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Transfer pricing transformation: Developments in South African law, regulations and guidance

South Africa has had transfer pricing legislation in place since 1995 and the South African transfer pricing guidance as set out in Practice Note 7 turned 20 years on 6 August 2019. Reflecting on 20 years’ transfer pricing guidance and 24 years of transfer pricing legislation it is worthwhile to consider the transformation of the South African transfer pricing rules over the years. This article discusses some of the major transfer pricing developments in the country.

By Christian Wiesener, Associate Director, Global Transfer Pricing Services Kpmg, SAICA Transfer Pricing Committee Chairman

The legislation

1995 legislation

Transfer pricing legislation was introduced in South Africa for the first time with effect from 19 July 1995 and in respect of goods or services supplied on or after that date. The legislation at the time applied to the supply or acquisition of goods or services in terms of an international agreement between connected persons where the price was not arm’s length. Where these requirements were met, the legislation gave the Commissioner a discretion in that it provided that he ‘may’ in the determination of the taxable income of either the acquirer or the supplier adjust the consideration in respect of the transaction in order to reflect an arm’s-length price. In addition, the legislation at the time also contained specific thin capitalisation rules.

2012 legislation

Over time, several amendments were made to the South African transfer pricing legislation. Of these, the amendment to the legislation with effect for years of assessment commencing on or after 1 April 2012 is noteworthy. Already in mid-2010 − the Organisation for Economic Co-operation and Development (OECD) had concluded its work to update the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2010) − the substantial redrafting of the South African transfer pricing legislation was announced.

The main changes and updates related to the focus on economic substance and the arm’s-length nature of the transaction as such as opposed to a focus on the price only as was the case until then. Also, the ambit of the legislation was broadened to close some apparent loopholes and the term ‘affected transaction’ was created. The term ‘affected transaction’ broadly means any transaction, operation, scheme, arrangement, etc, between a resident and a non-resident; between a non-resident and the permanent establishment (PE) in South Africa of another non-resident; between a South African resident and the PE of another resident; and between a non-resident and a controlled foreign company and these persons are connected persons as defined and that transaction etc is not arm’s length.

In addition, the amendment provided that there was no longer a discretion for the Commissioner as to whether a transfer pricing adjustment needed to be made and it was clarified therefore that the obligation to transact at arm’s length was with the taxpayer.

Furthermore, the thin capitalisation rules were removed and from then on, a taxpayer needed to ensure that a financial transaction was at arm’s length. In practice this meant that it was not sufficient for a taxpayer to ensure that the 3:1 debt to equity ratio was observed as the guidance set out in Practice Note 2 stated, but the general rules regarding applying the arm’s length principle applied to financial transactions. Therefore, a taxpayer needed to demonstrate that the whole transaction was arm’s length − that is, both interest rate and debt capacity needed to be tested and supported.

Finally (for South Africa) the secondary adjustment rules changed. In South Africa, a transfer pricing adjustment, by SARS or by the taxpayer, results in a so-called secondary adjustment. The rationale for such secondary adjustment is debated. Some are of the view that the purpose of the secondary adjustment is to compensate South Africa for the amount of dividends tax foregone because, for example, a South African taxpayer overpaid its foreign connected person in respect of goods acquired. However, others are of the opinion that the secondary adjustment is a punitive measure.

Until 2012, while secondary tax on companies (STC) was applicable, a secondary adjustment was levied in the form of STC. However, this changed from 1 April 2012. With the introduction of dividends tax in South Africa, STC was repealed and the transfer pricing legislation was updated with the effect that a secondary adjustment took, from then on, the form of a deemed loan in respect of which interest was incurred until the repayment of such loan. This mechanism, however, created a number of unintended consequences, and after only two years the deemed loan mechanism was again repealed in favour of dividends tax-related measures. Today, a secondary adjustment is deemed to be the distribution of an asset in specie in respect of which 20% dividends tax is applied. It was clarified recently that no double taxation relief, neither unilateral nor multilateral, should apply in respect of this.

The 2012 changes to the legislation other than those relating to the secondary adjustment (which is rare as only a few countries apply this) brought the South African transfer pricing legislation in line with the OECD transfer pricing guidelines and the rules applied in most other countries. This alignment to international best practice was needed and useful.

Since 2012 only minor refinements or additions, for example regarding financial assistance and intellectual property-related transactions, have been made to the transfer pricing legislation.

The OECD transfer pricing guidelines

South Africa has always considered the OECD Transfer Pricing Guidelines as ‘… as an important, influential document that reflects unanimous agreement amongst the member countries…’ and Practice Note 7 on transfer pricing states that ‘The OECD Guidelines should be followed in the absence of specific guidance in terms of this Practice Note, the provisions of section 31 or the tax treaties entered into by South Africa.’

As stated above, South African legislation was amended to align with international changes in transfer pricing, particularly the changes in terms of the OECD Transfer Pricing Guidelines (2010). However, shortly after the OECD Transfer Pricing Guidelines (2010) were released, many countries raised concern over perceived tax avoidance by multinational groups and it was claimed that international tax frameworks were not adequate to counter this. In addition, many governments were under fiscal pressure as a consequence of the financial crisis. The G20 Finance Ministers Conference then instructed the OECD to consider the issue and to propose a solution that would address this perceived base erosion and profit shifting (BEPS) but at the same time not hinder international trade. It has been said that the BEPS initiative has resulted in the most significant changes of international tax in 100 years.

Following the announcement of the BEPS initiative, 15 BEPS actions were initially proposed in 2013. In October 2015, final BEPS action reports were published including recommendations and guidance in respect of the various actions. The plan included proposals to ensure, first, that countries like South Africa don’t lose tax revenues due to some companies pricing purchases and sales of goods and services at a price different from what a third party would pay or receive. Second, the proposals were aimed at making sure that foreign companies doing business in for example South Africa will pay their fair share of tax here. Third, the proposals were geared towards generally tightening the rules to make sure ‘clever schemes’ that result in for example excessive levels of interest or royalties are paid out of a country like South Africa to low tax jurisdictions are combated.

Of the 15 BEPS actions, four actions, namely Actions 8 through 10 and Action 13, directly dealt with transfer pricing. The BEPS action reports were approved by the G20 Finance Ministers late in 2016, and in July 2017 the OECD Transfer Pricing Guidelines were updated to include a number of new chapters, which included the new guidance of the relevant BEPS action report. For example, a new chapter V contains the BEPS Action 13 report on transfer pricing documentation.

Following the finalisation of the BEPS Action Plan, several countries across the world have updated existing transfer pricing documentation requirements, or introduced such requirements, in line with the recommendations set out in the OECD Transfer Pricing Guidelines (2017).

Although South Africa is not a member of the OECD, the country enjoys observer status and broadly follows the OECD Transfer Pricing Guidelines (2017). Therefore, the following updated guidance as contained in the OECD Transfer Pricing Guidelines (2017) should be considered by South African taxpayers engaging in transfer pricing arrangements:

  • The new guidelines emphasise the need to accurately delineate a transaction so that the conduct of the parties to such a transaction replaces the contractual arrangements where they are incomplete or out of line with the conduct of the parties. Therefore, transactions can be disregarded for transfer pricing purposes where they lack commercial rationality.
  • Having legal ownership of an intangible does not in itself provide a right to all or part of the return generated from the exploitation of such intangible. Instead the return accrues to the entity or entities, which carry out the development, enhancement, management, protection and exploitation function (the so-called DEMPE functions) in relation to that intangible.
  • The return for risk borne is allocated to the party, which controls it and has the financial capacity to assume it. An entity that only provides capital is entitled to no more than a risk-free return.
  • A rule regarding how to apply the comparable uncontrolled price (CUP) method to commodity transactions must be considered.
  • A safe harbour rule for low value adding services is recommended, with a simplified benefits test and a prescribed net cost plus margin of 5%.
  • Certain changes to the rules on cost contribution arrangements were made to align them with the other transfer pricing outcomes.
  • Specific rules relating to financial transactions should be considered, including for example guidance on identifying the commercial or financial relations and determining the economically relevant characteristics of actual financial transactions (aligning with Chapter I of the OECD Transfer Pricing Guidelines (2017)), detailed guidance in respect of financial loans, guarantee fees, cash pool arrangements and treasury operations, hedging and captive insurance are still being discussed and agreed.
  • The updated transfer pricing documentation guidance as updated in Chapter V of the OECD Transfer Pricing Guidelines (2017).

Therefore, the OECD Transfer Pricing Guidelines have a significant impact on transfer pricing in South Africa in the form of specialised guidance, but it must be kept in mind that the guidance does not replace or override local regulations. The guidance should therefore be considered by taxpayers engaging in transfer pricing transactions as such. The guidance has changed over the years and it is followed by most countries in the world, although many countries, including South Africa, often deviate from these specific rules.

South African transfer pricing guidance and regulations

In addition to the South African transfer pricing legislation, and the guidance set out in the OECD Transfer Pricing Guidelines, South Africa also has specific local guidance and regulations in place. As such, over the years, the following publications are important from a South African transfer pricing perspective:

  1. SARS Practice Note 7 on transfer pricing, 1999
  2. Addendum to SARS Practice Note 7, 2005
  3. SARS Practice Note 2: Determination of taxable income where financial assistance has been granted by a non-resident of the Republic to a resident of the Republic, 1996
  4. SARS draft interpretation note: Determination of the taxable income of certain persons from international transactions: thin capitalisation, 2013
  5. Public notice: Duty to keep the records, books of account or documents in terms of section 29 of the Tax Administration Act, 2011 (Act 28 of 2011)
  6. Public notice: Return to be submitted by persons in terms of section 25 of the Tax Administration Act, 2011 (Act 28 of 2011)
Briefing note, 28 October 2016: Notice in terms of section 29 of the Tax Administration Act, 2011
  • External business requirements specification: Country-by-country and financial data reporting, published 17 May 2017
  • Public notice: Regulations for purposes of paragraph (b) of the definition of ‘international tax standard’ in section 1 of the Tax Administration Act, 2011 (Act 28 of 2011), promulgated under section 257 of the Act, specifying the changes to the Country-by-Country Reporting Standard for Multinational Enterprises, and
  • SARS Guide: How to complete and submit your country-by-country information.

Below, the regulations and guidance are discussed in more detail:

1. SARS Practice Note 7 on transfer pricing

The SARS practice note was introduced in 1995 and constitutes South Africa’s main local guidance on transfer pricing. Practice Note 7 applies in respect of goods or services supplied on or after 19 July 1995. The practice note provides broad transfer pricing guidance and also refers to the OECD Transfer Pricing Guidelines.

While the transfer pricing legislation was updated over the years, Practice Note 7 was not, hence some aspects of the practice note are not applicable anymore. Therefore, the guidance in the practice note must always be compared against latest developments.

2. Addendum to SARS Practice Note 7

An addendum to Practice Note 7 was published in 2005. The addendum mainly clarified the transfer pricing documentation requirements as set out in the existing Practice Note 7, that is, that a legal requirement to prepare documentation did not, at the time, exist, but that it was in the best interest of the taxpayer to prepare contemporaneous documentation.

This addendum has been made redundant with the update on transfer pricing documentation from 2016 (see below).

3. SARS Practice Note 2 on financial assistance

Practice Note 2 was published on 14 May 1996 and it provided specific guidance on financial assistance. In effect, the practice note included two safe harbours for interest rates on inbound foreign loans and on thin capitalisation, that is, a specific debt to equity safe harbour was provided.

However, Practice Note 2 specifically referred to subsection (2) of the transfer pricing legislation, which was removed when the legislation was overhauled for years of assessment commencing on or after 1 April 2012.

An addendum to the practice note was published in 2002.

This practice note was officially withdrawn by SARS on 5 August 2019 with effect from years of assessment commencing on or after 1 April 2012.

4. SARS draft interpretation note on thin capitalisation

To replace the guidance in Practice Note 2, SARS prepared and released a draft interpretation note in 2013. This note has not been finalised yet, but it is being referred to as guidance by SARS as well as by practitioners. Notably, the safe harbour rules in the old Practice Note 2 have been removed, and so-called ‘risk harbours’ have been included. In summary, a much broader approach to how the arm’s length nature of financial assistance is to be substantiated is being followed, which is in line with the updated legislation. 

5. Public notice: Country-by-country regulations

SARS has adopted the CbC reporting standard and introduced regulations, as published in Government Gazette 40516, issued on 23 December 2016.

For years of assessment commencing on or after 1 January 2016, the ultimate parent entity of a constituent entity, which is a South African resident, and in respect of which certain conditions apply, must submit the CbC report for the global group of companies to SARS within 12 months from the end of the relevant year of assessment. In addition, a constituent entity in South Africa may need to file the CbC report of the group even if that constituent entity is not the ultimate parent entity, for example if a suitable exchange of information mechanism is not in place between South Africa and the country in which the entity of the multinational group, of which the South African constituent entity is a member, which files the CbC report, is a tax resident.

It should be noted that South Africa does not entertain surrogate parent entity filing of CbC reports. Thus, South Africa does not offer the option for a multinational group to file in South Africa on a voluntary basis, for example to use South Africa’s treaty network or any other exchange of information mechanism, to share CbC reports with other countries.

However, if the South African resident company (constituent entity) is not the entity required to submit a CbC report in South Africa, it is obliged to notify SARS which entity will be the reporting entity for the group, and in which country it is located.

The CbC report provides SARS and other governments with the necessary information to identify global transfer pricing risks within the group.

An exchange of CbC reports is achieved through the Multilateral Competent Authority Agreement on the Exchange of Information in respect of CbC reports (CbC MCAA).[16] As at 30 August 2019, 82 countries had signed the CbC MCAA.[17] In addition, other mechanisms for the automatic exchange of CbC reports could be bilateral tax conventions, for example DTAs or tax information exchange agreements. The exchange of CbC reports commenced in 2018.

6. Public notice regarding the duty to keep the records, books of account or documents

For years of assessment commencing on or after 1 October 2016, new transfer pricing documentation retention rules were introduced to South Africa. The rules are in terms of the Tax Administration Act 2011 connected party transactions, where the aggregate of the potentially affected transactions[18] for the year exceeds R100 million (without offsetting transactions against each other). Furthermore, specific additional documentation requirements are set out for individual transactions exceeding, or reasonably expected to exceed, R5 million. It should be noted that even if a taxpayer does not meet the R100 million potentially affected transactions threshold, it should still prepare documentation that supports and convinces SARS that all potentially affected transactions were entered into at arm’s length.

The rules set out in this public notice replaced the documentation rules as set out in Practice Note 7 and the 2015 addendum to Practice Note 7 with effect for years of assessment commencing 1 October 2016 (refer the section on the briefing note dated 28 October 2016, below).

7. Briefing note, 28 October 2016

This briefing note provides that the contents of the public notice regarding the duty to keep the records, books of account or documents replaces the transfer pricing documentation rules as set out in Practice Note 7. Interestingly, the briefing note also states that requests for alternative record-keeping arrangements under paragraph 7 of the public notice may be directed to SARS.

8. Public notice regarding the filing of local file and/or master file returns

For years of assessment commencing on or after 1 October 2016, new transfer pricing documentation rules apply and a taxpayer with potentially affected transactions for the year, the amount of which exceeds R100 million in aggregate (without offsetting against each other), must prepare and file electronically transfer pricing documentation consistent with the local file and/or master file format. An exception regarding filing the master file, in addition to the local file, exists, where the group is not headquartered in South Africa and no master file is prepared for any jurisdiction.

It should be noted that both master file and local file requirements applied to South African multinational groups that met the country-by-country requirements already for years of assessment commencing on or after 1 January 2016.

The format mostly follows Chapter V of the OECD Transfer Pricing Guidelines (2017) and is set out in Annexures 2 and 3 of the external business requirements specification: country-by-country and financial data reporting.

9. External business requirements specification: country-by-country and financial data reporting

The external business requirements specification: country-by-country and financial data reporting (BRS) sets out the background to South Africa’s CbC reporting as well as master file and/or local file filing requirements. The document sets out significant detail as to the requirements and how the extraction and completion of data as well as the filling should work. The document refers to BEPS Action 13, which essentially is Chapter V of the OECD Transfer Pricing Guidelines (2010), as discussed above.

A taxpayer required to file a CbC report in South Africa and/or a master file and/or local file should review the BRS and consider the requirements carefully.

10. SARS Guide: How to complete and submit your country-by-country information

Specific guidance on how to complete and file the country-by-country report in South Africa has been released. The guidance is mostly of a technical nature and includes guidance on how the master file and local file need to be submitted. It should be noted that SARS, in section 8 of the guide, also provides guidance on how the the value of a taxpayer’s annual aggregate potentially affected transactions must be calculated.


South Africa has transfer pricing legislation, regulations and guidance in place which is mostly in line with the latest global developments and local requirements across the globe.

While Practice Note 7, despite the updates over time, is not in sync with the modernised legislation, it is understood that SARS is in the process of completing new guidance, presumably in the form of an interpretation note, which should be finalised soon. However, global transfer pricing developments are continuing, for example the OECD is in the process of finalising guidance on financial transactions. Also, different approaches regarding how digital services providers should be taxed in respect of services provided are ongoing. In this regard, on 9 October 2019, the OECD published a proposal to advance international negotiations to ensure large and highly profitable multinational enterprises, including digital companies, pay tax wherever they have significant consumer-facing activities and generate their profits. The proposal, which is open to a public consultation process, would re-allocate some profits and corresponding taxing rights to countries and jurisdictions where MNEs have their markets. It would ensure that MNEs conducting significant business in places where they do not have a physical presence be taxed in such jurisdictions, through the creation of new rules stating (1) where tax should be paid (‘nexus’ rules) and (2) on what portion of profits they should be taxed (‘profit allocation’ rules). 

Therefore, it is important for taxpayers engaged in transfer pricing transactions to not only review and consider existing guidance, but to also keep abreast with international developments as these may have an impact on how transfer pricing is dealt with in South Africa.

Information in this regard can be obtained from SARS, the relevant recognised controlling bodies for tax practitioners such as SAICA and SAIT, and the OECD.