OECD Guidance: African Transfer Pricing Update

OECD Guidance on financial transactions
In February 2020, the OECD published its formal transfer pricing guidance on financial transactions. The new guidance deals in detail with the pricing of financial transactions, specifically loans, cash pooling, hedging, guarantees and captive insurance between related parties. As the OECD Guidelines are incorporated into the local legislation of most jurisdictions, taxpayers are encouraged to structure financial transactions in accordance with the new guidance.

The guidance seeks to contribute to consistency in the interpretation of the arm’s length principle and avoid transfer pricing disputes and double taxation across jurisdictions. The accurate delineation of actual transactions is emphasised in order to determine the structure, terms of arrangements and relevant parties’ capacity to provide financing and assume risks. The guidance also addresses the effect of implicit group support, group membership and stand-alone credit ratings of individual subsidiaries, forming part of a multinational group. A taxpayer’s capital structure remains a contentious issue, which is addressed in the new guidance. Article 9 of the OECD Model Tax Convention must however also be kept in mind, which states that not only the arm’s length interest rate, “but also whether a prima facie loan can be regarded as a loan or should be regarded as some other kind of payment, in particular, a contribution to equity capital” should be considered. The accurate delineation of the loan in the taxpayer’s transfer pricing documentation, together with other supporting information made available, will play a key role in determining (and accurately pricing) the capital structure.

The detailed considerations set out in the guidance increases taxpayers’ compliance burden. Transfer pricing documentation and support regarding the arm’s length nature of financial transactions would, for instance, have to include cash flow studies demonstrating the ability of the borrower to repay the loan, explanations of the terms and conditions of the loan and a discussion of the opportunities realistically available, from both the lender and borrower’s perspective.

It is important to note that updates to the OECD Transfer Pricing Guidelines do not have a specific effective date and serve the purpose of ‘clarifications’. Consequently, the new guidance may apply retroactively to existing transactions, which may create significant exposure for taxpayers.

South Africa – SARS focus on intra-group services
We have lately seen an increase in requests for information received by taxpayers from the South African Revenue Service (SARS), specifically relating to intra-group services. This approach is in line with a recent media release from SARS relating to transfer pricing and specifically focussing on revenue leaving South African in the form of intra-group services. Whilst the tax authority is under pressure to collect revenue, now more so than ever, taxpayers are reminded that a number of considerations must be met in order to support the arm’s length nature of intra-group service arrangements. These aspects must be documented in detail in a client’s transfer pricing documentation in order to prevent SARS from making adjustments and/or denying the service charge entirely. Taxpayers are encouraged to understand the transfer pricing risks when engaging in these types of related party transactions.

Zimbabwe – new transfer pricing return and COVID-19 extension
In March 2020, the Zimbabwe Revenue Authority (ZIMRA) introduced a new transfer pricing return to be filed by taxpayers, together with their annual corporate income tax return for the year ended 31 December 2019.
Taxpayers with international and/or domestic related party transactions are required to submit a transfer pricing return, which is used by the ZIMRA for audit selection and risk classification purposes. The introduction of the new transfer pricing return was carried out in collaboration with the African Tax Administration Forum and follows their recommended transfer pricing return format. Taxpayers with a December 2019 year-end should however note that the deadline to file their income tax returns (together with the transfer pricing return) has been extended to 31 August 2019 due to COVID-19 developments.

Zambia – New disclosure of related parties
A recent amendment to the Zambian Income Tax Act now requires that if, as a result of a direct or indirect change in shareholding, a resident or non-resident company becomes related to a Zambian company, the details of such a transaction must be disclosed to the Zambia Revenue Authority, within one month of such a change.
For Zambian income tax purposes, the following are considered to be related companies:

• Companies connected directly or indirectly through shareholding, equity or partnership;
• Any joint venture owned or operated jointly with an unrelated company;
• Connected persons (i.e. natural persons, trusts etc); or
• Companies connected through management and control.

In the case of non-compliance, a penalty, not exceeding ZMW 3 000 per day that the information is outstanding. In such a case, both the company and each officer in default is considered to commit an offence.

Contact us if you’d like to explore how these developments could impact your business.

But things have changed recently. The recent EU black-listing of Mauritius and Botswana (see the previous article) has made the South African HQC regime much more competitive. Now, may, therefore, be the moment to relook at South Africa as a possible launching pad for African investment, which means considering once again the pros and cons of using this tax incentive.

What is an HQC?

Obviously, before we can do this, we must ask what exactly an international headquarter company or HQC is.

Actually, the term is something of a misnomer.  What the incentive really encourages is the use by foreign groups of intermediate holding companies in South Africa’s jurisdiction – effectively an African base of operations for foreign enterprises as opposed to their “international headquarters” – which will then hold the group’s investments in subsidiaries or businesses in other parts of the African continent.

It should be said though that HQC’s are not only for foreign multinationals. South Africans looking to invest internationally are welcome to take advantage of these companies as well but some of the tax and exchange control benefits described below could be lost in some cases.

Benefits of the HQC regime

The tax and other fiscal benefits that apply to a South African company that qualifies as an HQC are summarised below:

Contact us to discuss if OECD Guidance is relevant for your business.

How can we help?

How you structure your business is a critical question as you expand globally.  The right structure will protect your assets, improve your currency position, support your business operations, facilitate future business expansion and changes, and optimise your overall tax rate. Trying to unscramble a sub-optimal structure entered into in haste or without full consideration of relevant facts is complex and expensive, so it’s important to plan upfront.

Structuring an international business is both a science and an art – this is our specialist area of expertise. Regan van Rooy is an international tax and structuring advisory firm focussing on Africa. We have offices in South Africa, Mauritius and Ireland and we can help you with any international tax or structuring query.