The Davis Tax Committee ("DTC") recently addressed the issue of base erosion and profit shifting ("BEPS") in South Africa. The international importance of transfer pricing was once again emphasized when 4 out of the 15 actions identified in the OECD Action Plan on BEPS related to transfer pricing. The 15 actions are scheduled to be finalised in three phases, and the DTC issued its interim report on the first of these phases, i.e. the September 2014 deliverables. A summary of the DTC's conclusions and recommendations on 'Action Plan 8: Assure that Transfer Pricing Outcomes are in Line With Value Creation / Intangibles' are set out below.

The OECD has in the past done extensive work on the transfer pricing of intangibles which are in line with Action Plan 8. In Action Plan 8, the OECD recommends that countries develop rules to prevent BEPS by moving intangibles among multinational enterprise ("MNE") group companies. This will involve: (i) adopting a broad and clearly delineated definition of intangibles; (ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation; (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and (iv) updating the guidance on cost contribution arrangements.

The DTC reiterates that transfer pricing is a key focus area for SARS and that the South African Reserve Bank has been approached to assist in determining the magnitude of BEPS relating to transfer pricing. The DTC's interim report lists certain recommendations on transfer pricing in general in South Africa. The DTC recommends that the legislators should ensure that section 31 of the Income Tax Act, 58 of 1962 ("the Act") itself, and not only SARS Practice Note 7 which is not legally binding, refer to the OECD Transfer Pricing Guidelines. The DTC suggests for this purpose that a legally binding General Ruling as provided for in terms of the Tax Administration Act, 28 of 2011 be enacted under section 31 and that the General Ruling should, without departing from the OECD Transfer Pricing Guidelines, include principles reflecting the South African reality. The DTC also recommends that SARS should ensure that the enforcement capacity of its transfer pricing unit is adequate and that there is sufficient training and capacity building in this unit.

The BEPS concern in relation to South Africa-owned IP is the possibility that MNEs may transfer valuable IP to low tax or tax-free jurisdictions to ensure a flow of royalty income to that jurisdiction. In assessing this concern, the DTC, amongst others, considered the South African exchange control rules which prohibits the export of South African developed IP and requires South African based owners of IP, which make the IP available to foreign related parties, to charge an appropriate royalty for the IP.

The DTC came to the conclusion that Action Plan 8 may not require major legislative attention in South Africa at this stage. The DTC is of the opinion that the exchange control restrictions mentioned above, the punitive tax consequences in terms of section 23I of the Act for the payments of royalties by South African taxpayers which previously used to own the relevant IP and the concept of "beneficial ownership" in the royalty article of double taxation agreements, amongst others, readily prevent transfer pricing of intangibles in South Africa.

The DTC however, is of the view that the potential undervaluation of local intangibles in determining profit splits as well as contract R&D arrangements which are highly artificial or lacking in substance are of potential concern for South Africa. The DTC further cautions that care should be taken in developing tax legislation on transferring of intangibles that is too restrictive and that limits the development of IP in South Africa.

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