In 2019 the South African National Treasury announced a proposed amendment to align the wording of the transfer pricing provisions with that of Article 9 of the OECD Model Tax Convention (OECD MTC) and the OECD Guidelines, which will effectively broaden the ambit of the South African transfer pricing rules.
In summary, the current South African transfer pricing legislation in Section 31 of the Income Tax Act 58 of 1962 (ITA) requires all “affected transactions” to be conducted at arm’s length. An affected transaction is (1) a cross-border transaction (as defined) that is (2) entered into directly or indirectly by persons who are (3) connected persons in relation to each other (as defined).
The proposed amendment to the definition of “affected transaction” will in effect replace the term connected persons with the OECD’s definition of associated enterprises. It is important to note that this amendment is made solely for the purposes of the transfer pricing rules and does not seek to amend the general definition of connected persons insofar as it applies to other provisions of the ITA.
It has long being recognised in South Africa that the definition of connected persons, mainly in respect of companies, is much more restrictive, especially when compared to the more liberal OECD definition of associated enterprises (as defined in Article 9 of the OECD MTC and referenced in the OECD Guidelines).
Concerns relating to the connected person definition primarily include its over-reliance on shareholding (which is akin to “participation in the capital” under the OECD’s definition of associated enterprises), whereas the OECD’s definition of associated enterprises covers, in addition to the foregoing, participation in the control and management of an enterprise.
Neither the OECD MTC nor the Transfer Pricing Guidelines proves clarity on the meaning or interpretation of the terms “management”, “control”, or “capital” for the purposes of Article 9. These terms will need to be defined in domestic legislation. In practice, however, “management” refers to the ability to significantly influence the decisions of the company, “control” is represented by the number of voting rights held, and “capital” is represented by the number of shares held.
What has yet to be considered in respect of this proposed legislation is the number of voting rights required for a person to be subject to South African transfer pricing legislation. Further, a domestic test needs to be developed for “significant influence” as a prerequisite for being subject to transfer pricing rules. It is my submission that the number of shares required for the application of South African transfer pricing legislation should remain the same as those under the current connected persons definition. It is through these actions, together with other necessary terms and definitions, that the proposed amendment will achieve the required outcome.
From the above, it is clear that this proposed amendment will have a significant impact on the ambit of South African transfer pricing legislation and will limit the potential of legislative circumvention of transfer pricing rules.