Engagement on Transfer Pricing

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Trade, Industry and Competition

25 March 2015
Chairperson: Ms J Fubbs (ANC)
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Meeting Summary

Mr F Shivambu (EFF) presented a paper on transfer pricing and the South African Mining Development Agency presented their perspective on transfer pricing as it related to the mining industry.

Mr Shivambu said transfer pricing was usually utilised by multinational corporations as a form of tax avoidance through selling the goods and services (particularly commodities) at a lower price at arm’s length in order to pay lesser taxes in the country of production. It was also done by overpricing the services a multinational corporation received for intangible services from its subsidiary corporation located in a tax haven.

South Africa lost R237 billion in illicit financial flows in 2011 and over R1 trillion between 2002 and 2010. A closer examination of all mining corporations in South Africa would reveal that virtually all mining corporations had subsidiaries in jurisdictions considered as tax havens and have financial relationships with the tax havens, whilst there was no real activity from those tax havens.

Despite the inadequacies that had been identified in the Organisation for Economic Cooperation and Development (OECD) approach to transfer pricing, the Davis Tax Commission still recommended that legislators should ensure that Section 31 of the Income Tax Act referred to the OECD guidelines. Without departing from the OECD Transfer Pricing Guidelines, the suggested General Ruling should include a set of principles reflecting the South African reality.

The OECD Transfer Pricing Guidelines described five transfer pricing methods that might be applied to establish whether the conditions of controlled transactions were consistent with the arm’s length principle. The Sixth Method originated in Argentina, where the government sought to address raw materials transactions that utilised an agent located in a country where significantly less tax was paid than in the exporting country. For developing countries with economies heavily dependent upon commodities exports, changes to transfer pricing rules might be viewed as a source for raising taxable income. This strategy appeared to be supported by international development organisations and mandating use of the Sixth Method had been an effective way for governments to increase the tax assessed on companies exporting commodities.

The Tax Justice Network recommended the implementation of strict General Anti Avoidance Rules (GAAR). This way, any impermissible tax avoidance structures, where the main purpose was to obtain tax benefits, would be subject to challenge. Tax authorities could do more audits of service fees and royalty payments that were made by multinational corporations to related parties. China was leading by example by doing selective audits for years 2004 to 2013, paying particular attention to companies in tax havens and to related parties in other overseas jurisdictions that had few or no functions. Domestic laws and tax treaties should follow the "source rule" for royalties, management expense, interest expense, and other payments.

The Committee commended Mr Shivambu’s presentation and voiced the importance of such a strategic discussion. Members wanted to know what strategic proposals from other Commissions could be of use and suggested that the Committee invited experts in this field to present to the Committee. Members clarified that tax avoidance was strictly speaking, legal, while tax evasion was illegal.  A focus area should also be to look at how tax avoidance or lack of declaring of profits undermined beneficiation. If these companies were selling their own products to each other and to themselves and then reducing the prices, it was very unlikely that anything would be sold locally to beneficiate locally.

The South African Mining Development Association (SAMDA) said as transfer pricing regulating was tightened in South Africa, more sophisticated forms were developed. Out of 151 countries, South Africa loses, on average, the 12th highest amount of money through illicit financial outflows.

Effective ownership was a requisite instrument to effect meaningful integration of historically disadvantaged South Africans into the mainstream economy. In order to achieve a substantial change in radical and gender disparities prevalent in ownership of mining assets, stakeholders committed to achieving a minimum target of 26% ownership to enable meaningful economic participation by 2014. Local procurement was attributable to competitiveness and transformation, captured economic value, presented opportunities to extend economic growth that allowed for the creation of decent jobs and widened scope for market access of South African Capital Goods and Services. In order to achieve this, the mining industry should procure a minimum of 40% of capital goods from BEE entities by 2014, ensure that multinational suppliers of capital goods annually contributed to a minimum of 0.5% of annual income generated from local mining companies towards socio-economic development of local communities into a social development fund from 2010; and to procure 70% of services and 50% of consumer goods from BEE entities by 2014.

The detrimental impact on Broad-Based Black Economic Empowerment (B-BBEE) ownership, beneficiation, procurement and all the other elements of the Mining Charter should be investigated. The alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice had not been made despite the fact that the Mining Charter had a 2014 deadline to comply with. SAMDA suggested that the immediate alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice should be done as it was long overdue to address transfer pricing and Charter non-compliance. Section 26(3) of the Mineral and Petroleum Resources Development Act (MPRDA) stated that any person who intended to beneficiate any mineral mined in the Republic outside the Republic may only do so after written notice and in consultation with the Minister. Companies that have been in breach of the 2014 Mining Charter deadline should be penalised under the relevant clauses of the MPRDA.

The Committee asked for practical proposals on how the MPRDA should be integrated into the proposed legislation, because a lack of compliance did not necessarily speak to a lack of legislation. The Committee raised awareness that companies involved in transfer pricing put up offices in areas of Special Economic Zones (SEZs) and simply state that most of the services were provided by SEZs, because of the lower tax regime.

Members said the presentations basically showed that said foreign monopoly capital was using transfer pricing to undermine beneficiation, B-BBEE and other transformation strategies and it needed to be addressed. The Committee further highlighted the ongoing debate on which tool was preferred between the Mining Charter and the B-BBEE Codes  and stated that it seemed sensible to envisage a future in which the Codes trumped all others, because the unencumbered value seemed more sensible. 

Meeting report

The Chairperson welcomed everyone to the meeting and the agenda for the meeting was adopted. She indicated that Mr F Shivambu (EFF) would be presenting his paper on transfer pricing.

Transfer pricing in South Africa

Mr Shivambu said the phenomenon of transfer pricing fell within the broader category of capital flight, illicit financial flows and the base erosion and profit shifting phenomena, which had received substantial attention from various organisations. Transfer pricing was usually utilised by multinational corporations as a form of tax avoidance through selling the goods and services (particularly commodities) at a lower price than would at arm’s length in order to pay lesser taxes in the country of production. It was also done by overpricing the services a multinational corporation received for intangible services from its subsidiary corporation located in a tax haven. Transfer pricing happened by manipulating the international trade system in order to transfer huge amounts of money to tax havens or jurisdictions without or very low taxes.

There were varying degrees of the consequences of illicit capital flight and/or transfer pricing in South Africa. The High Panel on Illicit Financial Flows from Africa convened by former President Thabo Mbeki observed that “Illicit financial outflows drained hard currency reserves, heightened inflation, reduced tax collection, cancelled investments, undermined trade, worsened poverty and widened income gaps. In an interview conducted with Moneyweb, the Director for African Monitor, Ms Namhla Mniki-Mangaliso admitted that South Africa lost R237 billion in illicit financial flows in 2011 and over R1 trillion between 2002 and 2010. A closer examination of all mining corporations in South Africa would reveal that virtually all mining corporations had subsidiaries in jurisdictions considered as tax havens and have financial relationships with the tax havens, whilst there was no real activity from those tax havens. This included mining corporations with Black Economic Empowerment (BEE) shareholders, even in relatively successful cases such as Patrice Motsepe’s African Rainbow Minerals.

The interim report of the Davis Tax Committee illustrated the fact that South Africa had transfer pricing legislation in Section 31 of the Income Tax Act. As the Organisation for Economic Cooperation and Development (OECD) recommended, South Africa applied the arm’s length principle to curb transfer pricing. The legislation focused on cross-border transactions, operations, schemes, agreements or understandings that had been effected between, or undertaken for the benefit of, connected persons. Despite the inadequacies that had been identified in the OECD approach to transfer pricing, the Davis Tax Commission still recommended that legislators should ensure that Section 31 of the Income Tax Act referred to the OECD guidelines. Without departing from the OECD Transfer Pricing Guidelines, the suggested General Ruling should include a set of principles reflecting the South African reality. The South African Revenue Services (SARS) should ensure that the enforcement capacity of its transfer pricing unit was adequate. It should also ensure that there was sufficient transfer pricing training and capacity building in its transfer pricing unit.

The OECD was a club of rich countries, and its member states would be under constant pressure from their large corporations to maintain the status quo, or to make only modest adjustments to how the tax pie is allocated between the “residence” countries (rich developed countries) and the “source” countries (usually developing countries). The Tax Justice Network illustrated that in truth, the arm’s length principle was very hard to implement, even with the best intentions.

The proposals and recommendations that should be considered in combating these phenomena were categorised into four categories which were the political actions, economic actions, the technical actions, and to reject the OECD and implement the Sixth Method.

The OECD Transfer Pricing Guidelines described five transfer pricing methods that might be applied to establish whether the conditions of controlled transactions were consistent with the arm’s length principle. The Sixth Method was a mechanism to deal with transfer pricing, which departed from OECD methods. The Sixth Method originated in Argentina, where the Argentinean government sought to address raw materials transactions that utilised an agent located in a country where significantly less tax was paid than in the exporting country. For many developing countries, exports of commodities were such a significant part of the economy that it was important to avoid price manipulations that lowered transfer prices and taxes collected. For developing countries with economies heavily dependent upon commodities exports, changes to transfer pricing rules might be viewed as a source for raising taxable income. This strategy appeared to be supported by international development organisations and mandating use of the Sixth Method had been an effective way for governments to increase the tax assessed on companies exporting commodities.

The Tax Justice Network recommended the implementation of strict General Anti Avoidance Rules (GAAR). This way, any impermissible tax avoidance structures, where the main purpose was to obtain tax benefits, would be subject to challenge. Tax authorities could do more audits of service fees and royalty payments that were made by multinational corporations to related parties. China was leading by example by doing selective audits for years 2004 to 2013, paying particular attention to companies in tax havens and to related parties in other overseas jurisdictions that had few or no functions. Domestic laws and tax treaties should follow the "source rule" for royalties, management expense, interest expense, and other payments.

Discussion

Mr B Mkongi (ANC) welcomed the presentation and said it was a very important strategic discussion for the Committee to have. The document argued for the establishment for a commission of enquiry, but what would happen to the recommendations made by other Commissions since there have been reports since 1994 with recommendations? He wanted to know what strategic proposals from other commissions could be of use in this matter. In terms of criminalistaion of tax avoidance, he suggested that perhaps it should be discussed with the Standing Committee on Finance. The premise of transfer pricing should form part of this Committee’s mandate because it spoke to industrialisation, beneficiation and job creation, because it would not be productive to base the debate on the mandate of the Standing Committee on Finance.

The Chairperson said the idea was certainly to focus on trade and industry and the Committee needed to get a better understanding of the tax implications. Going forward in engagements, Members would be ‘armed’ with a base knowledge.

Mr Shivambu replied that there were no concrete recommendations from the Commissions and the last interim report by the Davis Tax Committee just proposed continuation of the OECD guidelines and the arms length principle. There was no benchmark and no way to verify if what companies were doing was consistent with the law. Tax avoidance needed to be criminalised and too much money was being lost due to tax avoidance.

Mr N Koornhof (ANC) said there was a long history to transfer pricing and unfortunately, tax avoidance was strictly speaking, legal. Tax evasion was illegal and maybe because of the global framework, transfer pricing was viewed as tax avoidance. This was a mistake and Africa as a continent should look into taking what was due and payable to African nations. There were so many studies done on transfer pricing and maybe the Committee should look into inviting the Mbeki Foundation to come and do a presentation. The upcoming engagement with the Standing Committee on Finance was vital, because in the end the legislation would be initiated by the Finance Committee and by South African Revenue Services (SARS).

Mr Shivambu agreed that experts in this area should be invited to the engagements and perhaps a South African delegation should be sent to countries that had curtailed this type of crises.

Mr M Kalako (ANC) said the implementation and the follow-up actions from this type of engagements should be the focus. The subject itself affected the Committee’s mandate and although roles needed to be clearly defined, some sort of collaboration between government departments was needed to put legislation forward on this issue. There should be a report done on what other developing countries had done in this regard to see if similar strategies could be implemented in South Africa. A follow-up engagement was necessary to unpack the proposals made in the document to get a better of how it related to the mandate of the Committee and the broader transformation agenda of the country.

Mr A Williams (ANC) said a focus area should also be to look at how tax avoidance or lack of declaring of profits undermined beneficiation. If these companies were selling their own products to each other and to themselves and then reducing the prices, it was very unlikely that anything would be sold locally to beneficiate locally.

The Chairperson referred to the Justice Network recommendations as concrete recommendations that should be looked at. The issue of intellectual property came up during the Intellectual Property Laws Amendment Bill and it demanded that the issues raised should be looked at in different ways.

Mr Shivambu said the most workable solution would be to have collaborative engagements between the Trade and Industry, Finance, and Mineral Resources Committees. Legislation to be considered would come out of those engagements. 

The Chairperson asked Mr Shivambu to collate concrete recommendations and submit it to the Committee.

South African Mining Development Association (SAMDA): Transfer Pricing and Transformation within the Mining Industry

Ms Bridgette Radebe, President, SAMDA, said as transfer pricing regulating was tightened in South Africa, more sophisticated forms were developed. Out of 151 countries, South Africa lost, on average, the 12th highest amount of money through illicit financial outflows. The Minister of Finance in this 2015 Budget Speech stated that action had to be taken to close tax evasion loopholes such as transfer pricing and profit shifting strategies.  

The Mining Sector had direct and indirect contribution to the whole economy as demonstrated by a few of the many sectors of the economy below:

-17% of GDP (direct and indirect);

-38% of merchandise exports (primary and beneficiated mineral exports)

-19% of private sector investment

-11.9% of total investment in the economy

-50% of volume of Transnet’s rail and ports

-16% of formal sector employment (direct and indirect)

-94% of electricity generation via coal power plants

-40% of electricity demand

-37% of country’s liquid fuels via coal

-Accounts for R78 billion spent in wages and salaries

Ms Radebe cautioned however, that the above figures of the direct and indirect mining contribution to the South African economy were artificial and misleading because the genuine figures had been eroded through transfer pricing. The whole economy was therefore denied the opportunity of sustainable growth, rapid economic transformation was sabotaged, the National Development Plan was being eroded and subsequently disgruntled workers embarked on labour unrest. Within 21 years of our democracy it was only the government that had thus far made meaningful contributed towards addressing the social and economic inequalities.

Effective ownership was a requisite instrument to effect meaningful integration of historically disadvantaged South Africans into the mainstream economy. In order to achieve a substantial change in radical and gender disparities prevalent in ownership of mining assets, stakeholders committed to achieving a minimum target of 26% ownership to enable meaningful economic participation by 2014.

Ms Radebe highlighted the different scorecards, according to the Mineral and Petroleum Resources Development Act (MPRDA) against which companies have to be found compliant to be licensed. Local procurement was attributable to competitiveness and transformation, captured economic value, presented opportunities to extend economic growth that allowed for the creation of decent jobs and widened scope for market access of South African Capital Goods and Services. In order to achieve this, the mining industry should procure a minimum of 40% of capital goods from BEE entities by 2014, ensure that multinational suppliers of capital goods annually contributed to a minimum of 0.5% of annual income generated from local mining companies towards socio-economic development of local communities into a social development fund from 2010; and to procure 70% of services and 50% of consumer goods from BEE entities by 2014. Beneficiation sought to translate comparative advantage in mineral resources endowment into competitive advantage as fulcrum to enhance industrialisation in line with state development priorities. In this regard, mining companies should facilitate local beneficiation of mineral commodities by adhering to the provision of Section 26 of the the Mineral and Petroleum Resources Development Act (MPRDA) and the Mineral Beneficiation Strategy. She provided the Committee with a practical case study that showed how transfer pricing in the mining industry took place.

SAMDA welcomed the fact that the Minister of Finance had established a Commission under Judge Dennis Davis that would investigate the extent, type and impact of commodity price manipulation in the country and also welcomed the opportunity to share the transfer pricing challenges of the mining sector with the Commission. The role of local and foreign marketing agents and their impact on the mining sector should be researched, better understood through the due diligence process on transfer pricing. The role and benefits of companies with primary listing off-shores should be researched and reviewed. The detrimental impact on Broad-Based Black Economic Empowerment (B-BBEE) ownership, beneficiation, procurement and all the other elements of the Mining Charter should be investigated. The alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice had not been made despite the fact that the Mining Charter had a 2014 deadline to comply with. SAMDA suggested that the immediate alignment of the Mining Charter with DTI’s B-BBEE Codes of Good Practice should be done as it was long overdue to address transfer pricing and Charter non-compliance. Section 26(3) of the MPRDA stated that any person who intended to beneficiate any mineral mined in the Republic outside the Republic may only do so after written notice and in consultation with the Minister. Section 26(3) of the MPRDA could be used to assist government in determining the true value of the commodities being transferred to the end user or consumer. Companies that have been in breach of the 2014 Mining Charter deadline should be penalised under the relevant clauses of the MPRDA.

Discussion

Mr Mkongi said the presentation referred to licences being issued to companies that complied with the scorecards of the Mining Charter, but yet it seemed there were licensed companies that did not comply. He asked how these companies managed to be licensed. There were similarities to the presentation by Mr Shivambu and the recommendations of the two reports should be integrated. He asked for practical proposals in terms of how the MPRDA should be integrated into the proposed legislation.

The Chairperson said the Committee agreed that there needed to be alignment between B-BBEE and the MPRDA, but she asked Ms Radebe to share with the Committee, both verbally and in writing, what could be done in this regard.

Ms Radebe replied that Section 100 of the Act referred to the Mining Charter which spoke to issues of beneficiation, procurement, capital and goods. The scorecard behind the Mining Charter was specially designed to address beneficiation and enterprise development. The previous submission by SAMDA extensively unpacked SEZs and the tax regime and benefits related to SEZs. As producers of minerals, integrated resources development was fundamental. The Finance Department should look into the Act in terms of transfer pricing, DMR should focus on Charter compliancy, ensure that B-BBEE Codes were aligned to the Charter and that beneficiation happened in terms of industrialisation and localisation of procurement. The Act prescribed that any company that took commodities to go and create an end product should apply to the government before that product was created. The Act should become viable and usable and the right people in government were needed to ensure that it was implemented.  Government officials that allowed companies that were not Charter compliant to get licenses and permits were acting outside the law.

The Chairperson agreed and said the Committee would meet with other Committees and the point had been made at the last meeting with SAMDA. The lack of compliance did not necessarily speak to a lack of legislation.

Mr Shivambu said there should be awareness that companies involved in transfer pricing put up offices in areas of SEZs and simply state that most of the services were provided by SEZs, because of the lower tax regime. There need to be further discussion with DTI on the rollout of SEZs, because there would be attempts by private corporations to avoid tax internally through SEZs.

Mr Williams said foreign monopoly capital was using transfer pricing to undermine beneficiation, B-BBEE and other transformation strategies and it needed to be addressed. He asked if the company Ms Radebe mentioned would lose their license.

Ms Radebe replied that the company never complied and in all the years the partners were never able to own shares. The loan repayment went up because dividends were never paid. The loan was never repaid even when there was enough capital because they did not need the income, because of selling the oil at a price beneficial to them. The banks stepped in and said there had not been payment and the interest on the shares and skyrocketed. By so doing, the company now had to restructure the loan and the non-B-BBEE partners needed to continue with the guarantees and they would, because they made the money. The DMR after issuing numerous compliance notices issued a letter to impose Section 98 which was remedial action, because the company was not compliant. It was thus shocking when two weeks ago the DMR signed the Section 102 the company applied for. It did not make sense to approve a company that was not compliant, because there were many aspects of the Mining Charter scorecard the company could not be approved for. The Act did not provide for the 2014 Compliancy Regulations to be deferred or extended beyond 2014. Officials of the DMR had no mandate to change laws of the country and should be brought to task. A decision was made not so sign because there would be no meaningful ownership that impacted the lives of South Africans.

The Chairperson asked that Ms Radebe give this account in writing because it had been referred to last time in the colloquium when the challenge of unencumbered ownership was highlighted. The document should highlight concrete proposals and should be linked with SAMDA’s previous presentation.

Mr Stephen Harnival, Chief Economist, DTI, said the Depertment had been motivating for developmental pricing to unlock beneficiation and both the presentations today essentially stated that developmental pricing was possible in the mining industry in South Africa. The DTI was asking for a discount of 10% to 20% in the spot market price in many of the prioritised value chains such as platinum, titanium, iron and steel. It was not unreasonable demands in order to unlock beneficiation and job creation. These engagements should be kept in mind when assessing whether the developmental pricing regime was reasonable or not. The DTI was mindful of the possibilities of transfer pricing and tax avoidance occurring in SEZs. The Department also did not want existing investments in other parts of South Africa being transferred or relocated to SEZs purely to benefit from the better tax regime and this would be monitored quite carefully. In terms of the MPRDA and B-BBEE, DTI was engaging with DMR  and in the course of this year there would be a detailed review of compliance levels and The DTI expected to be allowed to participate in that review. Because there was an area of misalignment in terms of the Mining Charter and the overall B-BBEE Codes, it had been picked up that some of the South African mining companies were now importing capital equipment through a B-BBEE agency or intermediary and this did not have any localisation benefit to the economy. DTI was engaging DMR to ensure a much tighter alignment.

Mr G Hill-Lewis (DA) said when there had been discussion around the B-BEEE Amendment Act and the new generic Codes; the Committee was persuaded that the requirement of the new Codes for unencumbered ownership did not target gross ownership, but rather net unencumbered value. It was better than measuring share ownership that would never really be realised and he asked whether Ms Radebe agreed. There was still some debate on which tool was preferred between the Mining Charter and the B-BBEE Codes and that debate was still continuing. It seemed sensible to envisage a future in which the Codes trumped all others, because the unencumbered value seemed more sensible.

Ms Radebe said the legislation was designed for people to be able to own shares, to later use those shares as collateral to enhance their businesses. The Charter prescribed that at least 26% equity ownership and the Charter Compliancy Regulations should prevail and contributions should be made to the Davis Commission to perfect the regulations.

The Chairperson said engagement with the Standing Committee on Finance was scheduled to take place towards the end of April 2015 and the meeting with the Portfolio Committee on Mineral Resources should be scheduled to happen before that.

The Chairperson thanked everyone for their input. She thanked Ms Radebe especially, because she had been the first person to highlight the challengers transfer pricing posed and the challenges in the lack of alignment with the MPRDA. The intention of SEZs was never to encourage transfer pricing, but rather to make local products more competitive. There would also be engagements with the Ministers of Finance, Mineral Resources and Labour in this regard.

The meeting was adjourned.

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