South Africa amended its transfer pricing secondary adjustment regulations, effective 1 January 2015. With only a few changes to the South African transfer pricing regulations in the past, including secondary adjustments, it is not always clear how the new regulations apply.
A secondary adjustment is defined by the OECD as an “adjustment that arises from imposing tax on a secondary transaction in transfer pricing cases” and a secondary transaction is defined as “a constructive transaction that some States assert … after having proposed a primary adjustment in order to make the actual allocation of profits consistent with the primary adjustment.”
Prior to 1 January 2015, section 31 of the Income Tax Act (ITA) treated secondary adjustments as a deemed loan. If the loan was not repaid within the same year of assessment in which the primary adjustment was made, the taxpayer also had to account for an arm’s length interest rate on the deemed loan. The accrued arm’s length interest “income” was subject to tax and was capitalised to determine the total deemed loan outstanding for each year of assessment. However, this was impractical as the deemed loan and applicable interest rate were difficult to administer by the South African Revenue Service (SARS). Furthermore, the deemed loan and applicable interest rate were rarely repaid by foreign entities for a number of reasons, including that there was no obligation to do so.
Section 31 of the ITA was therefore amended and from 1 January 2015, secondary adjustments are treated as either:
- in relation to a company, a deemed dividend consisting of a distribution of an asset in specie (referred to as deemed dividend in specie), which will be subject to 15% dividends tax; or
- in relation to persons other than companies, as defined in section 1 of the ITA, a deemed donation, which will be subject to 20% donations tax.
The amended section 31 of the ITA provides a transition mechanism for outstanding deemed loans in existence prior to 1 January 2015. Section 31 converts the outstanding balance of the deemed loan prior to this date, into either:
- a deemed dividend in specie declared and paid by the tax payer on 1 January 2015; or
- a deemed donation made and paid on 1 January 2015.
In relation to whether the deemed dividend in specie would be subject to relief in terms of a double tax agreement (DTA), the Davis Tax Committee Interim Report stated the following:
“It is suggested that the secondary adjustment should take into account the fact that, regardless of the relationship between the South Africa taxpayer and the counter-party, a transfer pricing adjustment is triggered as a result of economic value being transferred from South Africa for no, or inadequate, consideration. This transfer of economic value results in depletion in the asset base of the South African taxpayer; and a resultant potential loss of future taxable income for the Fiscus. For this reason it is suggested that transfer pricing adjustments are economically similar to outbound payments of dividends to foreign related parties since they represent a distribution of value from South Africa to the foreign company. Therefore the secondary adjustment mechanism should result in a tax equivalent to the proposed 15% withholding tax. For example, a tax similar to the old secondary tax on companies (STC) would be appropriate. Because it would be a tax levied on the South African company rather than on the foreign related party, no DTA relief would be available.”
While the report is not binding in law, it may give guidance as to how SARS may interpret and apply the respective amendments.
The following point regarding withholding taxes is also not clear at this stage. How should a taxpayer treat the withholding tax paid in relation to the excessive amount which is reduced via the primary transfer pricing adjustment? Withholding taxes will have been paid (if not reduced by a double tax treaty) for specific charges, such as interest and royalties, and the question is whether this can be offset against the withholding tax applicable for the deemed dividend in specie.
From a timing perspective, section 31 of the ITA states that the deemed dividend in specie is declared and paid on the last day of the period of six months following the end of the year of assessment in respect of which that adjustment is made. This means that the withholding tax is due and payable to SARS by the last day of the month following the month during which the dividend is deemed to have been made (declared).
If you have any questions, or would like to discuss this further, please contact:
- AJ Jansen van Nieuwenhuizen: firstname.lastname@example.org or +27 (0) 10 590 7481
- Marcus Stelloh: email@example.com or +27 (0)10 590 7473