The taxpayer, opposing an interlocutory application by the Commissioner of the South African Revenue Service (SARS), is a Western Cape based group of companies that operates 1,751 corporate and 360 franchise outlets in 14 countries. The primary business of the Taxpayer Group is food retailing, and selected non-food products typically found in supermarkets, to consumers of all income levels.
In addition to the supermarkets, the taxpayer also has an entity in Mauritius, which is generally accepted as a great location for holding trademarks and has the material benefit of not having exchange control provisions.
Where you have a South African entity transacting with a connected foreign entity, you must account for transfer pricing. This is the tax anti-avoidance mechanism to ensure that both South Africa and the foreign country receives its fair share of taxes.
Small Percentages Add Up
The taxpayer adopted a transfer pricing policy of 1% on a cost-plus basis to determine the royalty fees. This means that for each R100 of costs incurred, a royalty of 1% or R1 was charged. SARS maintained that the applicable rate should have been 4% or R4 in the example.
This may sound like small tax percentages, but it adds up to R118.3 million as additional income tax, before penalties and interest, for the 2015 year of assessment and a further R162.3 million in additional income tax for 2016. These amounts are for just two tax years and one can imagine what the adjustment will be should SARS win and include more years of assessment.
SARS stated earlier in official communication, following the release of an interpretation note on intra-group loans, that transfer pricing on its own is not good or bad, but simply a necessity given that parties transact with each other. “In a tax context, transfer pricing is of concern in situations where parties manipulate the transfer price to achieve a more desirable tax outcome. This is of particular concern in cross-border transactions between related parties as it is easier to manipulate the pricing and take advantage of different tax jurisdictions. This often results in tax jurisdictions not receiving the tax revenue they are rightfully entitled to receive.”
SARS Brings in Heavyweight Expert Witness
Transfer pricing turns on having the correct expert in your corner. SARS is relying on Dr Maning in this regard, a move the taxpayer strongly objected to, leading to the opposed interlocutory application. It is important to bear in mind that this is not the main case on whether the taxpayer or SARS is wrong, but an interim step to determine whether the introduction of Dr Maning is an amendment which runs foul of the Rules of the Tax Dispute process.
The respondent contended that Dr Maning’s report could not serve any relevant purpose and should be withdrawn. SARS pleaded that it relies on this report for purposes of supporting the assessment raised and the determination of an arm’s length compensation. SARS and Dr Maning used different methods in their calculations.
The presiding officer, Judge J. Dolamo, ruled the use of any of the methods will not change the factual basis of the assessments.
The judgment is unclear on a number of aspects, and one will have to wait for the main case to be decided. However, what is confirmed, is the principle that SARS can place on record an alternative basis for a tax assessment and very late in the SARS dispute phase. The test is whether there is a factual or legal basis which amounts to novation or requires the issuance of a revised assessment, which the Tax Court found not be the case on the facts before the judge.
The case highlights that even as far back as 2015, items can come back to haunt you.
Cracks in the Confidence?
It is clear SARS is not shying away from taking complex tax cases to court and call in expert witnesses in strengthening their arguments.
In this instance Dr Maning’s report introduced by SARS appeared to have unnerved the taxpayer, prompting an attempt to stop the tax authority from relying on the report.
If the taxpayer had a fully robust, expertly prepared transfer pricing policy in place, and was confident in discharging their onus of proof, one must ask: why launch an opposing interlocutory application just to raise an exception on the witness’ report. The taxpayer simply could have allowed Dr Maning to give evidence and demonstrated in court that their method is the correct one in law.
As SARS continues to bring in heavyweight experts and assert its position in court, it is clear that the strength of your tax expert may be just as critical as the strength of your case.
