South Africa: BEPS Action 8 On Hard-To-Value Intangibles: Is This The Last Piece Of The Puzzle Required By SARS To Issue Its Updated Transfer Pricing Practice Note?

Last Updated: 20 July 2017
Article by Lavina Daya and Ivette du Toit

Most Read Contributor in South Africa, July 2017

One of the main action items identified by South Africa's National Treasury in its summary of the country's position on the G20/Organisation for Economic Co-operation and Development ("OECD") action plan on base erosion and profit shifting ("BEPS"), is the requirement for the South African Revenue Service ("SARS") to update the Transfer Pricing Practice Note in line with the OECD Transfer Pricing Guidelines to include new guidance on the arm's length principle and an agreed approach to ensure appropriate pricing on intangibles that are difficult to value.

Action 8 of the BEPS Action Plan mandated the development of transfer pricing rules or special measures for the transfer of Hard-To-Value Intangibles ("HTVI") and the general rules of how to deal with HTVI can be found in section D.4 of the revised chapter VI of the OECD Transfer Pricing Guidelines, contained in the 2015 Final report on Actions 8-10: "Aligning Transfer Pricing Outcomes with Value Creation" ("BEPS TP Report"), which is now formally adopted as part of the OECD Transfer Pricing Guidelines. However, the BEPS TP Report also mandated the development of guidance for tax administrations on the implementation of the approach to HTVI ("HTVI Implementation Guidance"). Although the transfer of intangibles by a South African resident to a related party non-resident is currently restricted in terms of South African exchange control regulations, the approach towards HTVI is regarded as one of the main focus areas of SARS and therefore, it appears highly unlikely that SARS will issue an updated version of its Transfer Pricing Practice Note until the HTVI Implementation Guidance has been finalised by the OECD.

It is in this context that the discussion draft setting out the HTVI Implementation Guidance ("Draft HTVI Implementation Guidance"), which was released by the OECD on 23 May 2017, appears to be particularly relevant from a South African perspective.

Background

Intangibles are, by definition, mobile and they are also often hard-to-value, in particular, at an early stage of their development. According to the OECD, the misallocation of profits generated by valuable intangibles has heavily contributed to base erosion and profit shifting. This, together with the perceived information asymmetry when it comes to the valuation of intangibles, was also the reason why the OECD deemed it necessary to develop special rules on how to deal with HTVI.

What are HTVI?

The OECD defines HTVI as intangibles or rights in intangibles for which, at the time of their transfer in a transaction between associated enterprises, no sufficiently reliable comparables exist, and there is a lack of reliable projections of future cash flows or income expected to be derived from the transferred intangible, or the assumptions used in valuing the intangible are highly uncertain.

Existing OECD Guidance on HTVI

To deal with this, the OECD's guidance on HTVI proposes that tax authorities be allowed to use ex post "evidence", (the use of hindsight to evaluate the appropriateness of the pricing of transactions previously entered into) to assess the arm's length nature of transfer pricing arrangements in respect of intangibles that fall within the definition of HTVI.

Where the HTVI approach applies, tax administrators are entitled to consider ex post outcomes as presumptive evidence in evaluating the appropriateness of ex ante pricing arrangements.

However, in certain circumstances, a taxpayer can rebut ex-post outcomes as presumptive evidence by demonstrating the reliability of the information supporting the pricing methodology adopted at the time that the controlled transaction took place.

In particular, the use of ex post outcomes/hindsight will not apply in the following cases:

  1. The taxpayer provides:
    1. details on the ex-ante projections used at the time of the transfer together with how risks were accounted for; and
    2. reliable evidence that any significant difference between the financial projections and the actual outcomes is due to unforeseeable or extraordinary events that could not have been anticipated at the time of price setting;
  2. the transfer of the intangible is covered by a bilateral or multilateral advance pricing agreement;
  3. a safe harbour threshold where the variation in financial projections and the actual outcomes is no more than 20% of the intangible's valuation; or
  4. a commercialisation period of five years has passed following the year in which the HTVI first generated unrelated party revenues for the transferee and in which commercialisation period any significant difference between the financial projections and actual outcomes mentioned in a) 2 above was not greater than 20% of the projections for that period.

Additional guidance provided in Draft HTVI Guidance

The Draft HTVI Implementation Guidance essentially reenforces the principles laid out in the initial OECD Guidance on HTVI.

In particular, no changes have been made to the underlying principle that tax authorities will be entitled to consider ex post outcomes as presumptive evidence in evaluating the appropriateness of ex ante pricing arrangements, unless a taxpayer can rebut ex-post outcomes as presumptive evidence.

Accordingly, once it has been determined that an intangible qualifies as a HTVI, ex post outcomes may be considered. Tax authorities are, however, restricted in using the ex post outcomes, since the Draft HTVI Implementation Guidance makes it clear that tax authorities cannot base any revised valuations on the actual income or cash flows without also taking into account the probability, at the time of the transaction (ie time of transfer of the HTVI) of the income or cash flows being achieved.

In addition, the Draft HTVI Implementation Guidance indicates that in implementing the HTVI approach, tax administrators may make appropriate adjustments, including through the consideration of alternative pricing structures, (ie adjustments that reflect a contingent pricing arrangement that is different from the pricing structure adopted by the taxpayer), if it relates to something that independent third parties would have also considered. This should be of great concern to taxpayers and we therefore caution taxpayers to consider potential alternative pricing structures when determining the pricing for the use or transfer of intangibles that could be regarded as HTVI.

Furthermore, the Draft HTVI Implementation Guidance also indicates that the guidance for the tax administrators in implementing the approach to HTVI should not be used to delay or bypass normal audit procedures. It is further stated that, in fact, it remains important for tax administrators to identify HTVI transactions as early as possible and to act on the information at hand as a matter of good administrative practice. The Draft HTVI Implementation Guidance does, however, recognise that some countries may encounter difficulties in implementing the approach to HTVI due to short audit cycles or a statute of limitations. The Draft HTVI Implementation Guidance therefore suggests that tax authorities identify transfers of potential HTVI and seek information about ex post outcomes, even where those outcomes arise in years subsequent to those under audit, to be in a position to consider the appropriateness of the ex-ante pricing at an early stage.

Conclusion

The Draft HTVI Implementation Guidance is an important missing piece of the puzzle in the OECD's approach towards BEPS and, once finalised, should put SARS in a position to issue a first draft of its own Transfer Pricing Practice Note.

From a transfer pricing technical point of view, it does not provide anything substantially new, but to a large degree reconfirms the underlying principles as set out in the existing OECD Guidance on HTVI.

In order for taxpayers to be able to rebut the use of ex post outcomes as presumptive evidence by tax authorities in determining the arm's length nature of transactions involving HTVI, it is important that, at the time the transaction is entered into, that a detailed analysis is performed, which clearly sets out the following:

  • the nature of the intangible, and whether it could be regarded as HTVI;
  • the details of the projections used at the time of the transactions and how the main risks were accounted for; and
  • if applicable, whether alternative pricing structures were considered to cater for potential substantial deviations of the projections used at the time.

While the use of an advance pricing agreement provides for an alternative option to manage the risks around HTVI, this option is, unfortunately, not available for South African taxpayers at this stage.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.