ALERT TAX & EXCHANGE CONTROL - Cliffe Dekker Hofmeyr
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4 MARCH 2021
TAX &
EXCHANGE
CONTROL
ALERT
IN THIS South Africa’s “second” transfer pricing case?
ISSUE It is no secret that revenue authorities the world over continue to place
significant emphasis on Base Erosion and Profit Shifting (BEPS), with
transfer pricing being one of the key focus areas. The South African
Revenue Service (SARS) is no different. In fact, the Minister of Finance
(Minister) in the recent 2021 National Budget Speech specifically
requested an additional spending allocation of R3 billion to SARS
which would, amongst others, be used to expand SARS’ specialised
transfer pricing audit and investigative skills.
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TAX & EXCHANGE CONTROL
South Africa’s “second” transfer
pricing case?
It is no secret that revenue authorities exhaust emissions. In the course of this
the world over continue to place
Despite the significant activity, the Applicant purchased certain
significant emphasis on Base Erosion metals, known as the Precious Group
focus of SARS on BEPS and Profit Shifting (BEPS), with transfer of Metals (PGMs), from a related party
and transfer pricing, pricing being one of the key focus based in Switzerland (Swiss Entity). On
it is interesting that areas. The South African Revenue completion of manufacture, the catalysts
Service (SARS) is no different. In fact, would be sold to customers in South
there is a dearth of the Minister of Finance (Minister) in the Africa known as original equipment
transfer pricing cases in recent 2021 National Budget Speech manufacturers (OEMs) or more simply
South Africa. specifically requested an additional motor vehicle manufacturers.
spending allocation of R3 billion to SARS
SARS conducted a transfer pricing
which would, amongst others, be used
audit into the Applicant’s 2011 year
to expand SARS’ specialised transfer
of assessment which included a
pricing audit and investigative skills.
consideration of whether the transaction
Despite the significant focus of SARS on between the Applicant and the Swiss
BEPS and transfer pricing, it is interesting Entity for the purchase of the PGMs
that there is a dearth of transfer pricing was conducted at arm’s length. After
cases in South Africa. We previously considering various aspects of the
questioned in our 13 July 2018 Tax Alert transaction including an analysis of
whether the Crookes Brothers case the underlying cost base as well as the
was South Africa’s first proper transfer functions, risks and assets of the Applicant
pricing case. With this context in mind, in purchasing and manufacturing the
when first reading the recent (as yet catalytic converters, SARS concluded that
unreported) judgment of ABC (Pty) the Applicant’s Full Cost Mark-Up (FCMU)
Ltd v Commissioner: SARS (IT 14305) of 1% fell between the minimum and lower
[2021] ZATC 1 (7 January 2021), referred quartile of SARS’ arm’s length interquartile
to herein as IT14305, the key words range achieved by the comparable
“transfer pricing”; “arm’s length price”; company dataset. Based on this, an
“transactional net margin method”; and adjustment was warranted.
“full cost mark-up” certainly pique one’s
While the Applicant did make submissions
interest. In this article, we consider the
regarding SARS proposed transfer pricing
discussion of transfer pricing principles
adjustment, it would appear that the
and findings in this case.
Applicant did not specifically test (and
Background document) the transactions for transfer
pricing purposes which took place prior
The Applicant in IT14305 was in the
to the introduction of mandatory transfer
business of manufacturing, importing,
pricing documentation (TPD) in 2016. SARS
and selling chemical products. In
therefore based its findings on its own
particular, one of its activities included
transfer pricing analysis drawn from the
the manufacture of catalytic converters,
guidance in SARS’ Practice Note 7 (PN7)
which to the layman, perform a critical
and the OECD Transfer Pricing Guidelines
environmentally protective function
(TPG). In this regard, SARS adjusted
for motor vehicles in reducing harmful
2 | TAX & EXCHANGE CONTROL ALERT 4 March 2021
TAX & EXCHANGE CONTROL
South Africa’s “second” transfer
pricing case?...continued
the Applicant’s FCMU to the median of to seek the separation of issues
The matter to be SARS’ arm’s length interquartile range was created in the rules so that an
achieved by the comparable company alleged lacuna in the plaintiff’s case
determined by dataset. This set of facts follows a fairly can be tested; or simply so that a
the present court standard transfer pricing audit into a factual issue can be determined
was whether an taxpayer’s affairs. which can give direction to the rest
of the case and, in particular, to
application for Issue
obviate the leading of evidence… .”
separation of a legal While the Applicant disputed SARS
In simple terms therefore, it allows a
issue in terms of additional assessment such that an income
separation of a question of law or fact to
Rule 33(4) of the tax appeal on the merits is currently still
be decided first before any evidence is led
pending, the matter to be determined
Uniform Rules of by the present court was whether an
in the main matter. Essentially it saves costs
the High Court, as application for separation of a legal issue
and time particularly where the separated
issue is determined in such a way that puts
provided for in terms in terms of Rule 33(4) of the Uniform
paid to the matter proceeding thereafter.
of Rule 42(1) of the Rules of Court, as provided for in terms of
In civil cases, an obvious example is where
Rule 42(1) of the Tax Dispute Resolution
Tax Dispute Resolution Rules, should be granted in favour of
the parties first agree to determine liability
Rules, should be for damages whereas the quantum of
the Applicant.
damages is then determined subsequently.
granted in favour of The purpose and rationale of separation By determining liability first, it may be that
the Applicant. as per Rule 33(4) of the Uniform Rules of determination of quantum becomes moot.
Court was set out in The City of Tshwane
Para 22 of the judgment neatly summarises
Metropolitan Municipality v Blair Atholl
the crux of the issue in the present case
Homeowners Association 2010 (3) SA 382
as follows:
(SCA) as follows:
“As a reminder, the point raised by
“If, in any pending action, it appears
applicant, which it seeks to separate
to the court mero motu that there
from the issues raised in the appeal,
is a question of law or fact which
concerns the powers of respondent
may conveniently be decided
as sanctioned by section 31(2) of
either before any evidence is
the ITA. Applicant challenges that
led or separately from any other
on a proper reading of section 31(2),
question, the court may make an
respondent was only entitled to
order directing the disposal of such
adjust the price/consideration paid
question in such manner as it may
for the PGMs as between itself and
deem fit and may order that all
the Swiss Entity. Consequently, the
further proceedings be stayed until
act of adjusting its profits, pursuant
such question has been disposed
to the application of the TNMM
of, and the court shall on the
and the FCMU, was not a legitimate
application of any party make such
exercise of transfer pricing power
order unless it appears that the
authorized by section 31(2).”
questions cannot conveniently be
decided separately…The entitlement
3 | TAX & EXCHANGE CONTROL ALERT 4 March 2021TAX & EXCHANGE CONTROL
South Africa’s “second” transfer
pricing case?...continued
It thus follows that while IT14305 raised profitability. If that was the case, then the
SARS argued that an issue of separation, the court was matter would end there. On the other
nevertheless tasked with unpacking the hand, SARS argued that the issue under
the issue under provisions of the previous section 31(2) consideration was inextricably bound
consideration was of the Income Tax Act, 58 of 1962 (Act) in with the main issue in the appeal, and
inextricably bound determining whether the application for that is whether the transactions between
separation should be granted. Applicant and the Swiss Entity were at
with the main issue
arm’s length.
in the appeal, and Arguments made by the parties
Interestingly, reference was also made to
that is whether the The Applicant essentially argued that
the amendment to section 31. In 2011,
transactions between section 31(2) of the Act (as it then read
section 31 was substantially amended for
in 2011) only permitted SARS to adjust
Applicant and the the consideration in respect of the
purposes of introducing modernisation
Swiss Entity were at transactions between it and the Swiss
changes to the transfer pricing rules in
accordance with the OECD TPGs. The
arm’s length. Entity to reflect an arm’s length price for
Explanatory Memorandum on the Taxation
the purchase and supply of PGMs. It was
Laws Amendment Bill, 2011 further stated
submitted that SARS’ powers thus did
that the new wording of the section
not extend to adjust the consideration
also removed previous uncertainties. In
between the Applicant and third party
particular, it stated that the literal wording
customers (i.e. overall profitability of
focused on separate transactions, as
the Applicant). SARS’ adjustment was
opposed to overall arrangements driven by
(according to the Applicant) outside the
an overarching profit objective.
scope of section 31(2) and was legally
impermissible. The Applicant thus argued The Applicant thus contended that the
that the court should first determine amendment to section 31 supported its
whether SARS acted outside the scope of argument for the separation of the issues.
section 31(2) in adjusting the Applicant’s The point made by the Applicant was that
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4 | TAX & EXCHANGE CONTROL ALERT 4 March 2021TAX & EXCHANGE CONTROL
South Africa’s “second” transfer
pricing case?...continued
a major reason for the amendment was not test whether the PGM transactions
The court held that that the section (as it then stood) limited complied with the requirements of the
SARS to adjust the consideration relevant arm’s length principle. Given this, the court
the question of to the impugned transaction. According to agreed with SARS that the issue sought to
adjustment does the Applicant, it did not permit the wider be separated raised no cogent point of law.
not even arise prior approach that focused on overall profits.
In dismissing the application for
to determining the SARS counter-argued that the Applicant separation, the court held [at para 40] that
arm’s length nature was misguided in its understanding of the question of adjustment does not even
the amendments. SARS stated that the arise prior to determining the arm’s length
of a transaction.
amendments were effected to clarify nature of a transaction. The inquiry into
The inquiry into the what the legal position had always been. the arm’s length nature of a transaction is
arm’s length nature In this regard, SARS submitted that the an overriding principle in transfer pricing
of a transaction is an adjustment contemplated in section 31 matters and cannot be back-ranked. In
was always with reference to the profits other words, the establishment as a fact
overriding principle declared by the taxpayer. The amendments whether a consideration is or is not at
in transfer pricing in 2011 merely highlighted what was arm’s length precedes the question of
matters and cannot be already in the legislation. adjustment, regardless of what transfer
back-ranked. pricing method is employed. The ordering
Judgment
of separation was therefore, according to
Given the dearth of South African transfer the court, of no practical benefit but would
pricing cases, the court first discussed instead raise piecemeal litigation, increase
[at paras 25 to 27] three international costs, and delay finalisation of the matter.
transfer pricing cases to illustrate the point
Discussion of applicability of
that regardless of what transfer pricing
Practice Note 7 and OECD Transfer
method has been used to determine the
Pricing Guidelines to South African
arm’s length consideration, ultimately,
transfer pricing
adjustments are made to the profits of the
taxpayer to ensure that tax is levied on the SARS had relied on both PN7 and the TPGs
correct amount of taxable income. in testing the arm’s length nature of the
transactions and adjusting the Applicant’s
The court noted that the Applicant itself
taxable income. The Applicant on the
had in fact referred to the authoritative
other hand raised the argument that
statement in both the TPGs and PN7 which
section 31 makes no reference to the TPGs
seeks to tax profits that ought to have
or PN7.
accrued to a party. On that basis, the court
surmised that the Applicant had pursued In relation to PN7 (which also refers to
its case on the basis that the transactions the TPGs with authority), the Applicant
involving the PGMs had no transfer pricing submitted that SARS reliance thereon is
implications as they were “flow through misplaced given the judgment in Marshall
transactions”. Therefore, the Applicant did and Others v Commissioner, South
African Revenue Service 80 SATC 400.
5 | TAX & EXCHANGE CONTROL ALERT 4 March 2021TAX & EXCHANGE CONTROL
South Africa’s “second” transfer
pricing case?...continued
In the Marshall case, the Constitutional Federal Court in Commissioner of Taxation
The court concluded Court held as follows in considering v Glencore Investments Pty Ltd [2020]
the authoritative nature of SARS FCAFC 187, in which the Australian court
that one cannot interpretation notes: purportedly rejected to apply the OECD
deny that the TPGs. The court (in the present matter)
“Why should a unilateral practice
TPGs are a world of one part of the executive arm
stated that, given that the judgment was
handed down in relation to the 2007 to
standard in transfer of government play a role in the
2009 financial years, it was doubtful that
pricing matters. determination of the reasonable
the same court would reach the same
meaning to be given to a statutory
conclusion now. Even though judgment
provision? It might conceivably
was handed down in the Glencore
be justified where the practice is
case in 2020, this was by virtue of the
evidence of an impartial application
observation by the present court that
of a custom recognised by all
BEPS now stood on a different footing
concerned, established by one
as compared to when the assessments
of the litigating parties. In those
were raised.
circumstances it is difficult to see
what advantage evidence of the The court then concluded that one cannot
unilateral practice will have for deny that the TPGs are a world standard in
the objective and independent transfer pricing matters. Given the dearth
interpretation by the courts of the of transfer pricing cases in South Africa,
meaning of legislation, in accordance many taxpayers and SARS refer to the TPGs
with constitutionally compliant and PN7 for guidance. It is in this context,
precepts. It is best avoided.” that taxpayers would be well advised to
[Our underlining] take heed of this aspect of the judgment.
With reference to the fact that the Concluding remarks
Applicant itself had referred to PN7 and
It is evident that while IT14305 fell a putt
the TPGs in its pleadings, the court held
short of being South Africa’s first true
that the Marshall case in fact supported
transfer pricing case, there is no doubt
SARS’ reliance on PN7 in that PN7 and
that it discussed various important issues
the TPGs demonstrate a practice that is
pertaining to the application of section 31
internationally accepted and applied by
of the Act. In particular, it highlights the
both taxpayers and SARS alike.
need for taxpayers to properly test whether
In addition, while the Applicant raised their related party transactions comply
the argument that South Africa is not a with the arm’s length principle. Given
member of the OECD such that reliance the increasing focus on transfer pricing
on the TPGs is tenuous, the court held matters by SARS and the emergence (albeit
that it is in fact necessary for countries to slow) of judicial precedent, it may be that
align themselves with the OECD TPGs to South Africa’s first full transfer pricing case
overcome challenges brought about by is just beyond the horizon.
BEPS. Interestingly, the court commented
on the decision of the Australian Full Jerome Brink
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