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18 Aug 2020
BY Andries Myburgh , Robyn Kantor AND Simon Weber

When the going gets tough: Four points to consider during a SARS transfer pricing audit

Earlier this year, Glencore Investments Ltd (the head of the Australian “consolidated tax group”) successfully defended an AUD92.7-million (about ZAR1.15-billion) transfer pricing tax bill in the Federal Court of Australia. The Australian Tax Office (“ATO”) had argued that certain sales of copper concentrate by a group company to its Swiss parent were not concluded at arm’s length, which resulted in an understatement of the Australian entity’s taxable income. The court disagreed, penning a landmark transfer pricing judgment in the process.

Back at home, the South African Revenue Service (“SARS”) has seemingly been measured in tackling profit shifting and base erosion. This is evident from the dearth of reported cases on transfer pricing. But the time might be ripe for sharper focus: South Africa has now fully implemented master file, local file, and country-by-country requirements for certain taxpayers, and SARS has made noteworthy strides in bolstering its technical capacity. Moreover, as the national budget shortfall is expected to reach an abysmal ZAR326.6-billion in the 20/21 fiscal year, there will undoubtedly be pressure on SARS to collect additional tax revenue. Judge Dennis Davis has recently remarked that at least ZAR50-billion in additional revenue can be collected by SARS if it focused on, inter alia, transfer pricing. This is not surprising. From a South African perspective, the quantum of a transfer pricing assessment may include the so-called secondary adjustment, understatement penalties, and interest, which are all in addition to the primary income tax adjustment. And once the assessments are issued, the taxpayer must fight the “pay-now-argue later” principle, pending the objection and appeal process.

While the arm’s length requirement, which is inherent to section 31 of the Income Tax Act, 1962 (“ITA”), will take centre stage during a transfer pricing audit, taxpayers must not lose sight of other important considerations that may come into play. In this ENSight, we unpack four such considerations:

  1. It all starts (and ends) with the audit

Chapter 5 of the Tax Administration Act, 2011 (“TAA”) allows SARS to conduct an audit. It also provides SARS with wide, but not unfettered, information gathering powers for this purpose. For instance, section 46 allows SARS to request “relevant material”, and section 48 allows SARS to conduct a field audit. In the context of transfer pricing, a field audit may often include so-called functional analysis interviews by SARS with key employees of the taxpayer (and employees of its non-South African resident transacting counterparty) to understand the functions performed, assets employed, and risks assumed in the value chain.  

At the end of the audit, SARS must provide the taxpayer with the outcome of the audit and the bases of any proposed tax adjustments. The taxpayer must then be afforded an opportunity to respond to all the “facts and conclusions” as set out in the finalisation of audit letter: section 42(2) of the TAA is prescriptive in this regard.

Rushed or lackadaisical responses to requests for relevant material and audit findings simply won’t do. These will form the basis of any subsequent proceedings, whether potential settlement negotiations or Tax Court litigation. Taxpayers should accordingly procure professional legal assistance as soon as they receive an audit notification.

  1. Know your taxpayer rights – and enforce them

Taxpayers must take cognisance of the rights afforded to them by the TAA. Enforcing these rights may inevitably lead to questions along the lines of:

  • Does SARS have the right to issue an additional assessment? Or has it prescribed in terms of section 99?
  • Are taxpayers obliged to conclude extension of prescription agreements with SARS?
  • What constitutes “relevant material” for purposes of section 46?
  • From who may SARS ask this relevant material?
  • What about documents that are confidential or subject to foreign privacy laws?
  • How does the Double Tax Treaty between South Africa and the foreign jurisdiction impact on SARS’ right to make transfer pricing adjustments?

A taxpayer’s rights to just administrative action, as guaranteed by section 33 of the Constitution, 1996, fundamentally underpins the relationship between the taxpayer and SARS. Where this right is flouted, the taxpayer will not be without recourse.

  1. Are they “connected persons”, after all?

Section 31 of the ITA can only apply where an “affected transaction” has been entered into. This requires, inter alia, that the parties that have transacted must be “connected persons” as defined in section 1 of the ITA.

In most cases, the definition can be applied without difficulty. It is, after all, quite broad. But having said that, the interpretation of paragraph (d)(vA) relating to “management” and/or “control” is not clear at all. While SARS briefly explains its views on the subject matter in its non-binding Interpretation Note 67, there is currently no case law that has definitively pronounced on the meaning of these concepts. How exactly can one company factually “control” another company, for instance, where that “controlled company” has its own duly appointed board of directors and executive management? Do common board members warrant such a conclusion? It is important to keep in mind that “control” in this context refers to factual control, and not the type of control exercised by a shareholder who holds more than 50% of the equity shares or voting rights in a subsidiary. 

If the waters were not muddy enough, with effect from 1 January 2021, the “associated enterprises” definition in article 9 of the Model Tax Convention will be made applicable to section 31 of the ITA. Not too dissimilar from paragraph (d)(vA), article 9 applies where there is direct or indirect “participation in the management, control or capital” of an enterprise (or enterprises) by another enterprise.   

The take-way is simply that taxpayers should not assume that the relevant parties are “connected”. A thorough “connected person” analysis must be conducted, having regard to all of the facts. SARS may of course rely on the prior, perhaps misguided, disclosures made by taxpayers in this regard. An audit is the perfect opportunity to set the record straight.  

  1. Transfer pricing compliance documents alone won’t cut it

Having expensive TP documents in place may tick the compliance box. But their mere existence is not enough to discharge the burden of proof that rests on the taxpayer in terms of section 102(1) of the TAA. These documents must be supported by verifiable facts and witnesses (both factual and expert) who can testify accordingly.

Taxpayers with significant cross-border transactions should consider collating supporting evidence to support their transfer pricing documents on an annual basis, even before SARS comes knocking.

A multi-layered approach should be adopted in transfer pricing disputes. This requires an in-depth knowledge of the ITA, TAA, double tax treaties and the law of evidence. While we can only speculate, a well-managed tax audit surely played no small part in Glencore’s ZAR1.15-billion transfer pricing victory (albeit for the time being only temporary, as the ATO has launched an appeal).

If you want peace, prepare for war!


Andries Myburgh

Executive | Tax

+27 83 289 3907


Robyn Kantor

Tax Manager | Tax

+27 82 563 3273


Simon Weber

Associate | Tax

+27 66 269 4671