Transfer Pricing and Corporate Tax: briefing by National Treasury & South African Revenue Services

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Mineral Resources and Energy

19 November 2014
Chairperson: Mr S Luzipho (ANC) Co-Chairperson: Mr Y Carrim (ANC)
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Meeting Summary

The Portfolio Committee on Mineral Resources held a joint meeting with the Standing Committee on Finance to receive a briefing by the National Treasury and the South African Revenue Services (SARS) on transfer pricing and corporate tax.
 
The National Treasury said that South Africa ran a twin deficit and South Africans did not save much. Because of this, the country was forced into getting savings from outside South Africa. Multinational companies and enterprises contributed a significant chunk of foreign investment into South Africa, and these companies were welcomed because the country was in need of their investment. Enterprises moved supplies and cash between countries, and this was generally mutually beneficial.

Transfer pricing was the price at which entities within a multinational enterprise (MNE) transacted with each other for the transfer of goods and services. Setting transfer pricing was important, because according to the United Nations Conference on Trade and Development (UNCTAD), over 60% of the world trade was within or involved MNEs. Due to their relationship, entities in MNEs had the ability to distort transfer prices and ultimately profits reflected in particular jurisdictions, thereby eroding the tax base and depriving countries of their correct share of taxes. For this reason, tax administrations had cause for concern when transfer prices were incorrect or mispriced.
 
SARS said the global financial crisis had put a spotlight on declining tax revenues, and this had increased the burden on ordinary citizens to cover the tax shortfall. The G20/OECD (Organisation for Economic Cooperation and Development) had launched the Base Erosion and Profit Sharing (BEPS) action plan in July 2013, which was aimed at addressing mismatches and gaps and weaknesses in international tax and treaty law that permitted double non-taxation. Of the 15 action items in the BEPS action plan, four were directly related to transfer pricing. SARS in response had established a Transfer Pricing Unit at the Large Business Centre. Over last three years, the unit had audited more than 30 cases and had found transfer pricing of just over R20 billion, at a conservative estimate, with an income tax impact of over R5 billion. A similar number of cases were currently in progress and others were in the process of being risk assessed.

Part of the solution to transfer mispricing involved keeping abreast of international best practice and active participation in international forums, to ensure that South Africa’s issues were taken into account. While there was no denying the significance of transfer mispricing, it was vitally important that South Africa responded in a manner that was balanced and which did not pose a deterrent to foreign direct investment. Increasing capability, tighter legislation, greater taxpayer co-operation and more advanced systems were some of the immediate challenges faced by SARS. Also, transfer pricing audits did not yield quick and certain results. However, there was no easy solution and SARS has to work within the confines of both domestic and international law.
Members asked how much of the R5 billion tax impact was from the mining sector? Were there enough resources to tackle the issue of transfer pricing in the country, or was there a need for some regulatory change? Was this the new fashion for avoiding tax? How successful was SARS in retrieving money? How accurate was the percentage contributed by the mining sector to the GDP? With regard to the unit established for dealing with transfer pricing, was this unit linked to tax base erosion? What mechanisms were in place to ensure that companies doing business with the government were not involved in schemes such as transfer pricing? What mechanisms were in place to ensure that corporate companies were encouraged to invest in the country, rather than an increase in tax for citizens?

The presentation had indicated that mining’s contribution to the GDP had not grown since 2013, and this was unacceptable. What were some of the reasons for this? What were some of the financial implications of auditing transfer pricing -- was there value for money for that kind of work within the country? Was South Africa on a par with the advanced digital tax systems being used in first world countries? What were the other factors which had contributed to the rise in transfer pricing and the avoidance of tax? How much was the country losing in revenue as a result of transfer pricing? What methods were being employed to measure these figures? Did SARS have enough administrative capacity to deal with the issues raised in the presentation? What were some of the countries from which South Africa could learn in order to curb transfer pricing?
 

Meeting report

Chairperson’s opening remarks
The Chairperson welcomed Members of the Portfolio Committee on Mineral Resources to the meeting. However, it was important that the Committee considered its own matters first.

Adoption of Committee Minutes

5 November 2014
Mr Z Mandela (ANC) moved the adoption of the minutes.
Mr M Matlala (ANC) seconded the adoption of the minutes.
The minutes of 5 November 2014 were adopted without any amendments.

12 November 2014
Mr Mandela moved for adoption of the minutes.
Mr Matlala seconded the adoption of the minutes.
The minutes of 12 November 2014 were adopted without amendments.

National Treasury: South Africa’s Tax Policy Structure with a focus on Corporate Income Tax,
The Chairperson welcomed Members from the Standing Committee on Finance. He indicated that Mr Y Carrim (ANC) would be assisting with the chairing of the meeting.
 
The Co-Chairperson thanked Members for agreeing to have a joint meeting between the two Committees. He indicated that SARS and National Treasury had come as a team and would therefore be giving the presentations and responding to questions as a team.
 
Mr Ismail Momoniat, Deputy Director-General: Tax and Financial Sector Policy, National Treasury, thanked the Committee for the invitation. He asked the officials from SARS and National Treasury to introduce themselves. He explained South Africa was in need of both domestic and foreign investment. South Africa ran a twin deficit and South Africans did not save much. Because of this, the country was forced into getting savings from outside South Africa. Multinational companies and enterprises contributed a significant chunk of foreign investment into South Africa and these companies were welcomed, because the country was in need of their investment. Companies came to invest in South Africa and then took out their dividends when there was a profit. Similarly, South African companies invested in other countries, and they also received dividends.

Enterprises generally moved supplies and cash between countries, and these were generally mutually beneficial. Transfer pricing was therefore not a mining issue specifically -- it was across the board. It was purely a tax issue. Up to 2008, countries had to pay bail out their banks, and tax payers had been forced to pay out large amounts of money in contribution to revenue. South Africa had just started looking at Value-Added Tax (VAT) and electronic services, an area which was proving to be challenging, not only in South Africa but in the world at large.

He argued that globally, coordinated action was needed to tackle taxation through the sharing of information. Tax issues needed to be differentiated from illegal flows which were not tax related, such as money laundering. Transfer pricing was a different issue. Tax revenue as a percentage of the national budget revenue was comprised of tax from individuals, which contributed about 35% to the national budget. VAT contributed 27%, companies contributed 20%, the fuel levy contributed 4.9%, specific excise contributed 3.3%, customs duties contributed 5% and dividends contributed 2% to the national budget’s revenue.

There were three main taxes; Personal Income Tax (PIT), VAT and Corporate Income Tax (CIT), and these contributed 81.7% to the national budget revenue. With regard to how much tax revenue contributed to the Gross Domestic Product (GDP), individuals contributed 9%, VAT 6.9% and companies 5.1%. The three main taxes, PIT, VAT and CIT contributed to 21% of the GDP.

Mining and quarrying contributed 5.6% to the GDP, a drop from the 8.6% which the sector contributed in 2000. The biggest contributors to the GDP were finance, real estate and business services (24.2%), manufacturing (16.9%), general government services (15.3%) and wholesale, retail and motor trade, catering and accommodation (14%). The mining and quarrying sector had not grown in compound annual growth since the year 2000.

With regard to CIT, he said the current headline rate was 28%. Some economists and tax specialists argued that corporate income tax should be abolished, as companies were able to pass some or most of their tax liabilities on to consumers (higher prices), labour (lower wages) or shareholders (lower dividends). CIT played an important withholding function, and acted as a backstop to PIT. CIT captured part of the benefits of public expenditures on infrastructure, the legal and regulatory system, education and training and legal provisions used by corporations. However, internationally the corporate income tax rate had been on the decline. Many countries had managed to maintain or broaden the corporate income tax base and corporate income tax revenues. However, the corporate income tax base was under threat due to base erosion and profit sharing.

With regard to mining taxation in South Africa he said that mining companies were taxed at the normal CIT rate, which was 28%, except for gold. With regard to mineral royalty revenues, during the 2012/13 financial year mining had contributed R5 billion, and in the 2013/14 financial year it had contributed R6.4 billion.
 
Tax implications of cross border transactions/ International Taxation
Mr Franz Tomasek, Group Executive, SARS spoke about the evolution of the South African tax system, the impact of globalization on the country’s domestic tax legislation, the G20 and the Organization for Economic Co-operation and Development (OECD) Base Erosion and Profit Sharing (BEPS) action plan, and measures implemented by South Africa in relation to BEPS. Over the past years, the South African tax system had changed significantly. The major reform after 1994, based on the Katz Commission recommendations, was the move from a source-based system of taxation to a residence-based system of taxation, and the introduction of a capital gains tax. These reforms were aimed at broadening the South African tax base and developing a competitive tax system. Globalization boosted trade and increased foreign direct investments in many countries, and resulted in Multinational Enterprises (MNEs) becoming globally integrated. The application of different tax laws by different countries on MNEs had the potential to create double taxation, resulting in adverse economic growth and global prosperity.

Double taxation occurred where the same income of the MNE was taxed twice in different countries. In order to eliminate double taxation, South Africa -- like most countries -- had entered into tax treaties to eliminate double taxation, create fiscal stability and certainty and prevent tax avoidance and evasion. South Africa currently had tax treaties with about 76 countries. On the other hand, double non-taxation was the application of different tax laws by different countries on MNEs, and occurred when income was not taxed by any country. The OECD had published the BEPS action plan in July 2013, and it had been endorsed by G20 heads of state in September 2013. The BEPS action plan had 15 action items.

South Africa played a key role as a member of the BEPS Bureau Plus, and implemented the following measures in its domestic tax law in relation to BEPS:
• Transfer pricing rules
• Controlled Foreign Company (CFC) rules
• Excessive interest limitation rules
• Hybrid instruments and entities
• Digital economy
• Exchange of tax information
However it was important to note that South Africa had already implemented some of the above rules on domestic tax legislation even before the launch of the BEPS action plan in July 2013.
 
SARS: Transfer Pricing, Base Erosion, Profit Sharing and the Extractive Industry Sector,
Mr C du Plessis, Specialist: SARS explained that transfer pricing was the price at which entities within a multinational enterprise (MNE) transacted with each other for the transfer of goods and services. Setting transfer pricing was important, because according to United Nations Conference on Trade and Development (UNCTAD), over 60% of world trade was within, or involved, MNEs. Due to their relationship, entities in MNEs had the ability to distort transfer prices and ultimately profits reflected in particular jurisdictions, thereby eroding the tax base and depriving countries of their correct share of taxes. For this reason, tax administrations had cause for concern when transfer prices were incorrect or mispriced.
 
The global financial crisis had put a spotlight on declining tax revenues, and had increased the burden on ordinary citizens to cover the tax shortfall. The G20/OECD had launched the BEPS action plan in July 2013, which was aimed at addressing mismatches, gaps and weaknesses in international tax and treaty laws that permitted double non-taxation. Of the 15 action items in the BEPS action plan, four were directly related to transfer pricing. In response, South Africa had introduced transfer pricing legislation in 1995, with recent amendments in principle in 2011 and 2014. Section 31 of the Income Tax Act of 1962, provided that transfer pricing needed to be at “arm’s length.” The arm’s length principle was rooted in Article 9 of double tax agreements, and guidance at a generic and transactional level on its application was contained in the OECD transfer pricing guidelines for multinational enterprises and tax administrators. SARS in response had established a transfer pricing unit at the Large Business Centre. However, there were limited resources in the strategic audit.

Over the last three years, the transfer pricing unit had audited more than 30 cases and had found transfer pricing of just over R20 billion, at a conservative estimate, with an income tax impact of over R5 billion. A similar number of cases were currently in progress, and others were in the process of being risk assessed. Part of the solution to transfer mispricing involved keeping abreast of international best practice and active participation in international forums, to ensure that South Africa’s issues were taken into account. While there was no denying the significance of transfer mispricing, it was vitally important that South Africa responded in a manner that was balanced and which did not pose a deterrent to foreign direct investment. Increasing capability, tighter legislation, greater taxpayer co-operation and more advanced systems were some of the immediate challenges faced by SARS. Also, transfer pricing audits did not yield quick and certain results. However, there was no easy solution and SARS had to work within the confines of both domestic and international law.

Discussion
Mr J Lorimer (DA) said that according to the presentation, around R5 billion was lost in tax revenue. How much of this R5 billion was from the mining sector? Were there enough resources to tackle the issue of transfer pricing in the country, or was there a need for some regulatory change? How successful was SARS in retrieving money? Transfer pricing seemed to have become more prevalent recently -- was this the new fashion for avoiding tax? It seemed that SARS was acting quite efficiently in preventing transfer pricing -- were any of these actions proving to be a disincentive to investment?

Dr B Khoza (ANC) congratulated SARS on the positive work which they were doing. South Africa was under a lot of pressure from citizens who were beginning to raise concerns around the issues under discussion, because they were becoming required to subsidise corporate tax. The issue of transfer pricing was a criminal issue, not simply a moral issue. How accurate was the percentage contributed by the mining sector to the GDP? It had been estimated that mining was costing the country trillions of rands -- had any research been done in quantifying how much each sector was costing the country? With regard to the unit established for dealing with transfer pricing, was this unit linked to tax base erosion? She raised concern about some of the companies which were doing business with Parliament, asking what mechanisms were in place to ensure that these companies were not involved in schemes such as transfer pricing?
 
Mr D Ross (DA) said South Africa was running at a deficit, with the country needing over R10 billion in revenue. What mechanisms were in place to ensure that corporate companies were encouraged to invest in the country, rather than an increase in tax for citizens? The presentation indicated that mining’s contribution to the GDP had not grown since 2013, and this was unacceptable. What were some of the reasons for this? Judging from the activities which had been taking place in the industry, the Portfolio Committee on Labour needed to be engaged to address the challenges in the sector, such as strikes. Structural challenges within the labour sector need to be addressed as a matter of urgency. He argued that banks also played a significant role in detecting transfer pricing.

Ms T Tobias (ANC) said members of the Economic Freedom Fighters (EFF) had been raising the issue of transfer pricing continually, and it was therefore sad that no EFF members were present at the meeting. What were some of the financial implications for auditing transfer pricing? Was there value for money for that kind of work within the country? Was South Africa on a par with the advanced digital tax systems being used in first world countries?
 
Ms P Kekana (ANC) said the companies and entities which were practising transfer pricing were very smart and sophisticated -- were there enough mechanisms to ensure that South Africans did not fall prey to such practices? How were officials from SARS being enabled to better deal with such practices? Should South Africans be wary about multinational companies which showed an interest in investing in the country? Did these companies see South Africa as a haven for transfer pricing?

Mr D van Rooyen (ANC) said Members should not be worried about the absence of EFF members because there was no significant contribution they would make. He asked whether there was enough capacity within SARS to interrogate companies on their transactions. What were the other factors which contributed to the rise in transfer pricing and the avoidance of tax? How much was the country losing in revenue as a result of transfer pricing? What methods were being employed to measure these figures? Did SARS have enough administrative capacity to deal with the issues raised in the presentation? What legislative measures had SARS undertaken? What were some of the countries which we could learn from with regard to curbing transfer pricing? He asked about the legality of transfer pricing -- was it possible to declare the practice illegal?
 
The Co-Chairperson thanked SARS and National Treasury for the presentation. He said SARS was doing very well according to international standards, especially with its turnaround times. How cooperative were other countries in dealing with transfer pricing? Was there a win-win situation? He said the flow of money from developing countries to first world countries was greater than the money coming into these countries. What incentive was there for developing countries to cooperate? What was in it for them? Would the gains outweigh the costs of pursuing and tackling transfer pricing. The area of transfer pricing and base erosion was very complex and fast changing, and that made it difficult to set deadlines for addressing the challenges. However, there was a need for broad deadlines and monitoring. With regard to legislation, he said it would be useful for SARS to engage with Parliament more, because there were things which Parliament could do which SARS could not.

The Chairperson said that the issue of transfer pricing has been a general concern to Members of the Portfolio Committee on Mineral Resources. In addition, the mining sector was battling with the issue of illegal mining and that of derelict and ownerless mines.

Mr Momoniat said a tax incentive could be provided for the rehabilitation of mines. However, tax was generally a very blunt tool and was not very effective in generating certain behavior. SARS could, however, impose a “sin tax” to get a consumer to not do the wrong thing, such as that in the tobacco industry, but other additional mechanisms still needed to be added. Mining affected the supply to all other industries around it, such as manufacturing. With regard to what was legal and what was illegal, he said transfer pricing was important in a globalised world because it encouraged investment. The problem, however, was the issue of transfer mis-pricing. Tax evasion was illegal, but there was still a lot of room for the interpretation of transfer mis-pricing, which led to tax evasion. South Africa’s revenue was relatively high in comparison to other African countries, and so issues of competitiveness needed to be looked at.
 
Ms Yanga Mputa, Chief Director: Legal Tax Design, National Treasury, responded to the question on cooperation between developing and developed countries, and said it was a win-win situation for both countries to deal with the issue of tax evasion and transfer pricing. Cooperation between countries was necessary for the exchange of information.

Mr du Plessis said a lot of judgments needed to be made with regard to what the correct price was, but this was not always possible, as benchmarks were not easily available. Therefore in the transfer pricing space, things were generally not illegal because it was easy to make a mistake and different judgments were welcomed. There were generally legitimate reasons for differing prices because there was room for differences in opinion. SARS had all the essential elements for tackling transfer pricing. With regard to whether SARS was successful or not in retrieving the money, he said SARS was indeed successful. However the R20 billion mentioned in the presentation was no longer in South Africa, and that was money SARS could not get back. However, SARS could get the tax on it. It could go back as far as three years in attempting to get money back from companies. With regard to companies which did business with government, he agreed that some were guilty of transfer pricing as well.

Ms Sunita Manik, Group Executive, SARS, said there was a need to distinguish between transfer pricing, base erosion and profit shifting. Transfer pricing was only one of the mechanisms of profit shifting among others, such as extensive charges on interest and treaty abuse. Transfer pricing was more than just a tax issue, it was a societal issue. With regard to international taxation, she said good practices and guidelines needed to be followed. More than 70% of South Africa’s tax base was from multinationals, so the potential for transfer pricing was significant. Quantification was not easy to do, and this was a world-wide problem. Transfer pricing, however, was not illegal. With regards to dis-incentivising behaviour, she said SARS was very robust in making it very difficult for any tax payer to engage in transfer pricing and similar behaviour.

The Chairperson said there was not enough time for further engagements. He asked that any other questions which Members might have should be sent through to the Chairpersons, who would forward them to the relevant entity in writing.

Dr Khoza asked why South Africa was a member of the G20, but not of the OECD.
 
Mr Momoniat said South Africa had not decided to apply to be a member of ODEC, and only Mexico and Chile from the emerging markets were members, although South Africa did participate in the forums.
 
The Chairperson thanked the officials from SARS and National Treasury for the presentations, together with the Members from the two Committees for their engagements with the presentations.

The meeting was adjourned.
 

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