Home Articles INFLUENCE: Transfer pricing in South Africa Five things you need to know

INFLUENCE: Transfer pricing in South Africa Five things you need to know

The South African transfer pricing landscape poses a number of challenges to South African taxpayers engaged in cross-border intercompany transactions. Article by Cornelia Wolff and Michel Verhoosel

Over the past years, transfer pricing has been become increasingly important for those companies with cross-border intercompany transactions. It seems that this trend has not come to an end yet: tax administrations and the media are showing an increased interest in transfer pricing and the regulatory environment so that practical aspects are changing more than ever. Examples of the changing environment are the various projects of the Organisation of Economic Co-operation and Development (OECD) such as the project on Base Erosion and Profit Shifting (BEPS)2  and the introduction or amendments of local transfer pricing rules and regulations.


The complexity of transfer pricing regulations and the continuously changing transfer pricing environment make it challenging for multinational companies to manage their transfer pricing position and to be compliant with the latest requirements. This article provides a selection of issues one needs to know about transfer pricing in South Africa.

Scope of rules and regulations

Section 31 of the South African Income Tax Act contains provisions that require cross-border-related party transactions to take place at arm’s length conditions. Conditions made or imposed between connected persons should not differ from those which would be made between independent enterprises in a similar situation. The scope of section 31 is explicitly not limited to transactions between connected parties; it also looks at operations, schemes, agreements and understandings between connected parties. It is therefore important to carefully analyse the various interactions between a South African taxpayer and its foreign affiliates to ensure that all relevant interactions are properly remunerated (for example no double payments and no transactions uncompensated).

Even though South Africa is not an OECD-member country, the OECD and South Africa have various working relations and the South African Revenue Service (SARS) generally follows the guidance provided by the OECD Transfer Pricing Guidelines3  in determining an arm’s length price for intercompany transactions and arm’s length rewards for functions performed (taking into account assets used and risks assumed). When applying OECD principles, specific attention should be given to the fact and circumstances of the South African company. For instance, the benefit of intragroup services for South African subsidiaries as well as the applicability of a global transfer pricing policy in a South African context may require specific attention. The existing transfer pricing policies may need to be amended to support the arm’s length nature from a South African perspective.

Specific guidance from SARS

Up to now, SARS has issued two Practice Notes providing additional information with respect to the South African transfer pricing provisions: PN24  and PN75.  PN2 (already abolished) provided guidance with respect to financial assistance under the transfer pricing rules applicable for financial years starting prior to 1 April 2012. SARS issued a (draft) Interpretation Note regarding the new thin capitalisation rules for years starting on or after 1 April 20126.  PN7 provides guidance on procedures to be followed in determining arm’s length prices and sets out SARS’ view on documentation and other practical issues. PN7 was issued when the South African transfer pricing provision had a narrower scope than it has today. As the scope of current transfer pricing provisions is not limited to prices but also applies to other terms and conditions, the guidance included in PN7 nowadays should also be taken into account when reviewing such other terms and conditions. Some of the issues addressed in PN7 concern determining which party to a transaction to evaluate and the availability of information.

Party to be evaluated

The OECD Guidelines describe a number of “one-sided” approaches that analyse the margin or mark-up earned by one of the parties to the transaction7.  According to the OECD Guidelines, the party being evaluated (the “tested party”) will most often be the “less complex” party in terms of functions performed, assets used and risks assumed. PN7 explicitly states a preference for using the South African party as the tested party in evaluating the arm’s length nature of transfer prices applied. It is therefore important that in cases where a foreign party is selected as the tested party, the prices applied are also considered in relation to the South African operations. In practice this means that if the South African company is not selected as the tested party, an economic substantiation for this choice should be available.

Comparability data

The arm’s length nature of intercompany transactions is typically evaluated by reference to data regarding “uncontrolled transactions” between unrelated parties. In practice, such data is often obtained though database studies or “benchmarking studies”. Generally speaking, and in particular when applying the Comparable Uncontrolled Price method, information regarding uncontrolled transactions in South Africa is preferred. However, such information is not always available. In light of the difficulties in obtaining information on uncontrolled transactions in South Africa, PN7 explains that foreign country data may be used by South African taxpayers but that the expected impact of geographic differences and other factors on the price should be carefully assessed. In practice, South African taxpayers may not be able to rely on benchmarking studies performed by foreign affiliates without further analysis and/or providing additional substantiation. Selecting “comparables” from countries showing similarities with South Africa (for instance in terms of risk rating) is one of the steps that can be taken to enhance the quality of a benchmarking study.

Thin capitalisation rules: financial assistance

Current South African thin capitalisation rules require that all cross-border transactions involving financial assistance take place at arm’s length. In contrast to financial years that started before 1 April 2012 there are no safe harbours and no clear guidance is available at the moment. The draft Interpretation Note mentioned above has not been finalised and the final version may deviate from the current draft available.

The draft Interpretation Note provides an indication of the increased complexity of the analysis required for intercompany financial assistance. For instance, it indicates that it is not sufficient to only provide an analysis of the interest rates applied. An analysis of the economic substance of the funding is critical (for example to establish whether it is debt or equity in nature) as well as a substantiation of the arm’s length nature of the quantum of the funding obtained.

The absence of safe harbours in combination with current compliance requirements (as discussed below) for many South African taxpayers results in an extra effort being required to ensure and to document that intercompany financial transactions comply with the arm’s length principle. In all fairness, the abolishment of the general safe harbour rules follows international trends. There are an increasing number of legislators around the globe that are abolishing any safe harbour rules with respect to thin capitalisation.

Compliance requirements

Although there is no statutory transfer pricing documentation requirement, there are a number of reasons why South African taxpayers are required to have transfer pricing documentation available in practice. First, the ITR14 asks taxpayers whether or not transfer pricing documentation is available that supports the arm’s length nature of the intercompany transaction in the year of assessment. The answer to this question can be used by SARS for risk assessment purposes8. If a taxpayer with a significant value or ratio of cross-border intercompany transactions does not have transfer pricing documentation in place it could increase the chance of being selected for audit.

Second, the ITR14 requires South African taxpayers to state whether they have entered into “affected transactions”. South African taxpayers need to self-assess whether they have complied with the arm’s length principle. Such an assessment is difficult if no adequate transfer pricing documentation has been prepared. If the taxpayer is engaged in affected transactions, a series of transfer pricing tables must be populated by the taxpayer.

PN7 states that if taxpayers do not maintain appropriate records, reviewing the compliance with the arm’s length principle is far more difficult. SARS may be forced to rely on less evidence when reviewing a transfer pricing method, resulting in a greater degree of judgment. Hence the absence of transfer pricing documentation is likely to make discussions with SARS more difficult and/or bear a potentially higher transfer pricing risk.

Transfer pricing adjustments

Based on section 31 of the South African Income Tax Act, any difference in price between what was charged between connected persons and what would have been charged between independent parties needs to be adjusted for in the taxpayer’s ITR14. The adjustment of the transfer price is generally referred to as the “primary adjustment”. For financial years starting on or after 1 April 2012, a deemed loan will arise to the extent that the taxpayer has not recovered the difference between the arm’s length charge and the actual charge from the foreign connected party. This is typically referred to as the “secondary adjustment”. Deemed interest will accrue on the deemed loan. In terms of the draft 2014 Taxation Laws Amendment Bill9  the deemed loan treatment will be replaced by a deemed dividend. The classification of the transfer pricing adjustment as dividend is aligned with the recommendation provided by the European Joint Transfer Pricing Forum10.


The topics discussed above show that the South African transfer pricing landscape poses a number of challenges to South African taxpayers engaged in cross-border intercompany transactions. The preparation of transfer pricing documentation helps taxpayers to manage and mitigate their transfer pricing risks. Transfer pricing analyses performed and transfer pricing documentation prepared by foreign affiliated companies may be used when preparing South African transfer pricing documentation but changes may be required to reflect the specific situation in South Africa.

A challenge may arise in relation to the applicability of global transfer pricing policies in a South African context, for example when the business model applied in South Africa deviates from the business model operated elsewhere in the group (due to differences in business environments, regulatory landscape, etc). Attention should also be given to intragroup services: SARS seems to be increasingly focusing on service transactions and associated charges. In particular, the economic and/or commercial benefit of the intragroup services needs proper substantiation. And in case of cost-based transfer pricing policies, SARS may show a particular interest in the cost base used.

When determining an appropriate transfer pricing documentation approach, the specific facts and circumstances of the case should be taken into account. For example, the nature and complexity of the transactions are critical factors for determining the most appropriate approach for each taxpayer. Determining an appropriate approach is an important step in the process of managing and mitigating transfer pricing risks. ❐


1        Any errors or omissions in this article are those of the authors and this article is           written in their personal capacity.

2        Following the declaration on BEPS adopted at the 2013 Ministerial Council Meeting           and at the request of G20 Finance Ministers, in July 2013 the OECD launched a BEPS           Action Plan identifying 15 action points. Action points relating to transfer pricing           include Action Points 8, 9 and 10 to assure that transfer pricing outcomes are in line           with value creation and Action Point 13 to re-examine transfer pricing           documentation. See http://www.oecd.org/ctp/beps.htm for more information.

3        OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax           Administrations, July 2010.

Practice Note no 2, 14 May 1996:

4        “Income Tax: Determination of taxable income where financial assistance has been           granted by a non-resident of the Republic to a resident of the Republic”.

5        Practice Note no 7, 6 August 1999 (and the addendum dated 29 September 2005):           “Determination of the taxable income of certain persons from international           transactions: transfer pricing”.

6        Draft Interpretation Note, 22 March 2013: “Determination of the taxable income of           certain persons from international transaction: thin capitalization”.

7        The term “transaction” in an OECD context generally has a broad definition which           also covers schemes, operations, etc, similar to the broad definition used in section           31 of the South African Income Tax Act.

8        The use of information for risk assessment purposes is also discussed by the OECD (OECD, White Paper on Transfer Pricing Documentation, 30 July 2013).

9        Republic of South Africa, National Treasury Department, Draft Taxation Laws           Amendment Bill, 17 July 2014.

10       European Commission, 18 January 2013, doc: jtpf/017/final/2012/en, EU Joint           Transfer Pricing Forum, Final Report on Secondary Adjustments, Meeting of 25           October 2012.

Author: Cornelia Wolff is Director and Africa Leader of EY’s transfer pricing and operating model effectiveness group and Michel Verhoosel is a manager in EY’s transfer pricing and operating model effectiveness group.                                .