Author: Christian Wiesener, SAICA transfer pricing sub-committee member and associate director for transfer pricing at KPMG

While South Africans turn their focus to the upcoming Budget Speech in February 2025, many are wondering how expected increased Government expenditure can be financed. Of course, an increase in revenue collections would help, but the Finance Minister’s ability to maneuver this topic without negatively impacting the economy is very limited.

One area that still seems to offer a possibility for the Revenue Service to increase collections is “transfer pricing”, and the current Base Erosion and Profit Shifting (BEPS) initiative coordinated by the Organisation for Economic Cooperation and Development (OECD) may just provide a solution.

Transfer Pricing

The African Tax Administration Forum (ATAF), in its recently updated “ATAF Suggested Approach to Drafting Transfer Pricing Legislation” defines transfer pricing as “the mechanism for pricing transactions between connected legal entities within the same multinational enterprise (MNE)”.[1] The application is broad and includes services, financial assistance, license fees and the sale of goods. In terms of South African transfer pricing law, the taxpayer bears the onus to transact with other members of the MNE at “arm’s length” (i.e. the transaction must be in accordance with what independent third parties would have agreed to). If a Revenue Authority audits a taxpayer and is of the opinion that a transaction does not meet the arm’s length standard, the Revenue Authority will adjust the taxpayer’s income or loss to reflect what an arm’s length price or return would have been. South Africa, in addition to this transfer pricing adjustment, also applies a so-called secondary transaction, which triggers dividends withholding tax at 20%, together with interest and penalties. While such a transfer pricing adjustment often results in double taxation, double taxation agreements entered into by South Africa with other jurisdictions provided for mechanisms to achieve double tax relief.[2]

South Africa is a large importer of goods, and many of the South Africa based distributors are members of foreign MNE Groups, purchasing stock from other foreign group members. Determining an arm’s length return for a distributor operating in a jurisdiction such as South Africa is complex, because supply chains, the economic environment, certain logistics and related costs, as well as operating risks and forex differ from countries where comparable data is easily available. In practice, disputes about what the correct and arm’s length return is for a distribution entity arise often, and these are lengthy and costly for both taxpayers and the Revenue Authority.

In addition, Mutual Agreement Procedure with the Revenue Authority in the other jurisdiction also often prove lengthy, difficult and costly, and the outcome may result in the South African Revenue Authority losing out in the negotiation process. Therefore, a simplified mechanism for determining an appropriate return for a local distribution entity, which would also bind the foreign Revenue Authority could be beneficial for taxpayers and the South African Revenue Authority. Particularly for the South African fiscus this would mean potentially increased tax revenue and less cost for dispute resolution etc.

OECD BEPS initiative

The first BEPS initiative resulted in a 15 BEPS Action Report released in 2015 with broad impact on international tax laws, and specifically in the transfer pricing space, around the world and in Africa. The second part of the BEPS initiative gained momentum when on 8 October 2021, 137 countries signed a statement regarding the key aspects of the OECD’s Inclusive Framework on BEPS initiative (often referred to as BEPS 2.0).

One aspect of this second BEPS initiative is referred to as “Amount B”, and the purpose of Amount B is to simplify and streamline the application of the arm’s length principle to in-country baseline marketing and distribution activities, with a particular focus on the needs of qualifying jurisdictions.[3] In 2024, the OECD Inclusive Framework released a report setting out guidance in respect of the application of Amount B, which applies for tax years commencing on or after 1 January 2025. Thus, the related rules are already in place, but subject to local jurisdictions accepting and applying them.

What is Amount B?

As indicated, Amount B serves the purpose of simplifying and streamlining the application of the arm’s length principle to baseline marketing and distribution activities. The rules mostly impact MNE Groups with distribution entities that sell tangible goods on a wholesale basis (i.e. they purchase from foreign group entities for sale to end customers in-country and potentially in another country). Other activities such as services, retail sales, commodity sales do not qualify.

The OECD report distinguishes several options for jurisdictions, including the mandatory or elective application of the rules for Amount B.

Amount B is based on the Transactional Net Margin Method and this method is, in practice, used mostly to benchmark distribution entities.

For the purposes of Amount B, the OECD devised a pricing matrix, which is based on three industry classifications (the second one covering the vast majority of distribution activities), and five bands of operating asset and operating expense intensity. Depending on where within the pricing matrix an entity is based, an operating margin of between 1% and 6% would be considered appropriate.[4]

It should be noted that in addition to the operating margin determined in terms of this pricing matrix, a so-called “uplift” will be applied where a distribution entity is based in a “qualifying jurisdiction”. The term qualifying jurisdiction is defined in the OECD Report,[5] and South Africa is listed as a qualifying jurisdiction, and therefore such an uplift would apply. While in an extreme scenario an upliftment can be as much as 7.3% on top of the operating margin per the pricing matrix (which is between 1% and 6%) identified for a distribution entity based in a qualifying jurisdiction it is not expected that such an extreme result would apply to a distributor based in South Africa. Nevertheless, it is submitted that even an operating margin towards the upper end of the pricing matrix per Amount B may be higher than what many benchmarking exercises suggest as being arm’s length.

Historically, there was a concern that countries would only apply Amount B rules if they were beneficial to them, therefore causing double taxation. The OECD has therefore devised very specific rules to strengthen the position of particularly developing countries who wish to apply Amount B, thus potentially forcing other countries to apply Amount B if a qualifying jurisdiction such as South Africa desires to do so.

Noteworthy

Although the implementation of the Amount B rules to South Africa would possibly result in increased revenue collections (i.e. increased tax for MNE Group entities operating in South Africa) this should not result in double taxation for the MNE Group, if the other jurisdiction also applies Amount B.

It should be noted that early in the process, South Africa, together with Brazil, Mexico, Argentina and Costa Rica, had expressed their willingness to apply Amount B.

In addition, on the day when the OECD released the Amount B report, the ATAF also released a statement[6] advising that ATAF’s members consider Amount B as it will be beneficial to them, and that ATAF will be providing practical support to its members as they implement Amount B. Subsequent to this, in November 2024, ATAF then issued its updated ATAF Suggested Approach to Drafting Transfer Pricing Legislation, which includes Section 13 that effectively introduces Amount B in the relevant legislation.

One of the jurisdictions supporting the mandatory application of Amount B is the US, a major trading partner of South Africa and the top third country from which South Africa imported in 2024.[7]

In conclusion, while South Africa has not yet issued guidance on the application of Amount B, given that South Africa has indicated its willingness to apply the mechanism, it is widely expected that SARS will implement the rules, and possibly as early as 2025.

It can be expected that the application of Amount B is likely to result in increased revenue collection, particularly given that the arm’s length margin will be based on operating asset/expense intensity, and of course the additional margin by virtue of the uplift. This is because, if compared to the position prior to implementation of Amount B, when operating margin results were based on comparables identified mostly by relying on database benchmarking exercises with foreign, often European, comparables, these would have resulted in an arm’s length range, and operating asset/expense intensity may not have been considered in full, and there would not have been an uplift to the margin.

The impact of the introduction of Amount B for South Africa will, however, also depend on whether South Africa will provide a mandatory or an elective mechanism.

It will be interesting to see if the Minister of Finance will mention Amount B in this year’s Budget Speech, the timing for its implementation as well as the expected additional revenue collections.

Notes:

[1] https://events.ataftax.org/index.php?page=documents&func=view&document_id=295, page 2.

[2] It should be noted that double tax relief in respect of the secondary adjustment is not available in the form of any article dealing with avoiding double taxation of dividends.

[3] Qualifying jurisdictions are non-EU jurisdictions with a publicly available long term sovereign credit rating of BBB+ (or equivalent) or lower, as determined by a recognised independent credit rating agency, and less than five comparables in the global dataset (previously determined by the OECD in terms of a database benchmarking search prepared). This uplift should be modest, but in an extreme scenario may result in an up to 7.3% uplift to the expected operating margin.

[4] This takes into account the 0.5% variability threshold provided in the OECD Report.

[5] As mentioned above, the uplift is related to the sovereign credit rating of a jurisdiction, as well as some other factors, refer footnote 3 above.

[6] https://www.ataftax.org/ataf-responds-to-oecd-g20-inclusive-framework-s-report-on-pillar-one-s-amount-b.

[7] https://www.sars.gov.za/customs-and-excise/trade-statistics/ (November 2024).