Alternatives for the treatment of secondary transfer pricing adjustments in South Africa
Harmse, Lana Heleen
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Deviations from arm’s length prices (prices charged between independent persons) charged between connected cross-border companies are corrected by primary transfer pricing adjustments, effected by the tax authorities of a country, resulting in secondary transactions classified as constructive loans, constructive dividends or constructive equity contributions. Tax could be imposed on the secondary transaction, giving rise to a secondary adjustment. For years of assessment commencing on 1 April 2012 secondary transactions, previously regarded as constructive dividends with Secondary Tax on Companies, were amended to be treated as constructive loans with interest adjustments. The primary research problem addressed by this literature study was to establish whether the constructive loan is the appropriate treatment of secondary transfer pricing transactions in the South African context and if not, whether the other alternatives suggested by the Organisation for Economic Co-operation and Development (“OECD”) guidelines should be considered. The OECD suggests that a transaction should be characterised in accordance with its substance. Determination of the subjective economic substance may be established by the motives of multinational groups for setting transfer prices. Multinational groups could have various motives for setting transfer prices that deviate from the arm’s length principle, influencing the economic substance of secondary transactions. In order to determine if the treatment of a secondary transaction, as a constructive loan, would be appropriate and reflect the economic substance of adjustments arising as a result of these motives, the characteristics of each alternative were analysed. The characteristics determined for each of the alternatives were then applied to the economic substance arising from a motive, to determine the appropriateness of each of the alternatives as a secondary transaction. Based on the motives for entering into these transactions, an analysis was performed. The findings led to the conclusion that in the case of the economic substance of transactions, which give rise to transfer pricing adjustments, a constructive dividend appears to be the appropriate treatment for a secondary transaction in most circumstances, as opposed to the constructive loan currently applied by South Africa. Constructive loans or constructive equity contributions may be reflective of the economic substance in exceptional circumstances. The study makes recommendations that South Africa should consider amending the current treatment of a secondary transaction as a constructive loan, to a constructive dividend. It was also recommended that overlapping criteria in the dividend definition be eliminated and that further research should be undertaken in order to determine how the exceptional circumstances for characterisation as a constructive loan or constructive equity contribution, should be provided for in the Income Tax Act (58 of 1962).