Last week I showed you what you need to be aware of to establish whether you or your company (or close corporation) could be at risk from international transfer pricing. This week I will look at what needs to be done should you decide you may be at risk.
If you do have international transactions with connected parties, get
professional advice as to the procedures to follow to reduce your risk of
price adjustment by the South African Revenue Service (SARS), and the
taxes, penalties and interest that go with it.
Last week I touched on the debt:equity investment ratio guidelines set out
in Practice Note 2. These are known as the thin capitalisation guidelines.
They must be maintained at a ratio of 3:1 debt to equity.
However, even if your company's debt:equity ratio is right, or the loan is
not from a shareholder, but still from a connected person, it is still
necessary to look at the interest rates charged on a loan account between
an offshore connected party and you or your company. SARS has advised that,
if the interest rate charged to you or your company is more than prime plus
two percent (if the loan is in Rands, or the relevant interbank rate plus
four percent, if the loan is in another currency), it will disallow the tax
deduction claimed in respect of the excess interest. It will also charge
secondary tax on companies (STC) at a rate of 12,5 percent.
Practice Note 2 does not give guidelines on the prices that need to be
charged in respect of any other types of transactions (purchases and sales
of goods and services) between international connected parties, although a
Practice Note giving SARS' guidelines is being drafted.
Meanwhile, how do you protect yourself against attack? First, you need to
establish whether the transactions that are taking place are being charged
at arm's length prices. Then you need to make sure that the reasons why you
consider those prices to equate arm's length prices are clearly documented.
This is because, should SARS dispute that a transfer price is a reasonable
arm's length price, the onus will be on you to prove that it is.
Generally, a transfer pricing policy document, setting out the methodology
and principles on which prices charged for specified items being sold
between you, or your company, and your offshore connected party, will
satisfy this need.
Such a document would need to set out the method used to determine the
prices. International guidelines set out a number of methods, for example,
the CUP (comparative uncontrolled price) method, which compares the price
charged by or to you, with the price which would be charged to or by an
unconnected person.
This may, however, be difficult to establish, or alternatively, need to be
adjusted for various factors that may exist within your business
environment, versus the CUP being compared. Such factors may include risks
carried by each of the parties, economies of scale that may exist,
political or economic factors that may exist in relation to you or your
company operating in South Africa, versus another country from which the
CUP has been derived.
If the CUP is not suitable, then the reasons for using another method (for
example the resale price method, which looks at the reasonability of the
gross margin when the product or service is onsold to a third party, or the
cost plus method), need to be set out. There are a number of methods that
you could use. Of key importance, though, is documenting why a specific
method is used.