Multinationals have been abusing South Africa’s transfer pricing system to take significant profits offshore and this can only be stopped if the country tightens up taxation rules on related party transactions, says Sars commissioner Edward Kieswetter.
He told Business Times that the complex area of transfer pricing was being abused through “cost loading” or charging below an arm's length rate (market rate) to avoid tax obligations.
Transfer pricing refers to the taxes levied on transactions for goods and services between related companies or subsidiaries under the same group, or between an offshore company and its locally-based subsidiary.
Kieswetter said some companies use these gaps in tax policy to shift funds to jurisdictions with lower taxation regimes.
“[When it comes to] a South African who has an offshore parent, very often that offshore parent is in a more favourable tax jurisdiction and that offshore parent supplies the local subsidiary with management support, allowing them to use intellectual property or even may provide other services and materials.
“The law requires you to make those services available at arm’s length, in other words as if you would buy it [at market value]. So if [a] cup is generally available at R10 and ... the parent company gives it to the subsidiary ... [it] must charge R10. Cost loading would mean [the parent company] charges R20 and therefore takes R10 offshore and erodes the profit in South Africa.
Some companies use gaps in tax policy to shift funds to jurisdictions with lower taxation regimes
“I can’t make this cup in South Africa and then pretend that it’s made in Jersey. Because all I’m doing is I’m taking a cost that is incurred here and I’m relocating it. And that’s also a form of profit shifting. Now it’s easy when it’s physical goods. It’s not so easy when it’s intellectual property and knowledge work.”
Locally, Sars lost a transfer pricing court case with telecommunications company ABD Limited. ABD had allowed 14 companies across the continent to use its trademark and charged them a 1% royalty fee.
Sars argued that this royalty was not an arms-length fee and sought an additional assessment for R1.2bn
But ABD successfully appealed the assessment that Sars imposed on it and in February the South Gauteng High Court in Johannesburg ruled in its favour, saying it made a case that Sar's decision to seek the higher assessment, based on an analysis that had not met the test of rigour, was unreasonable. The revenue service is appealing.
Kieswetter said an emerging challenge that gave rise to the inclusive framework was an aggressive form of tax planning by corporations and multinationals. He said the inclusive framework changes how a taxing right is assigned to a country from physical presence to economic presence.
“You take a company like Amazon or Google, who ... are domiciled in America, but the economic presence is ... around the world. And so, as a principle of equity, as economies become digitalised ... why should the profits that those big companies earn be going to a country where they are ... not predominantly economically active?”
He said taxing rights are a highly contested area because of sovereignty and domestically sourced mobilisation for governments, and the debate around taxing rights could be expected to intensify.
“The first principle is to change the principle on which taxing rights are assigned from physical presence to economic presence. So, what it says is if Google or Amazon or one of those companies is economically active in South Africa, then some of their income or profits must be proportionally shared with South Africa.”
To protect tax bases around the world, especially in developing economies, OECD (Organisation for Economic Cooperation and Development) countries are striving towards a minimum tax so that regardless of where a company is headquartered and how it is organised, it will not get away with paying less than 15% tax.
Michael Hewson, founder and director at Graphene Economics, said the abuse of transfer pricing posed a risk to the South African economy and the profitability of companies, impacting the collections of the revenue authority and the wealth of the country as a whole.
“However, it is interesting to note that many of the transfer pricing controversy matters that we are involved in are not in low tax jurisdictions. Rather, they relate to intercompany transactions involving entities in higher tax jurisdictions.”
He said in those instances, the taxpayer is not trying to benefit from a lower tax rate, but disputes arise because of the inherent difficulty of determining what an arm’s length price should be.
“There are instances where a revenue authority on one side of the transaction believes the price is too high while the revenue authority on the other side believes it is too low. In that situation, regardless of what the price actually is, there will be a dispute one way or another.”
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