Transfer Pricing
Transfer
pricing is the name given by tax professionals to the business phenomenon
whereby a company would sell or purchase goods or services from or to a related
company.
The price
of such goods or services sold between related parties might differ from the
price charged by unrelated parties.
If a
multinational company on -sells goods or services from a country where a lower
tax rate is levied, for onward transmission to the end user, whist purchasing
goods from a related company which is resident in a higher taxed jurisdiction, the potential
price manipulation could be harmful to the high tax jurisdiction, as low or no
tax might be paid in the high tax jurisdiction.
South
Africa is a relatively high tax jurisdiction, as it has neighbors within the
SADC with much lower rates of tax.
Abusive transfer pricing (the manipulation of
related party prices to avoid tax) is also a mechanism that enables capital to
be exported.
The high
tax country obviously will lose revenue if such measures are allowed to
succeed.
Therefore
tax authorities in high tax countries have rules in place to combat the
phenomenon known as transfer pricing.
The issues
surrounding transfer pricing are top priority for a number of countries’ tax
authorities all over the world. In a recent article posted on the International
Law Office web page, author Patricia Lewis states that the IRS Commissioner has
declared that transfer pricing is one of the highest priorities in terms of USA
revenue and enforcement.
Every
country has its own sovereign jurisdiction, however and the high tax country’s
tax authorities have no jurisdiction over the lower tax country company.
Thus tax
authorities face difficulties in enforcing transfer pricing rules. At paragraph
4 of the transfer Pricing Guidelines of the OECD (Volume 1 Materials on International and EC
Tax Law 2004/2005, Kees Van Raad International Tax Centre, Leiden) it states
that:
“ In the case of tax administrations, specific
problems arise at both policy and practical levels. At the policy level,
countries need to reconcile their legitimate right to tax the profits of a
taxpayer based upon income and expenses that can reasonably be considered to
arise within their territory with the need to avoid the taxation of the same
item of income by more than one jurisdiction. Such double or multiple taxation
can create an impediment to cross border transactions in goods and services and
the movement of capital. At a practical level, a country’s determination of
such income and expense allocation may be impeded by difficulties in obtaining
pertinent data located outside its own jurisdiction.”
The
Organisation for Economic Co Operation and Development (OECD) has however
established guidelines for the drafting of legislation to combat abusive transfer
pricing.
South
Africa also looks to the OECD for guidance. South Africa is not a member of the
OECD, but, like many other countries that are non- OECD members, nonetheless
acknowledges the efforts of the OECD at promoting fair tax practices worldwide.
One of the
bulwarks of fair pricing that the OECD makes use of to promote fair taxation of
multinationals is the arms length principle.
This
principle, which has the objective of ascertaining the price at which goods or
services would be traded between independent parties, is not easily given
effect to.
The range
of factors that may influence the price of goods or services is very large.
Also, different enterprises sell goods and services within an extremely large
range of prices for similar goods.
It is
therefore not possible to find a median point with accuracy. In some
jurisdictions, the markets are small so that comparison of prices for similar
goods or services sold between independent parties in simply not possible.
In terms of
the OECD guidelines at paragraph 16 thereof, the desired perspective of tax
authorities is set out as follows:
“ Tax administrations atr encouraged to take
into account the taxpayers commercial judgment about the application of the
arm’s length principle in their examination practices and to undertake their
analyses of transfer pricing from that perspective.”
The stance
of the tax authorities in ascertaining the correct pricing of goods and
services, should be to place themselves in the position of the company and to
take the relevant commercial criteria into consideration.
In her
article in which she advocates the
provision of safe harbor legislation for small taxpayers, author Patricia
Lewis, referred to above, stresses that smaller taxpayers have not the
resources to deal with the requirements of revenue authorities to defend their
pricing strategies.
According
to the 2012 Ernst and Young Transfer Pricing
tax authority survey, the documentation burden is growing.
A high
percentage of South African companies that have been targeted in the past have
been subject to double tax because of the revenue authority interference with
their commercial pricing decisions.
This seems
unfair, as the mandate of the tax authorities in South Africa is not to cause
harm but to gather the appropriate amount of tax.
Where
double tax has been experienced by a business, either one or both the taxing
authorities of the countries where taxes were imposed, is overreaching its
mandate and acting, it is submitted, ultra vires.
Under the
South African Constitution at Section 33, every person has a right to
administrative action that is lawful, reasonable and procedurally fair.
It is
submitted that it cannot be fair to tax a person twice on the same amount of
income, simply because that person has a related company in another
jurisdiction.
Indeed, it
is doubtful if the tax authority I allowing the taxpayer to be thus burdened
has take proper note of paragraph 16 of the preface to the OECD transfer
pricing guidelines.
Especially
given the fact that it is well nigh impossible to accurately come up with an
independent arms length price, the tax authority should proceed upon a
reasonable basis. Such reasonability is obviously lacking when the same income
is taxed twice as such double tax would be impossible but for the relationship
between the parties.
Another
aspect of the tax authorities approach
that is alarming is that, potentially, Section 31 would allow the tax authority
to levy a deemed tax after the event, that is, in a subsequent assessment.
It is
submitted that an assessment thus made after the fact would might well be
sustainable, for the following reasons:
Section
79(1) provides for tax to be levied in an additional assessment in
circumstances where the taxpayer has income that is unassessed in a particular
year, limited to three years in retrospect.
Should a
taxpayer have submitted all relevant documentation to the tax authorities and
been assessed upon all cross border transactions, then it must be assumed that
the authorities have, upon issuing the first assessment, have applied their
minds to the facts and made the necessary calculations as outlined in Section
31.
However, if
the calculation referred to in Section 31 shows that the transfer prices fall
outside of an acceptable range, then there will be an amount, per the
calculation that is so unassessed.
Thus
Section 79(1) may be invoked and a re-assessment issued.
This
Section thus seems to empower the tax authorities in an unseemly manner and can
give rise to major uncertainty.
On the
other hand, if the effect of a re-assessment is to tax the taxpayer twice, the
result will be both harsh and unreasonable.
Perchance a
case can be made where, upon reliance upon the common law presumptions, in the
event of double taxation being the result, that Section 79 cannot be made use
of as there would not in such circumstances have been any unassessed income, the excess having been taxed in the
other jurisdiction.
The common
law presumption being that the legislature in enacting a statute must have
intended a meaning that will avoid harshness or injustice[1].
The
Constitutional safeguard against unreasonable administrative action might also
be made use of in the working up of such a case against a re-assessment that
would give rise to double taxation.
Peter
O’Halloran
[1] Devenish, Interpretation of
Statutes, 1st Ed at page 162.
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