South Africa has transfer pricing legislation which generally applies to cross border transactions between connected persons. This is achieved through the reference to an “affected transaction” in section 31 of the Tax Act, which in turn refers to a “connected person” as defined in section 1 of the Tax Act.
The Draft Taxation Laws Amendment Bill, 2019, which was released on 21 July 2019 (“Draft Bill”) proposes amending the definition of an “affected transaction” to extend the scope of the transfer pricing rules to include transactions between those persons who are “connected persons” as well as “associated enterprises” in alignment with the OECD and UN use of the concept of “associated enterprises” when applying the arm’s length principle for allocating profits from transactions between “associated enterprises”.
In principle it makes sense to have a uniform approach in dealing with transfer pricing, to avoid a situation of potential economic double taxation in instances where one country may apply a relatively broad concept of “associated enterprises”, resulting in a transfer pricing adjustment, while another counter-party jurisdiction to the same transaction, may apply a narrower concept and does not make a similar transfer pricing correction. However, there is currently no clear definition of the term “associated enterprise”. Therefore, amending the transfer pricing rules to also include “associated enterprises” may not achieve the objective of a uniform approach.
An “associated enterprise” is defined in the Draft Bill as an “associated enterprise” as contemplated in Article 9 of the Model Tax Convention (“MTC”) on Income and on Capital of the OECD as:
“Where: (a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or (b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.”
The Commentary on Article 9 of the OECD and UN MTC merely describes an “associated enterprise” as essentially, parent and subsidiary companies and companies under common control.
In terms of the current transfer pricing legislation, there must be a relationship between the parties and this arises where the parties are “connected persons” as defined. By widening the scope of the transfer pricing legislation to also include “associated enterprises”, it would be necessary to test whether there is an “affiliation”. In particular, it must be determined whether one party is exercising control over the other party, which is the underlying concept of affiliation in terms of the definition of an “associated enterprise” which, from a transfer pricing perspective, is an important determination in considering whether prices between parties are being or could be influenced.
A further issue to consider is that varying countries use different definitions and interpretations of the concept of “associated enterprises”, with reference to Article 9. The “control” element in the description of “associated enterprises” in accordance with Article 9 seems particularly open to interpretation.
The Draft Bill proposes amending section 31 with effect from 1 January 2020 and is applicable in respect of years of assessments commencing on or after that date.