The transfer pricing section 31 of the Income Tax Act, 1962 has recently undergone a substantial makeover. An unintended consequence of the amendments has been that South African companies funding expansion offshore through offshore subsidiaries are vulnerable to transfer pricing consequences. The Taxation Laws Amendment Bill 2013 amends section 31 to provide relief.
The transfer pricing provisions apply to international transactions between connected persons. A foreign subsidiary of a South African company is by definition a connected person in relation to the holding company. The South African authorities are keen to promote foreign direct investment by local companies, particularly into the rest of Africa. Yet at the same time the transfer pricing provisions, which apply where a transaction between connected persons takes place on terms other than at market value, inhibit the ability of local companies to fund offshore activities. It is not financially easy to impose a market related rate of interest on a foreign subsidiary, especially one in a start-up phase, and particularly where the start-up phase can be a long one.
Recognising this difficulty, the authorities are amending section 31 with effect from 1 April 2014 to exclude from its provisions loans by South African holding companies to their non-resident subsidiaries where these loans bear equity-like characteristics. Typically, these loans have no fixed repayment date, are liable for little or no interest, and tend to be subordinated in favour of outside trade creditors. If a loan has similar risk to equity, the transfer pricing provisions will not apply to it. Four requirements must be present for the exclusion to apply:
- as already stated, the creditor must be a South African resident company;
- either the creditor or another company in the group must hold at least 10% of the equity share capital and voting rights in the non-resident debtor;
- the loan must not be redeemable within 30 years of its being granted;
- redemption is conditional on the solvency of the debtor.
Clearly these provisions will not apply very frequently, but they will be welcome where groups prefer to fund their foreign ventures through loan rather than equity capital.
November 2013.
