South Africa: Draft interpretation note on intragroup loans, new transfer pricing guidance

Generally aligns with the new financial transactions guidance pursuant to the OECD’s Transfer Pricing Guidelines

New transfer pricing guidance

The South African Revenue Service (SARS) in February 2022 released an updated and effectively new draft interpretation note on intragroup loans that generally aligns with the new financial transactions guidance pursuant to the OECD’s Transfer Pricing Guidelines.

Read the February 2022 draft interpretation note [PDF 307 KB] on intragroup loans. 

Background

Intragroup financial assistance is an important mechanism for multinational entities (MNEs) to meet financing needs of group entities. Revenue authorities and taxpayers alike have therefore been focusing on intragroup loans and other intragroup financial transactions from a transfer pricing perspective because intragroup financial transactions have been identified as a common mechanism for MNEs to shift profits into tax favourable jurisdictions, thereby eroding the local tax base. Consequently, guidance on how to determine and demonstrate that an intragroup financial transaction is arm’s length was needed as financial transactions transfer pricing is a complicated, technical, and sometimes subjective area.

The Organisation for Economic Cooperation and Development (OECD) in 2020 released transfer pricing guidance on financial transactions, which was later incorporated in the OECD’s “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration” in January 2022. 

Approach in South Africa

In South Africa, the transfer pricing law underwent a significant change when, in 2012, the legislation was amended and the country moved from a thin capitalisation safe harbour-based rule relying on a three-to-one (3:1) debt-to-equity ratio, to a broader system whereby the focus shifted to an overall arm’s length requirement regarding the financial assistance transaction(s). Thus, since then, the interest rate applied as well as the debt capacity of the lender must be in compliance with the arm’s length principle.

In 2013, a draft interpretation note was released by SARS, providing guidance as to how SARS would expect a taxpayer to confirm arm’s length nature of an intragroup financial transaction.  Most notably, the 2013 draft guidance included a risk ratio regarding when SARS would consider a financial loan transaction riskier from a South African perspective—a debt-to-EBITDA* ratio of the (South African) borrower of more than three-to-one to identify the taxpayer as a higher risk. However, the obligation to prove the arm’s length nature remained with the taxpayer.

The 2013 draft interpretation note was never finalized, although in practice, SARS tended to rely on the guidance provided in that draft note.

SARS on 11 February 2022 released an updated and effectively new draft interpretation note on intragroup loans. The 2022 draft interpretation note does not contain the risk threshold rule; has been updated to align with the South African interest limitation rules (introduced subsequent to the 2013 draft); and clarifies that the transfer pricing rules are to be applied before the interest limitation rules.

Other guidance in the draft interpretation note relates to withholding taxes, and the guidance in the note now aligns with the new financial transactions guidance in the OECD Transfer Pricing Guidelines.

Comments on the draft interpretation note on financial loans has been requested and are due by 29 April 2022. 

KPMG observation

Tax professionals view the 2022 draft interpretation note on intragroup loans favorably as a welcome step towards providing guidance to taxpayers, especially because it now aligns with global principles and guidance.

Read a February 2022 report [PDF 284 KB] prepared by the KPMG member firm in South Africa 

*EBITDA = earnings before interest, taxes, depreciation, and amortization

 

 

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