Authors: Lavina Daya and Scott Salusbury.
In October 2015, the Organisation for Economic Cooperation and Development (“OECD”) published its final reports on the Base Erosion and Profit Shifting (“BEPS”) project, including the final report on BEPS Action 13, Transfer Pricing and Country-by-Country Reporting (“Action 13 Report”). The Action 13 Report recommended a three-tiered approach to transfer pricing documentation, requiring a global master file and local file to be submitted by multinational enterprises (“MNEs”) to local tax authorities and a country-by-country (“CbC”) report to be submitted by the “ultimate parent entity” of an MNE in the jurisdiction in which it is tax resident. The CbC report will contain information to provide the tax authorities with an overview of the global allocation of income, business activities and taxes paid within the MNE. The tax authorities of various jurisdictions will share CbC reports through automatic exchange of information mechanisms, such as the Multilateral Competent Authority Agreement on the Exchange of CbC Reports, to which the South African Revenue Service (“SARS”) is a signatory.
In line with the other participants in the OECD’s BEPS project, SARS has issued draft guidance and legislation relating to transfer pricing documentation requirements. Although the OECD provides clear guidance and templates for tax administrations in respect of the proposed three-tiered approach, SARS’ guidance does not in all instances align with that of the OECD. In particular, on 15 December 2015, SARS issued a Draft Notice on transfer pricing documentation (“Draft Notice”) proposing comprehensive documentation requirements for South African resident MNEs with a consolidated group turnover of R1-billion or more. While the documentation/record keeping requirements in terms of the Draft Notice have some similarities to the recommendations of the Action 13 Report, they are, in some instances, substantially more onerous. The terminology of the Draft Notice is also inconsistent with that of the Action Report in that the Draft Notice makes no mention of the master file/local file concept, nor does it deal with CbC reporting.
Subsequently, on 11 April 2016, SARS issued draft regulations in terms of the Tax Administration Act 28 of 2011 (“TAA”) which will entrench CbC reporting in domestic legislation (“Draft Regulations”). The requirements for CbC reports in terms of the Draft Regulations follow the recommendations of the Action 13 Report closely. In particular, Article 4 of the Draft Regulations requires that CbC Reports must, inter alia, contain the information set out in, and apply the definitions and instructions contained in, Annexures III to Chapter V of the Action 13 Report. This is somewhat surprising, since the recommendation of the Davis Tax Committee in respect of CbC reporting was that South Africa should require the disclosure of additional transactional data over and above that recommended by the OECD. Indeed, the Action 13 Report lists South Africa among the countries which would have preferred CbC reports to include additional data, particularly in relation to related party payments of interest, royalties and service fees.
Most recently, as of 18 April 2016, SARS has updated the ITR14 corporate income tax return (“ITR14”) with immediate effect to include, inter alia, significant new disclosure requirements in respect of transfer pricing. The new information required by SARS in the ITR14 includes the additional transactional data that the Davis Tax Committee recommended be included in the CbC report (i.e. a break-down of intra-group interest, royalties and service fees by jurisdiction). Because the ITR14 falls outside the formal framework for the exchange of CbC reports, SARS will not be obliged to share the information obtained with other jurisdictions. Furthermore, the transfer pricing sections of the ITR14 are potentially applicable to any “medium to large business” in terms of the Comprehensive Guide to the ITR14 Return for Companies, i.e. a company with total assets exceeding R10-million or gross income exceeding R20-million. This is a far cry from the CbC reporting threshold of R10-billion consolidated group revenue.
Briefly set out below are some of the relevant changes to the ITR14.
Firstly, it should be noted that the previous tax return required the disclosure of further transfer pricing information if the taxpayer had entered into an “affected transaction” as defined in section 31 of the Income Tax Act 58 of 1962 (the “Act”). An “affected transaction” is essentially a cross-border transaction between connected persons, the terms of which are different from those which would have existed between independent persons dealing at arm’s length. The requirement to disclose further transfer pricing information in the tax return was therefore previously only triggered where there was a cross-border transaction between connected persons on non-arm’s length terms. In the updated ITR14, however, the transfer pricing sections are required to be completed if the taxpayer has “entered into any transaction, operation, scheme, agreement or understanding as set out in section 31(1)(a)”. The effect of this change is to remove the requirement that the transactions must have been on non-arm’s length terms. Any time there is a cross-border transaction between connected persons therefore, the taxpayer must complete the transfer pricing sections of the ITR14. Clearly, this is a significantly broader trigger requirement than before.
As regards the information required in the transfer pricing sections of the ITR14, we note the following:
- Previously, and remembering that the return only related to “affected transactions”, the taxpayer was required to disclose the aggregate amounts paid/payable and received/receivable in respect of certain transaction categories, including the sale of goods, commission, interest, management fees and research and development fees. The aggregate amount receivable/payable for each category was required in respect of local, foreign connected and foreign non-connected persons.
- The updated transfer pricing sections require the categorised aggregate amounts in respect of foreign connected and non-connected persons. There is no longer a requirement to report the value of local transactions with connected persons.
- The updated return requires disclosure of the number of jurisdictions involved in the transactions for each category and, in the case of the top five jurisdictions by transaction value, the value of the transactions and a country code identifying the jurisdiction. This information is similar to that required in the CbC report in that it provides SARS with an overview of the allocation of group income and business activities between jurisdictions.
- The ITR14 is more limited than the CbC report in that it does not require values for each jurisdiction in respect of measures such as tax paid, accumulated earnings, number of employees and tangible assets other than cash.
- The following new questions have been added to the “transfer pricing supporting information” section of the ITR14:
- Was there any change between the company and non-resident connected person since the previous reporting period with respect to the transfer pricing methodologies/transaction, operation, scheme, agreement or understanding classification?
- Did the company transact with a connected person that is tax resident in a country with which South Africa does not have a tax treaty?
- Is the “tested party” of any transaction operation, scheme, agreement or understanding a tax resident outside South Africa?
- How many “tested party/parties” of the transaction operation, scheme, agreement or understanding are a tax resident of another country?
- Did the company, on or after 1990, transfer, alienate or dispose of any South African developed (or previously South African registered) intellectual property to any non-resident connected person or any foreign branch of a South African resident?
- In addition to the financial ratios required in terms of the transfer pricing sections of the old tax return, the taxpayer is now also required to provide a debt in relation to total tangible assets ratio.
According to the Action 13 Report, the recommendations attempt to balance the information needs of tax authorities with the compliance costs imposed on business, as well as concerns about inappropriate use of the information. Certain emerging market countries including South Africa, would however, have struck the balance differently in favour of further reporting requirements. The new ITR14 will bring a far greater number of entities within its reporting requirements than will the CbC reports and SARS will not be required to share the resulting data with other tax administrations. The introduction of the new ITR14, therefore provides SARS with a valuable new transfer pricing risk assessment tool. In the process however, a significantly increased compliance burden has been handed to the taxpayer.
*Scott Salusbury is a candidate attorney in ENSafrica’s tax department.
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