This is in direct response to the growing worldwide trend towards globalization and South Africa's regained acceptance in the international community. Therefore, it is important to be aware of the business decisions being made and focus on the potential tax implications so that decisions are made in the most tax efficient manner. The term is a way of indicating that it is a fixed price within a group and not reached on the open market.
In particular, carrying interest-bearing debt in the country where the investment is located usually provides tax advantages. This has resulted in tax authorities in a growing number of countries concerned about the loss of tax revenue through the repatriation of profits from their countries to other countries in the form of interest rather than dividends, paying close attention to financing methods, i.e. , to the issue of thin capitalization. In most countries, when a company receives capital from a foreign parent company or other foreign associate in the form of debt bearing a commercial interest, the interest on the debt would often (but not always) be allowed as a deduction from the company's normal tax purposes in the hands of the borrowing company.
However, where capital is provided through equity rather than debt, the return on equity would normally be in the form of dividend distributions. Therefore, if a corporate group decides to provide funds from a parent company in one country to a subsidiary in another country almost entirely through debt bearing a commercial interest rate, the tax liability of the subsidiary company may be significantly reduced, in the absence of provisions special for the opposite, compared to the situation when similar funds were provided.
The classic thin capitalization case is one in which the financing provided by the parent company represents a high ratio of debt-to-equity capital. The following chapters deal with questions related to debt-to-equity problems and indicate how interest on debt provided by a foreign investor can be paid out of a country in the most tax-efficient manner.
Definitions
Evidence supporting the group's pricing philosophy and policies is inconsistent with information provided to the commissioner in the past. Measures by the commissioner to combat transfer pricing, in particular the setting of an arm's length price. In addition to Article 31 of the law, several legal provisions exist that can be applied to counter transfer pricing maneuvers.
The first requirement is that the expenditure must be incurred in the production of the income. In ITC 10116, the court again had to decide whether a salary paid by a father's company to his son qualifies as an expense by the company in the production of the income. This ruling has placed some uncertainty on the role of the courts in setting arm's length prices.
But it does not seem to me that it is competent for the Commissioner or myself to decide what is a fair wage in the tobacco industry. In order to prove that part of the expenditure was incurred in good faith, it must be demonstrated that the price paid was a market-related price.
The 'business test' used by the courts to determine whether the second requirement of 1 03(1) is met is reminiscent of the market principle. What is arrived at after adding the cost mark-up plus the above costs can be considered the market price of the original controlled transaction.” In the case of a foreign investor, the interest would normally fall within the ambit of section 10(1)(hA) of the Act and would therefore be exempt from ordinary tax.
This will enable the Commissioner to adjust the interest rate in the form of a non-market loan based on the arm's length principle.' Calculate the loan amount that is acceptable under the thin capitalization rules and reject the interest on the excess as a deduction. On the tax-deductible portion of the loan, determine if the interest rate is too high and reject the excessive portion.
The effect of the application of transfer pricing provisions is to neutralize the tax benefits arising from such transactions. Only on the same basis will interest bearing financial assistance be taken into account in applying the transfer pricing provisions of subsection (2) in cases where it is applied in conjunction with the provisions of subsection (3) to determine whether the interest calculated on that part of the financial assistance which falls within the 3:1 guideline based on market price (interest rates). If there has been no major change in the level of financial assistance during the assessment year, the amount of financial assistance as it exists at the end of the relevant assessment year may be applied.
The amount of fixed capital used in the calculation of the formula symbol is the amount equal to the fixed capital at the end of the relevant assessment year. The thin capitalization provisions only apply if the recipient of the financial assistance is 'managed or controlled' in South Africa. An amendment to section 31 of the Act by the Commissioner made transfer pricing provisions applicable to South African branches of foreign-owned companies.
Branches in South Africa which are foreign owned face a potential risk if they have not determined their transfer price on an arm's length basis to the satisfaction of the Commissioner. The concept that directors must be deemed to be in control of the company has been specifically adopted in a number of South African cases. In terms of the original wording of s 31 [of the Act], this branch would therefore escape the scope of s 31.
In the case of companies, the total amount of the excessive and impermissible [non-deductible] interest will be deemed to be a dividend declared in terms of s 64C(3)(e) of the Act and STC will be payable on the excessive and impermissible [non-deductible] interest. Since the determination of the excessive and impermissible [non-deductible] portions of interest and the exercise of the Commissioner's discretion must be done at the time when the relevant assessment is raised, the dividend cycle in respect of such deemed dividend, for purposes of the definition of "dividend cycle" in s 648(1), is deemed to end on the date of assessment in respect of the year of assessment to which the excessive and impermissible [non-deductible] interest relates. MNEs must be aware of the documentation requirements, both from a South African and international perspective.
In South Africa, the burden of proof will most likely fall on the taxpayer in terms of s 82 of the Act.
Conclusion
Affected companies should be aware not only of the issue of transfer pricing, but also of the relationship between tax and customs law regarding the valuation of related parties. If an attempt is made to artificially reduce the price of the goods excessively, the company may be subject to this. In this context, the Katz Commission recommended a prior price agreement procedure, which, if adopted, would allow the transfer price of a group to be agreed in advance with the Commissioner.
Armed with new powers under the Income Tax Act, the Commissioner has begun implementing recent legislation addressing the issues of transfer pricing and undercapitalization. Details of the prices that would have been used if the transaction had taken place between independent parties trading on arm's length terms. If this question is not answered correctly, the taxpayer should be aware that no prescription applies within the meaning of Article 79(1)(/).
Since section 31 of the Act applies to all related party transactions entered into on or after 19 July 1995, the Commissioner will be able to resume all assessments after that date, regardless of how many years have passed. It is easy to ignore transfer pricing because the Commissioner seems to ignore it in general. John Stanley in an article28 criticizes the commissioner for his simplistic yes-or-no questions in the corporation tax returns in relation to these questions.
Stanley explains that if the taxpayer answers “yes” to the transfer pricing question, the taxpayer must file schedules with complex details of the transaction. This includes an explanation of the method used to determine the price and an explanation of what the price would have been had it been negotiated by independent parties. However, an incorrect 'no' could be regarded by the commissioner as a misrepresentation.
The taxpayer's assessment could then be reopened even after the normal statute of limitations (three years from the date of the assessment) has expired. In the case of low capitalization, the taxpayer should explain why the aid received should not be considered excessive compared to the permanent capital of the subsidiary. In circumstances where the taxpayer is actually required to gather potential evidence against itself, the Commissioner should provide guidance on how to determine the market price where the market answer is not obvious.
