Nataly Marchbank: BEPS and Transfer Pricing in South Africa

Recently there has been a steep increase in interest in the taxability of Multinational Companies (MNCs). What effective tax rates are being paid? Are MNCs paying their fair share of taxes in their home countries? Moreover, the very contentious question being asked is: What is a fair amount of taxes to pay?

All these questions have been raised in recent months, but the answers have not been forthcoming – this is primarily due to the fact that it comes down to whom you ask. If you ask an MNC, it would most probably be that it pays whatever is prescribed by the government’s tax legislation. If you were to ask governments, they would reply that MNCs do not pay enough.

Herein lays the difficulty that most governments face. The taxation of companies generates income for a country. If collections are low because MNCs are able to structure their affairs in such a manner so as to be tax efficient, this could potentially result in lower taxes being paid. It is no surprise that governments are looking at ways to increase tax revenue.

South Africa is no different than any other government in the world when looking at increasing its tax receipts. The country’s National Treasury Department has started to shift its focus to that of Base Erosion and Profit Shifting (BEPS) principles.

“Is it prudent to think that this BEPS campaign will have an effect on the South African tax collection strategy?”

The South African tax landscape draws heavily on the Organisation for Economic Cooperation and Development (OECD). With this as the backdrop of many of South Africa’s proposed changes in tax policy, it is no surprise that South African Revenue Services (SARS) has made BEPS one of its focus areas.

BEPS is currently on the minds of every tax authority and is the buzz phrase making its rounds in every tax authority’s corridors and offices. In February 2013, the OECD published a report entitled, Addressing Base Erosion and Profit Shifting, in which it stated the view represented by the OECD member countries on the matter.

The OECD clarified in this report that base erosion constitutes a serious risk to tax revenues, tax sovereignty and tax fairness for OECD member countries and non-members alike. While there are many ways in which domestic tax bases can be eroded, a significant source of base erosion is profit shifting.

Following the February report, as well as discussions with stakeholders on 19 July 2013, the OECD then released its BEPS Action Plan that set out 15 actions to be taken and further proposing significant changes to the OECD Transfer Pricing Guidelines, the OECD Model Tax Convention, but also to domestic legislation.

These proposed changes will affect corporate tax, international tax (including CFC), and indirect tax legislation. It is evident that the OECD has been a major driving force behind the campaign against BEPS. In this report the views expressed were that it skews competition and leads to an inefficient allocation of resources because of the distorting of investment decisions and issues of what is fair.

For this reason if taxpayers view MNCs as legally avoiding income tax it will certainly undermine their voluntary compliance towards tax as a whole. But as governments struggle to deliver and contain national deficits in the post-2009 world – and South Africa is no different in this realm – the trend that has been seen world-wide is to affix blame to large corporations and their tax advisors. Therefore in South Africa, as anywhere else in the world now, BEPS is gaining momentum quickly.

Is it not fair to ask the question that a business cannot be faulted for using the rules of government? Perhaps the blame (if there is any to apportion) should shift to government. Is it not government’s responsibility to revise their rules or introduce new laws if they feel that there is an aggressive trend towards BEPS in their country? It would be most interesting to debate whether the ideals of corporate governance and the “triple bottom line” approach extend to the parameters of tax planning as well.

Is it prudent to think that this BEPS campaign will have an effect on the South African tax collection strategy? It could be argued that all the newly introduced legislation over the past ten years is enough to contain the South African appetite for BEPS. Furthermore, if there are only 459 companies with taxable income exceeding R100m, then SARS is surely in a position to detect abuse?

The answer to the question, it would seem, is no. In recent months there has been much press about the low levels of tax being paid by large MNCs. Such press has undoubtedly stirred the interest of National Treasury in South Africa with the recent introduction of WHT taxes to be levied on services and interest payments in the near future. These are expected to take effect from 1 January 2015.

Not all companies are too concerned about BEPS in South Africa as this is probably more for large MNCs conducting business in the country and how they are measured on the true taxes that are applicable to their local income.

Whichever way you look at it, South Africa is going to need the cooperation of foreign tax authorities if it is going to get to the bottom of the story entitled BEPS .There is no doubt that there is not a single country that unilaterally can ever fully address BEPS on its own.

Transfer Pricing
Controversy over Transfer Pricing (TP) has been on the rise in Africa. The amount of limited resources, along with inexperience by taxpayers and tax authorities, has made managing the risk and obtaining resolutions a major challenge.

This doesn’t mean that tax authorities in Africa, and especially in South Africa, are not sitting up and taking notice of the need to overhaul their TP principles. Looking to the OECD again, which released its initial report on BEPS, one of the key principles that underlie the taxation of cross-border activities is a mismatch in entities and instrument characterisation (hybrids and arbitrage), and related party debt financing.

National Treasury in South Africa took similar preventative measures. When the 2012 draft Taxation Laws Amendment Bill was issued it contained certain provisions whereby debt would be reclassified as equity in certain instances (i.e. the instrument when reclassified will pay a dividend and not interest).

However, these new rules were excluded from the final 2012 Taxation Laws Amendment Bill when it was introduced in parliament for promulgation. As was expected, these provisions were deferred for introduction in 2013/14. It was proposed in the 2013/14 budget that certain debt instruments, such as shareholder loans without a date of repayment or profit participation loans will be reclassified as equity.

It seems that the thin capitalisation provisions (dealing with excessive connected party debt) were addressed in the 2013/14 budget. Under the old SARS Practice Note 2 it stated a debt to equity safe harbour of 3:1. This safe harbour can no longer be used, as the new Draft Interpretation note will replace the old Practice Note 2.

Nataly Marchbank

South Africa has therefore overhauled and revised its Transfer Pricing rules with effect of the years of assessment commencing 1 April 2012. This overhaul sees South Africa move away from the old safe harbour rules to that of the at an arm’s length test.

With the draft interpretation being the source of information for Transfer Pricing currently, there is uncertainty in the universe of TP in South Africa, and this is expected to be the case for some time as the onus and risks shift more and more to the taxpayers to ensure that they have the adequate TP documents in place and that their feasibility studies are in place, in order to explain to SARS the basis for their benchmarking in their TP policies.

Taxpayers are urged to ensure that they comply with the newly introduced IT14 tax return disclosure requirements for TP and now must have a TP document almost immediately in case of a request by SARS.

With increasing focus being placed on Transfer Pricing by the media, both domestically and internationally, there is pressure on South Africans to act according to their stated intention to combat the complex international schemes that have been singled out as contributors to the erosion of the tax base. It will be interesting to see how stringent South African tax audits will become and whether they will be based in BEPS or TP investigations. Only time will tell.

About the Author

Nataly Marchbank is a qualified professional accountant (CPA (SA)) and master tax practitioner (MTP (SA)), with a specialism in Tax. She has a Higher Diploma in Tax and a Masters degree in South African and International Tax. She is currently employed as the Country Tax Manager for IBM South Africa.