A transfer pricing adjustment might not be the end of the road

Transfer pricing adjustments

Transfer pricing refers to the mechanism which is used to determine the arm’s length price of goods and services transferred between related parties. The arm’s length price represents the price that would have been imposed if the parties to the transaction were wholly independent of each other.

Transfer pricing is founded in a comparability analysis, which draws from a functional analysis. The results of these analyses are used to determine the transfer pricing method that will be the most appropriate to determine the arm’s length price for the related party transaction.

Following the determination of an arm’s length price or range, the parties may be required to effect certain adjustments:

• Compensating price adjustments: These adjustments are made by a taxpayer to align the actual prices of goods and services in its accounting records, with the arm’s length price / range as per the taxpayer’s transfer pricing policy. They are based on credit / debit notes issued by the foreign related party.
• Compensating tax adjustments: These adjustments are made by the taxpayer for tax reporting purposes only. These adjustments do not affect the actual price charged for goods and services by the foreign related party.

Where the actual price of goods and / or services are adjusted, the change in the consideration paid / payable to the foreign connected party may require the taxpayer to reconsider some of its other tax liabilities, such as value-added tax (“VAT”) and customs duties.

Value-added tax adjustments

The Value-Added Tax Act No. 89 (1991) (“VAT Act”) requires a person to pay VAT on the importation of goods (“import VAT”). A person is also required to pay VAT on the supply of imported services, to the extent to which these services are utilised or consumed in South Africa for purposes other than making taxable supplies.

Importation of goods

Where a vendor imports goods, the vendor is entitled to claim an input tax deduction for the import VAT paid to the extent to which such goods are acquired by the vendor for consumption, use or supply in the course or furtherance of making taxable supplies.

The quantum of the import VAT is based on the added tax value (“ATV”). The ATV includes the customs value of the goods, and the customs duties levied.

This means that compensating transfer pricing adjustments could alter the customs value of the imported goods, as well as the customs duties imposed. This would then result in an increase / decrease in the import VAT payable in respect of these goods.

Imported services

Compensating transfer pricing adjustments would only impact the VAT payable, where the imported services are not utilised or consumed by the vendor for purposes of making taxable supplies.

Customs duty adjustments

Customs duties are only payable on the importation of goods, and not on the importation of services.

Compensating transfer pricing adjustments may alter the customs duties payable. The quantum of customs duties is based on the origin and customs value of the imported goods.

Generally, the customs value is equal to the transaction value of the goods. However, where the importer and the foreign supplier are related parties, the importer should demonstrate that the parties’ relationship did not influence the transaction value of the goods.

To determine if the relationship influenced the transaction value of the goods, SARS Customs may perform an examination of the circumstances surrounding the sale. Alternatively, the importer could use test values to demonstrate that the transaction value was not influenced by the relationship between the buyer and the seller. Test values are determined by applying prescribed customs valuation methodology. The customs value declared to SARS Customs is then compared to the test values to determine the degree to which (if any) the relationship influenced the transaction value.

While the fundamental principles of transfer pricing and customs valuation methodology are similar, there are some differences between these methodologies that may preclude the adoption of the determined transfer price as the customs value. As a result, the taxpayer would not always be able to rely on the transfer pricing policy to demonstrate that the relationship between the seller and the buyer did not unduly influence the transaction value of the imported goods. Further analysis may then be required.

More than meets the eye

Transfer pricing adjustments are more than just mere journal entries. Where transfer pricing adjustments result in a change in the consideration paid / payable for goods and / or services, the taxpayer should consider the impact on VAT and customs duties.

Taxpayers should also consider any resulting reporting obligations and if there is a legislated reporting deadline.

As revenue authorities start to apply a more integrated approach, a more comprehensive approach to multinational entity group pricing policies has become imperative.

Author

Evádne Bronkhorst, Associate Director – Tax Consulting