Cross border transfer pricing legislation has been around since 1995, but

few taxpayers pay sufficient attention to it.

"Transfer pricing" refers to the price at which goods and services are

transferred between two parties (this includes interest on loans).

The legislation regulates the price charged for goods and services between

connected parties, one of whom is ordinarily resident in South Africa, and

the other outside South Africa.

The legislation aims to prevent the South African Revenue Service (Sars)

being prejudiced by the parties trying to move taxable profits into another

country with a lower tax rate.

Clearly, the law does not apply if you do not send or receive goods or

services to or from abroad in the course of your business, for example if

you are merely receiving a gift from a relative overseas.

But if in terms of normal tax rules you would be required to include an

amount of income in, or would be allowed to deduct an amount of expenditure

from, your taxable income, and the transaction is with an offshore

connected party, you must be able to show that the price you are charging

or being charged can be compared to the amount that would have been charged

in an arm`s length transaction.

If Sars thinks that the price is not comparable to a third party

transaction, you may find yourself with a bill for the income tax on the

difference between the actual amount of the transaction and the amount at

which Sars believes it should have been.

You may also be liable for a penalty (up to twice the amount of tax

charged) and interest at 16 percent from when the tax was payable.

In addition, if the transactions are between your company and an offshore

shareholder, their relative or a trust of which the shareholder or relative

is a beneficiary, you may also be liable for secondary tax on companies

(STC), plus penalties and interest. This will be levied at 12,5 percent on

the difference between the actual amount and the amount that Sars considers

to be reasonable.

So how do you avoid trouble in this arena? Firstly, if you have established

that you do have international transactions with connected parties, you

need to review and document your transfer pricing policies. I will discuss

this in more detail in next week`s article.

It is important to be aware of the concept of "financial assistance". If,

for example, an overseas company is an investor in your company or is

entitled to participate in 25 percent or more of its dividends, profits or

capital or exercise 25 percent or more of the votes and Sars is of the

opinion that the total of all financial assistance (loan provided by the

overseas investor), is excessive in relation to your company`s fixed

capital, it may disallow the interest charged by the offshore investor on

the amount regarded as excessive.

If your offshore investor has provided funds to your company in the form of

share capital and loans, and the loans exceed three times the amount of the

capital invested, the interest on the part of the loans exceeding three

times the capital will not be allowed as a tax deduction.

Deborah Tickle is a tax partner at accounting firm KPMG

For answers to tax questions of a general nature for publication write to:

Deborah Tickle, Personal Finance, P O Box 56, Cape Town, or e-mail

[email protected]