Johannesburg, 11 February 2021 – Will the increased focus on transfer pricing compliance and risk assessment help SARS master the increasingly difficult task of finding tax revenue? Christian Wiesener, Associate Director at KPMG & Chairperson of the SAICA Transfer Pricing Sub-committee, shares his insight.
In recent years, South Africa’s spending has increased, and tax collections have not kept up for various reasons. The budget deficit has widened, and we have hit the so-called Fiscal Cliff, the point when government spending including, for example, social spending, public sector wages and debt servicing equal income.
The only way to avoid this is to reduce government expenditure, to increase state revenue or (ideally) to do both. In last year’s Medium-Term Budget Policy Statement, it was recommended that both tax increases as well as budget cuts should be implemented over the next few years to address and overcome the issue.
However, the continuing devastating impact of the COVID-19 Pandemic in South Africa including the particularly severe economic impact on businesses is likely to result in further urgent social spending and any tax hikes would add additional burden on taxpayers. Furthermore, the cost of vaccines as well as other vital medical supplies will add to the expenditure burden.
So whereto should government turn?
Decreasing government spending
As indicated above, even if the call for reducing public service employee salaries was followed and if it was possible to achieve significant savings, it is clear from the above that this would just mean a shifting of allocated funds or “budget reallocation”, because new spending needs have arisen to address the impact of the pandemic. Also, implementing meaningful cuts to the public wage bill, particularly in the current situation, would also not be popular and may lead to strong opposition.
Even if budget savings can be achieved, these alone would likely not be sufficient to get South Africa out of the woods. Thus, one would need to look at options for increasing tax collections.
Increasing tax revenue
There are several potential options for government to increase taxes, for example an increase of the corporate tax rate, the tax rates for individuals, an increase of the VAT rate, or a Wealth Tax have been suggested. However, in the currently difficult economic environment - any proposal for increased tax or a new/additional tax must be very carefully considered. The desired increase of collections may be missed and the raising of tax rates/introduction of an additional tax may ultimately have an adverse effect. Businesses under pressure may be further burdened forcing them to close down, and foreign investment may be withdrawn or shifted to another jurisdiction resulting in the loss of tax revenue, and potentially also the loss of investment, employment opportunities etc. Another important issue that has been raised recently is the risk of a “tax revolt”. It has been reported that during a survey conducted in August 2020, 95% of participants said they were now less willing to pay tax, given how the government has handled the pandemic and subsequent lockdowns. It is unlikely that this position has improved to date given the ongoing situation and uncertainty. A related aspect to consider is that if tax rates are increased to an extent beyond the optimal relationship between tax rates and total tax revenue, which is measured by the so-called “Laffer Curve”, then this disincentivises income earning activities and/or the payment of taxes.
Thus, if taxes become too high, then they will discourage taxpayers to carry on the tax generating activities and this will result in a reduction of total tax revenue. To overcome this phenomenon, government would need to reduce taxes to incentivize economic activities. However, this is something South Africa cannot afford at this stage.
The question is what else can be done to increase tax collections, i.e. without increasing tax rates or introducing new taxes. This will be specifically relevant to this year’s Budget presentation.
Increasing Tax Collections - Transfer Pricing measures
One measure could be to improve collections relating to an area of tax where enforcement and compliance could be improved, for example transfer pricing.
Transfer pricing relates to the pricing of the cross-border sale of goods or the provision of services between related parties. Transfer pricing applies to Multinational Groups operating in different countries. Transfer pricing rules are designed to prevent these groups from shifting their profits to low tax countries. For transfer pricing purposes, the members of a Multinational Group are required to transact on an arm’s length basis, i.e. at the level that independent third parties would transact with one another.
There have been reports that Africa, including South Africa, is losing billions of USD due to illegal transactions and tax evasion such as abusive transfer pricing practices by Multinational Groups. While estimates and reports differ, the African Union’s High-Level Panel on Illicit Financial Flows, in 2016, estimated that the loss to the continent due to illegal transactions could be USD50 billion annually. SARS Commissioner, Edward Kieswetter, at the end of last year, raised again the need to curb transfer pricing practices and illicit financial flows. Thus, based on this there may be an opportunity for increased tax collections.
In addition, over the last couple of years, the Organisation for Economic Cooperation and Development (OECD) initiated several initiatives to counter aggressive international tax planning including transfer pricing, to counter Base Erosion and Profit Shifting. South Africa participated in these initiatives and follows international practice. Nevertheless, allegations that tax revenues are artificially channelled away from Africa, remains.
However, with the OECD initiatives, which focused on strengthening transfer pricing disclosure rules, exchange of information and more effective dispute resolution mechanisms, amongst others, significant improvements regarding transfer pricing rules and guidance were achieved. The successful enforcement of these new rules and mechanisms should help tax authorities, including SARS, to increase collections based on improved compliance by taxpayers and because of risk-based transfer pricing enquiries.
For example, the United Kingdom’s Tax Authority, HMRC, reported that its additional tax revenue collections from transfer pricing related enquiries, Advance Pricing Agreements and Mutual Agreement Procedure (MAP) cases etc. increased by about 25% from 2018/2019 to 2019/2020, resulting in a total transfer pricing related yield (collections) of GBP 1.454million. This significant growth shows the importance of good transfer pricing enforcement and transfer pricing dispute resolution mechanisms, and it indicates an opportunity for increased collections, perhaps also for SARS.
Transfer pricing enforcement
Of course, the position concerning transfer pricing in South Africa is somewhat different from that in the UK. On the positive side, many taxpayers in South Africa have significantly stepped up their transfer pricing compliance efforts to meet new requirements since 2016.
In addition, and even though resources seem limited, SARS has significantly increased transfer pricing review activity since the Commissioner warned non-compliant taxpayers following last year’s Budget Presentation. He then specifically pointed out SARS’ focus on transfer pricing and specifically intra group services transactions that result in tax revenue leaving the country. In addition, it has been noted that transfer pricing audits have increased lately, and sizeable transfer pricing adjustments are expected as a result.
If SARS can further build transfer pricing capacity and continue to improve enforcement, this should result in increased tax revenue either due to audit related transfer pricing adjustments or because taxpayer compliance is further improved. In addition, as South Africa has “Secondary Adjustment” rules, a transfer pricing adjustment generally also results in deemed dividend tax, in addition to additional income tax.
Advance Pricing Agreements (APA)
A further opportunity to increase tax collections from existing sources is presented by an APA regime.
An APA is a unilateral or multi-lateral arrangement regarding the determination of certain criteria for the determination of the transfer pricing of a transaction for a specific period. It is designed to provide clarity and certainty for both taxpayers and tax authorities.
A clear benefit of an APA is that both tax authority and taxpayer can determine the tax payable in advance and unnecessary and costly disputes can be avoided. Although one view suggests that only compliant taxpayers would enter into an APA, there is a strong alternative view, which states that the APA system encourages all taxpayers to comply, because it simplifies and removes unnecessary administrative processes.
Many countries, for example the UK, Australia, India, and the US, entertain APAs and the regimes are successful.
South Africa does not currently have an APA regime, but a discussion paper was released last year paving the road for an APA system. While it is acknowledged that it will still take time until such system is up and running, it can be expected that the ability to get certainty on transfer pricing will attract taxpayers and proper administration will no doubt increase tax collections.
While transfer pricing measures such as enforcement and APAs are likely to help increase tax collections and may thereby help South Africa moving away from the Fiscal Cliff, both measures may unfortunately not have immediate effect because capacity first needs to be further increased. Nevertheless, it is clear, based on the Commissioners repeated mentioning of transfer pricing as a priority area for SARS and the increased SARS transfer pricing review activity that there is a focus on transfer pricing. Taxpayers should be aware of this and ensure compliance with South African transfer pricing rules accordingly.
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