South Africa and others: broadening the tax base by clamping down on “white collar schemes”

Wed 16 Dec 2020

Near-term objective of the South African Revenue Service confirmed: “Remaining focused on international taxes, particularly aggressive tax planning using transfer pricing.” 

The South African (“SA”) economy, like many others, has been severely impacted by the Covid-19 pandemic. A recent speech by the country’s Finance Minister painted a dire picture of a country that is, in his words “poorer than we thought we were”. The speech highlighted that SA is facing increasing levels of debt which cannot be sustained along with a weak economic outlook. The Minister, however, reminded his audience not to tremble in fear when facing storms. He remained hopeful and reassured the SA population that “our compass points towards fiscal sustainability”.

Identifying the issue

A policy statement issued in October 2020 provides some insight in respect of how the SA government intends to achieve fiscal stability. The statement notes that, amongst others, the SA Revenue Service (“SARS”) will continue to rebuild its capacity following several years of mismanagement. In this context the top five near-term objectives of SARS were summarised, with one of them particularly highlighting an increased focus on transfer pricing.

The policy statement also refers to a study which is being conducted to quantify the gap between tax that should be collected and tax actually collected. This study, which is expected by December 2020, is likely to include detail in respect of the extent to which multinational groups, with operations in SA, have been shifting profits to low-tax jurisdictions.

The Commissioner of SARS reiterated the concern regarding profit shifting practises in several discussions following the Finance Minister’s speech. The Commissioner noted that there have been unusual activity in what he refers to as “white collar schemes”. In this context he noted that SARS has seen cases where suspiciously high interest is being charged by foreign parent companies in respect of loans granted to their SA subsidiaries. The Commissioner also mentioned that a noticeable increase has been noted in other cross-border related party charges, such as service fees, which according to him “leaves some more questions than answers”.   

Addressing the issue

The SA transfer pricing regime addresses the issue of profit shifting by requiring cross-border related party transactions to be entered into based on arm’s length terms. The onus of proof in this regard falls on the SA taxpayer.

SA has a well-established transfer pricing regime with legislative provisions and regulations providing specific detail in respect of the compliance obligations to be adhered to in terms thereof. To date, the SA transfer pricing regime has, however, only been tested in court once. The first and only SA transfer pricing judgement was delivered in May 2018 in the case of Crookes Brothers Ltd vs Commissioner for SARS. The case dealt with the question of whether a loan provided by the taxpayer to a cross-border related party had to be subjected to the SA transfer pricing rules or whether it could be excluded from the rules based on specific provisions of the SA Income Tax Act. The court however ruled in favour of SARS, noting that the terms of the loan in question did not meet the relevant requirements to be excluded from SA transfer pricing rules.

The fact that there has not been a multitude of SA court cases to serve as precedent does not mean that SARS has not been clamping down on profit shifting. A notable increase in transfer pricing risk assessments by SARS has been seen with most disputes being settled by the parties before going to court. Given the latest statements made by the Commissioner of SARS and in light of the policy statement issued by the SA government these disputes are also likely to increase.  

Broadening the SA tax base and addressing the implications of Covid-19

The SA Finance Minister’s speech in October 2020 also included a hopeful plea to the country’s “international partners who know that SA is a great place to invest”. In this context the Minister noted that the SA government intends to create stable and predictable policies and remove the needlessly complex red tape that increases the cost of doing business.

The call for investments into SA, which will enlarge the tax base, should however also be considered against the increased focus on transfer pricing to curb the erosion of that tax base. In the context of clamping down on the so-called “white collar schemes”, the Commissioner of SARS noted that “there are comfortably tens of billions [of Rand] that can be collected”. In this context he also noted that the SA government is fully aware of the burden that taxpayers are under which is why they are “broadening the base and improving compliance”.

In light of the above, one can only be hopeful that the SA transfer pricing regime would be appropriately enforced to avoid any unnecessary expenses and time being wasted on defending transfer pricing disputes.

Given the increased focus on transfer pricing, it has become increasingly important for taxpayers to properly consider all cross-border related party transactions. It is also critical to have these transactions appropriately addressed, analysed and substantiated in the taxpayer’s transfer pricing documentation.

The significant effect of Covid-19 on the businesses of multinational groups with operations in SA and the implications thereof on their cross-border payments cannot not be ignored. Given the unprecedented times we are living in, transfer pricing studies will also have to take account of, and properly address, the impact of Covid-19 on the business and financial performance of taxpayers.

As we look across the globe, we see the Covid-19 economic drain is not just a hurdle to overcome in SA.  In fact, many countries across Europe, Asia, Africa and the Americas are faced with a similar fiscal pandemic or crisis with respect to their state coffers.  They, too, struggle to replenish much needed funds and budget.  Clamping down on so-called aggressive transfer pricing schemes will be just one of many areas of tax focus to help improve national (and local) economies worldwide.  What are you seeing in your country, state or locality?  Is there any country that got it right thus far?