South Africa recently tightened its transfer pricing and disclosure requirements, implementing global standards. This was an important step to enable the South African Revenue Service (SARS) to enforce transfer pricing rules and to counter undesired base erosion through profit shifting.
However, the question remains what else can be done to address impermissible transfer (mis-) pricing and to stimulate investment into South Africa, as tax collections have not been where they should be and it is expected that further expenditure will be proposed in the 2019 Budget?
The impact of transfer pricing related profit shifting on tax collections
Base erosion and profit shifting (BEPS) has been an issue identified by governments around the globe and the Organisation for Economic Co-operation and Development (OECD) was tasked to identify and recommend measures to counter this.
The OECD BEPS initiative resulted in an action plan including 15 specific actions, which were published in 2015. This Action Plan was designed to counter BEPS. Four of these actions specifically related to transfer pricing.
Transfer pricing is the pricing of goods or services between connected persons and, in the case of South Africa, across border. Transfer pricing can be used as a method to shift profits from one multinational company to another group company in another country where these profits may be subject to a lower corporate tax rate. Ultimately, the effect of base erosion through profit shifting is that the country from which taxable profits are shifted away loses tax revenue, the country to which these profits are shifted would gain tax revenue (usually at a lower tax rate) and the Multinational Group may reduce its overall effective tax rate.
As mentioned above, BEPS is a global phenomenon. A recent research study estimates that South Africa loses approximately R7 billion a year due to profit shifting by multinational corporations; amounting to about 4% of total current corporate income tax receipts. Corporate income tax, together with personal income tax and VAT comprise approximately 80% of total revenue collections per year.
Countering transfer pricing related profit shifting in South Africa
The OECD published the final 15 BEPS Actions Reports in October 2015 and shortly thereafter, the G20 Finance Ministers approved these reports. Then, in 2017, the OECD Transfer Pricing Guidelines were updated to reflect significant changes, besides other measures relating to transfer pricing documentation, stemming from the BEPS Actions.
The new OECD Transfer Pricing Guidelines set out a new three-tiered documentation methodology together with a new multilateral transfer pricing automatic exchange of information process. Many countries implemented this approach, including South Africa. The information to be included in terms of the new documentation approach is intended to provide tax administrations with a much clearer detail regarding how and in which jurisdictions a multinational group operates.
The aim is for tax administrations to be able to better enforce transfer pricing compliance with a view to counter undesired profit shifting.
South Africa has followed suit and adopted these new requirements in terms of local regulations, which have already been fully implemented. The new regulations require taxpayers to not only prepare detailed transfer pricing documentation, but to also file this documentation electronically, provided certain requirements have been met. Therefore, SARS is now in a position to quickly identify taxpayers who may be considered risky form a South African transfer pricing perspective, for example due to the industry in which the taxpayer operates, or due to the type of transactions entered into by the taxpayer.
While it was often time consuming and tedious in the past to obtain the information required to identify such risk, the new system allows for exchange of information on a much broader basis.
However, albeit having access to more meaningful and more detailed information and access to technology to further perform tax risk assessments, until now, SARS’ transfer pricing audit activity and enforcement has not increased or even decreased. This may be due to the lack of a large team of transfer pricing specialists within SARS. Although there has been indication that the team is to grow, the challenge SARS faces is the lack of a sufficiently large pool of trained transfer pricing specialists in South Africa and Africa.
Although the framework required to seriously counter undesired profit shifting due to transfer (mis-) pricing has largely been created in South Africa, it would appear that effective implementation on a broad scale has not yet been achieved. Nevertheless, many South African taxpayers, which form part of Multinational Entities have been spending significant time and resources to comply with the new transfer pricing regulations.
Thus, transfer pricing is an important mechanism to ensure that the fair amount of corporate tax is paid in South Africa, general compliance and enforcement may need to improve.
Other transfer pricing related mechanisms to increase collections
The need to increase investment into South Africa has been made very clear by President Cyril Ramaphosa in recent statements, e.g. at an investment conference and in Davos. In addition, in his 2019 State of the Nation Address, the President confirmed that significant investment comes through Multinational Entities operating in South Africa.
Investment means spending in South Africa, employment and with successful business operations comes corporate tax etc. The latter would of course benefit the South African fiscus and South Africans overall.
As South Africa urgently needs to increase tax collections in order to address key inhibitors for economic growth such as the energy issue, service delivery, education etc., it is unlikely that tax rates will fall and any proposals for a decrease should not be expected in the 2019 Budget. However, there are other mechanisms that could make South Africa attractive to foreign and local investment, from a tax perspective. For example, the simplification of tax administrative processes, more efficiency and consistency of the tax system and so forth would certainly be attractive to investors.
President Ramaphosa announced in his 2019 State of the Nation Address that SARS has been stabilised and further steps will be taken for it to become a world-class institution.
In respect of transfer pricing, as mentioned, South Africa has already adopted many international standards and best practices. However, as so often, this can be taken further. Of course, transfer pricing is a complex area of tax.
Often, the treatment of certain arrangements becomes quite subjective and the need to use advisers or to have in-house transfer pricing specialists to help taxpayers ensure compliance is standard not only in South Africa, but in the rest of the world. Thus, transfer pricing compliance can become expensive and complicated. Therefore, South Africa should consider mechanisms to simplify transfer pricing rules and, more importantly, to ensure certainty, consistency and equity.
So-called Advanced Pricing Agreements (APAs) are a useful mechanism in transfer pricing. An APA is effectively an agreement between a taxpayer and the tax administration regarding what the pricing for a specific cross-border transaction between a taxpayer and its cross-border related parties will be.
APAs are often concluded over a future period, for example 3 years, and sometimes they may also cover past periods. APAs are popular and useful in many countries as they avoid conflict and ensure tax certainty and consistency. A further step to achieve certainty and to avoid double taxation are bilateral APAs as these included the taxpayer and its related party in the other country, as well as the respective tax administrations.
India for example has been very successful in concluding bilateral APAs. While an APA regime requires skill and experience on the side of the tax administration, the OECD Transfer Pricing Guidelines and the new South African transfer pricing documentation format acknowledge the existence of APAs.
To date, SARS has not engaged in APAs. However, considering the success achieved by the countries which have already introduced APA regimes and the recent increase in sophisticated transfer pricing regimes within Africa, it may be time to reconsider.
It would surely be a good thing if South Africa could offer APAs as a mechanism to attract foreign inbound investors regarding investment into South Africa and to facilitate investment through South Africa to other African countries by offering bilateral APAs with African countries.
South Africa needs an increase in tax collections. While there is still a concern that taxable profits are lost to the South African fiscus due to intentional or unintentional transfer (mis-) pricing activities, transfer pricing can also serve as a mechanism to ensure that a taxpayer pays its fair share of corporate tax in South Africa, and to facilitate investment.
An APA regime would serve to establish certainty, consistency and equity regarding corporate tax payable in respect of cross-border related party transactions. In addition, it would be a welcome mechanism to achieve simplicity regarding a complex area of text.