South Africa's first transfer pricing case?

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South Africa's first transfer pricing case?

• 16 July 2018
• Corporate Tax
• Jerome Brink

Important:

This article is based on tax law for the tax year ending 28 February 2019.

Author: Jerome Brink (Cliffe Dekker Hofmeyr)

Section 31 of the Income Tax Act, No 58 of 1962 (Act) contains South Africa’s transfer pricing provisions which constitutes one of the most contentious areas of tax law not only in South Africa, but around the world. Historically, there has been no judicial precedent in South Africa regarding the application of s31 of the Act and in particular the important “arm’s length” principle. However, in Crookes Brothers Ltd v Commissioner for the South African Revenue Service [2018] ZAGPHC 311 (judgment delivered 8 May 2018) (Crookes Bros) the High Court handed down findings regarding the application of certain provisions contemplated in s31 of the Act.

Background

The taxpayer in Crookes Bros formed part of a group of companies in the commercial agriculture industry operating in Southern Africa (Taxpayer). The Taxpayer had advanced (what purports to be) an ordinary shareholder loan to one of its subsidiaries located in Mozambique (Mozco) to enable it to fund certain costs associated with the establishment of a macadamia nut farm.

In its income tax return for the 2015 year of assessment, the Taxpayer made a transfer pricing adjustment to its taxable income in terms of subsection 31(2) of the Act as well as a “secondary adjustment” in terms of s31(3) of the Act resulting in a deemed dividend in specie being declared and paid to Mozco.

Subsequent to the filing of its income tax return, the Taxpayer realised that the transfer pricing adjustment had been made in error on the basis that the shareholder loan fell outside the application of the transfer pricing provisions in terms of s31(7) of the Act. In an abbreviated manner, s31(7) of the Act states that a debt will not be subject to the s31 transfer pricing provisions to the extent that:

• the debt is between a resident company and a foreign company in which the resident holds at least 10% of the equity shares and voting rights in the foreign company;
• the foreign company is not obliged to repay the loan within 30 years of the date the debt is incurred;
• redemption of the debt is conditional on the value of the assets being greater than the liabilities; and
• no interest accrued on the debt in the year of assessment.

The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2013 provides context to the introduction of the carve-out contemplated in the s31(7) as follows:

[I]t is proposed that transfer pricing relief should be extended to outbound loans that clearly resemble equity. In effect, taxpayers should not be forced to pay tax on notional interest from a share loan that is in substance nothing more than share capital... A loan that meets the [relevant] criteria is in substance exposed to the same economic risk as equity and thus poses little or no risk to the South African tax base if interest is under-charged (because interest should not be charged at all as an economic matter).

Please click here to read more.

This article first appeared on cliffedekkerhofmeyr.com.

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