pricing applied to transactions exceeding ZAR 5 million.

A local file and a master file are required by law to be prepared and filed if a company’s affected transactions exceed or are expected to exceed ZAR 100 million in aggregate.

Country-by-country reporting (CbCR) is required if the consolidated group revenue exceeds ZAR 10 billion during the financial year immediately prior to the current financial year.

The non-submission of a company’s tax return and related documents can result in administrative penalties levied by SARS. Penalties range between ZAR 250 and ZAR 16 000, depending on the taxpayer’s taxable income from the preceding year. These penalties are charged on a monthly basis, per return outstanding, until the non-compliance is remedied.

In the event that SARS must make adjustments to the taxpayer’s submission, an understatement penalty may be levied as a result of default, omission, incorrect disclosure, or misrepresentation. The penalty is calculated as a percentage of the shortfall arising from the understatement. Depending on the case, SARS can apply a percentage that ranges from 10% to 200% of the calculation. 

Taxpayers may request a remission of the penalties, as long as they meet the requirements of section 217 and 218 of the Tax Administration Act (TAA). Interest will be charged at the prescribed rate in conjunction with the penalties, however it is not possible to request remission of the interest charged.

Economic analysis and how to demonstrate an arm’s length result

Economic analysis is an important step in the transfer pricing methodology. It is used to avoid base erosion and double taxation, in addition to supporting the application of the arm's length principle. The analysis involves profiling the various aspects that make up a company to select the most appropriate transfer pricing method to apply to its affected transactions. 

Comparable transactions are identified by way of a benchmarking study. The benchmarking study finds comparable transactions from companies within the same industry to find a median against which the company’s transactions can be assessed in order to determine whether they are at arm's length.

Advanced pricing agreements (APAs), dispute avoidance and resolution

There is currently no APA system in operation in South Africa. An APA is an agreement that determines a taxpayer’s transfer pricing methodology for the pricing of their cross-border, related-party transactions in advance. This agreement is between a taxpayer and SARS to help mitigate the possibility of transfer pricing disputes. 

On 11 November 2020, SARS published draft legislation and proposed a model for the establishment of an APA programme in South Africa. In addition to the draft legislation, SARS also released a discussion paper addressing the various considerations around BEPS and the implementation of APAs in South Africa, and which acknowledges that South Africa is lagging behind in putting legislation in place. The discussion paper notes that while SARS is not yet ready to implement an APA system, it will begin planning and drafting the required legislation for approval.