Davis report on transfer pricing confirms …
NB: This article updated after two recent meetings of committee on transfer pricing. Report with clients.
South African Revenue Service (SARS) was completely lacking in sufficient staff to deal effectively with transfer pricing in order to spot illegal transactions, said Judge Dennis Davis in his capacity as chairperson of the Tax Review Committee when addressing the Parliamentary Portfolio Committee on Mineral Resources.
He also pointed out that SARS, in any case, was also not provided with sufficient information by declaring companies, particularly multinationals as legislation stood at present, to further probe cross-border transactions to determine whether the movements involved the illicit transfer of profits from high-tax to low-tax regimes.
He told parliamentarians that whilst about three years ago SARS had conducted a very specific and targeted investigation, and had raised in one financial year alone some R1.1bn, this only illustrated the far larger amount of “haemorrhaging” that was taking place.
Not transfers but manipulation…
The Judge had to explain to MPs time and time again that transfer pricing in itself was not illegal, only any manipulative tax behaviour usually involving non-declaration or undervaluation.
Judge Dennis Davis referred to the recent highly publicised case involving HSBC where some R23bn directly involved the SA fiscus “and which was under review by SARS”. He also drew attention to the fact that as a result of disclosures during the Marikana inquiry, Lonmin appeared to have profited by some R280m in saved taxes by transfers.
“Fictitious transfer pricing declarations were the problem”, he said, where multinationals managed to declare profits which appeared lower in countries with higher tax rates and higher in countries with lower tax rates. This occurred where the culprits identified transfers of intangibles for less than full value; showed over capitalisation of tax group companies and declared contractual arrangements with low risk tax environments.
The Davis Tax Committee had recommended to National Treasury Department that the current unit in SARS, dedicated to base erosion and profit shifting be strengthened. At present this constituted only twenty personnel. “Building up this team would enable SARS to dig deeper into companies’ affairs”, he said.
Billy Joubert, Tax Director, Deloittes, pointed to the fact that transfer pricing was in fact a “neutral” instrument in terms of its intention to promote industrialisation because its purpose was in fact to achieve arm’s length profits across the value chain.
Transfer pricing rules based on international best practice provided investors with certainty and it also protected the tax base of the relevant country, he said. It was therefore an essential part of any tax system, providing taxpayers did not manipulate prices by shifting profits to lower tax jurisdictions. He condemned the practice.
Arm’s length reporting in question
Joubert said South Africa was an observer and an active contributor to the OECD and their transfer pricing guidelines was a resultant consensus document. It was critical for SA to align with the tax policies adopted by their trading partners where they could, endorse “the arm’s length principle” adopting the guidelines in their own domestic environment and follow global standards.
He said that SARS had achieved the collection of approximately R5bn over the last three years from some 30 audits and adjustments of R20bn.
He concluded that SARS’s new rules “were now more closely aligned to the global standard and possibly ahead of many other countries”, noting, however, there was a lack of certainty in terms of outdated practice notes; limited guidance on implementation of “secondary adjustment mechanisms”; and also a lack of interaction with double tax agreements which were closely allied to the process.
Back to understaffing…
Prof Johann Hattingh of UCT pointed to the fact that the Davis Tax Committee recommended full compulsory OECD style taxpayer information disclosure and there “was more than enough in the legislative armoury of SARS to effectively combat intercompany mispricing or tax abusive behaviour”.
However, he also pointed to the fact that SARS was understaffed and simply outnumbered by input of declarations to effectively implement transfer pricing legislation across a broad spectrum.
Prof Hattingh explained that insofar as tax interpretation was concerned it was a complex and ultimately subjective evaluation because of the difficulty in identifying intangibles and services which were transferred or provided and the arm’s length price at which they were valued. Even the whole definition of an “arms length transaction” was subject to difficult legal, accounting and tax interpretation, he pointed out.
OECD the genisis
He said all BRICS countries, except Brazil, took the OECD guidelines as a starting point, Brazil using fixed international commodity prices which provided more certainty but which conflicted in many cases with double tax agreements, since double tax could arise in one of the countries involved in transfers.
EFF member Freddie Shivambu said that in terms of SARS, staffing with skilled personnel was not the only problem as far as could see but there was a lack of clarity on the way forward. Judge Davis replied that there were indeed criminal elements involved, such as illegal siphoning of money and under-declaration of assets, but his committee had established “empirical evidence” that the amount lost to the fiscus was not always as high as it was reported to be.
But the way forward, he re-empahsised, involved updating wording of legislation; the ability to follow up on “arms length transactions” and more staff to do this. His Committee’s report was with the President.
ANC says transfer pricing is manipulation
Some ANC members pointed to the fact that some multinationals were making “massive profits and not contributing to the country’s agenda to address poverty, inequality and unemployment and transformation” and that transfer pricing should be banned. Others called for it to be declared “illegal”.
They were corrected again by Judge Davis who explained that transfer pricing was a legitimate necessary process for companies doing legitimate transactions and as such it could not and would not be “banned” or illegalised.
Mr D Macpherson (DA) joined the debate to say that the issue of illicit transfer pricing should not become a political matter but that it was a national concern for all, pointing to the fact that whilst transfer pricing was one issue, the country was losing some R6bn through other forms of corruption.
It was all part of the same problem, he said, and the country had to take a stand against all illicit activities that deliberately robbed the government of revenue.
Not just mining worldwide
Meanwhile Judge Davis agreed with ANC members that “additional revenue was needed to redress historical injustices” but the World Bank had reported that South Africa had addressed this challenge better than most countries, including Brazil. There was no evidence to suggest that transfer pricing affected the mining industry notably.
He was joined by Billy Joubert of Deloittes who stated that such a transaction should not be criminalised because they were cross-border transactions, which was essentially transfer pricing, and re-emphasised that they were “neutral” until assessed and found to be illicit or not.
National Union of Mineworkers said transfer prices should in principle match either what the seller would charge an independent, arm’s length customer, or what the buyer would pay an independent, arm’s length supplier. He claimed that transfer pricing defeated the objectives of the Minerals and Petroleum Resources Development Act.
“All it meant”, said the NUM spokesperson, “was retrenchment of employees; low and unequal salaries: inadequate investment on skills development; poor implementation of social and labour plans and less investment on health and safety standards, resulting in injuries and fatalities.”
Bridgette Radebe of South African Mining Development Association (SAMDA) said her records showed that “out of 151 countries, South Africa lost, on average, the twelfth highest amount of money through illicit financial outflows”. She disagreed with Joubert of Deloittes on the ‘neutrality’ of transfer pricing and the effects and that the statement that the mining industry was a “small player” was incorrect.
She said the mining industry contributed 17% of GDP and 38% of exports, plus 19% of private investment with R78 billion spent in wages and salaries. “These figures were totally eroded and made misleading by transfer pricing”, she said. She provided the parliamentarians with a series of figures explaining how transfer pricing in the mining industry took place and claimed that manipulation was often the practice.
SAMDA suggested the immediate alignment of the mining charter with the B-BBEE Codes of Good Practice with transfer pricing and to address the issue of penalties contained in the charter for non-compliance. Much agreement from ANC members took place.
Multinationals under attack
One ANC member stated that “the bulk of South Africa’s mineral resources were in the hands of foreign nationals and it was good that SAMDA and organised labour came together and addressed the issue of transfer pricing in terms of the South Africa’s economy.”
A department of mineral resources (DMR) staff member attending was called upon by the chair to respond, who stated that all the issues raised would be discussed by his department and in the light of success with penalties under the Mine and Safety Act, increased penalties for breeches in declarations might be considered.
DMR and SARS had been working together, the spokesperson said, on the whole issue of transfer pricing, a memorandum of understanding between the two departments having been established.
SAMDA said that some multinational companies often wished to “manipulate prices to such an extent that there was no income for beneficiation or share distribution and consequently loans on shares could not be repaid.”
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