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SARS FINALLY PROVIDES GUIDANCE ON TRANSFER PRICING RULES

Fasken
Reading Time 4 minute read
January 18, 2023
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OVERVIEW


OVERVIEW

January 18, 2023

Since the withdrawal of Practice Note 2 (“PN 2”), confusion has reigned as to
the manner in which the SARS would apply the newly amended transfer pricing
provisions in section 31 of the Income Tax Act, 58 of 1962 (the “ITA”) to
intra-group loans. The only indication of the SARS view on this subject was a
draft interpretation note which remained in such form since 2013.

On 17 January 2023 the SARS finally published Interpretation Note 127 headed
Determination of the Taxable Income of Certain Persons from International
Transactions: Intra-Group Loans (“IN 127”), providing official guidance as the
manner in which the SARS will apply the provisions of section 31 in respect of
transfer pricing and thin capitalization.

IN 127 provides guidance on the application of the arm’s length principle in the
context of the pricing of intra group loans and covers several aspects of
section 31 including the scope of its application, transactions which qualify as
affected transactions, who qualifies as connected persons and associated
enterprises as well as the factors which the SARS will consider to determine
whether the arm’s length principle has been complied with.

Some noteworthy points raised in IN 127 are set out below.

No more safe harbours

Unlike PN 2 and previous drafts of the interpretation note, no more “safe
harbours” are provided.

Direct and Indirect Funding

The wording of section 31 is wide and applies to ‘transactions, operations,
schemes, agreements and understandings that have been directly or indirectly
entered into or effected between or for the benefit of either or both of the
parties specified in the definition. The section is therefore far wider than a
loan between two of the parties specified in paragraph (a) of the definition of
an “affected transaction” and takes into account the chain of borrowing entities
including the ultimate borrower’.

Indirect financial assistance is then included, which would include guarantees
provided by a party to support a borrower’s credit. A lender would need to
evaluate a guarantor in a similar way as the borrower to ensure the terms of the
transaction is arm’s length.

Determining the commercial and financial relations

The SARS takes a very broad view of the manner in which the actual transaction
is to be delineated and states in respect of determining the contractual terms:

[h]owever, between relevant parties the contractual arrangements may not always
provide information in sufficient detail or may be inconsistent with the actual
conduct of the parties or other facts and circumstances. It is therefore
necessary to look to other documents, the actual conduct of the parties –
notwithstanding that such consideration may ultimately result in the conclusion
that the contractual form and actual conduct are in alignment – and the economic
principles that generally govern relationships between independent enterprises
in comparable circumstances

Considering both sides of a transaction

In applying the arm’s length principal the SARS requires taxpayers to consider a
transaction from the perspective of the borrower and the lender. Accordingly an
arm’s length amount of debt for a borrower with a healthy balance sheet and
excess cash reserves may be nil and such a loan will fall within section 31 if
the borrower cannot show a business need or reason or commercial benefit for
obtaining the relevant loan.

Loan fees and charges

If loan fees and charges are seen in a loan between relevant parties, such fees
will also be subject to an arm’s length analysis.

Bank opinions

A bankability opinion will not suffice on its own to demonstrate an arm’s length
amount of debt or interest as it is the view of SARS that such an opinion does
not represent an actual offer to lend.

Timing

In order to determine whether a term loan will fall within the provisions of
section 31 an analysis must not only be done prior to implementation but also
during the term of the loan to reassess the appropriateness of the level and
cost of the debt. The interval of such reassessment will depend on the facts and
circumstances of the loan. Practically, annual assessments may be sufficient.

Deemed dividend or donation

In terms of section 31(1), the difference between the arm’s length amount that
is taken into account in calculating taxable income or the amount that would
have been taken into account, but for section 31(2), is subject to the secondary
adjustment and constitutes a deemed dividend in specie or a deemed donation.

As there is no beneficial owner of such dividend any exemption from dividends
tax or treaty relief will not be applicable.

Documentary guidelines

Public notice 1334 issued by the SARS provides specific requirements as to the
records to be kept for transfer pricing purposes.

Advanced Pricing agreement

Although an advanced pricing agreement process is not yet in place, the SARS is
considering such a process for the future.

In conclusion, although the publication of IN 127 is a positive development and
provides helpful guidance to taxpayers, it must be remembered that an
interpretation note is not binding on a court and its provisions are merely the
SARS’s view of the correct interpretation of section 31 of the ITA.


CONTACT THE AUTHORS


CONTACT THE AUTHORS

For more information or to discuss a particular matter please contact us.

Contact the Authors


AUTHORS


AUTHORS

Conor McFadden Partner Johannesburg +27 11 586 6087
cmcfadden@fasken.com
Johan Coertze Associate Johannesburg +27 11 586 6096
jcoertze@fasken.com


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