South Africa’s first Transfer Pricing case, and it’s a win for the taxpayer!
Before we get into the article we would like to add that Prof Dr Daniel N Erasmus and the TRM team represented the taxpayer in this matter. Dr Erasmus discusses the intricacies of Transfer Pricing trials in his upcoming book: “CONDUCTING A TP TRIAL“.
THIS ARTICLE WAS FIRST PUBLISHED BY REGAN VAN ROOY
Can we hear a “woohoo”!? Yes, you read right, South Africa has finally had its first TP case and whaddaya know, the taxpayer won! In this case, the taxpayer, referred to very creatively as ABD, appealed against an increased assessment imposed on it by the South African Revenue Service (SARS). ABD is a South African telecommunications company with subsidiaries worldwide, to which it licences certain intellectual property (“IP”) in return for a royalty. And of course the pricing of this royalty was the issue at stake.
What is an arm’s length royalty?
Well that’s the million dollar question, and everybody agreed the arm’s length principle is the fundamental concept governing the valuation of intellectual property (IP) for TP purposes, everyone also seemed to agree that the OECD Guidelines is the key playbook to follow. IP is of course just intangible i.e. non-physical assets, the value of which can be derived from their potential to generate revenue. What IP was being paid for was contested back and forth, but drilled down to brand-related IP, including trademarks but not goodwill. Defining IP is super complex, and requires a lot of specialist analysis, so there were some meaty discussions by some meaty folks throughout the case.
Basically, ABD charged all of the Opcos an identical royalty rate of 1% and SARS was not happy with this and argued it was not arms-length.
Let’s talk pie
ABD’s counsel decided to paint the picture using a comparison of a pie. Their counsel said the first determination is about the size of the pie and the second is about how to divide the pie. One flavour of the pie that SARS and ABD agreed on, is that the arm’s length principle should be applied in determining the royalty i.e. what would it be if it was between two independent enterprises as opposed to a company taxed in one jurisdiction and its subsidiary taxed in another. So far, so obvious but then things got a bit spicier.
SARS went through a rigorous process to contest the 1%, and relied on many expert opinions, including an economist charmingly called Dr (Clean) Slate. But even SARS’ experts differed over how to calculate both the size and division of the pie. SARS settled on their economist’s approach, which surprise surprise supported a much larger share in the pie for the tax-man. This “flip- flop” approach by SARS does not seem to have been considered favourably.
So SARS, advised by Dr Slate, contended that ABD should have charged a variable royalty rate depending on the country and the year it was earned. The fluctuations created by adopting this approach are considerable. And we all thought tax authorities were adverse to varying royalty rates! Although maybe that´s just if the SA tax-payer is paying rather than receiving royalties…
ABD disagreed with Dr. Slate’s calculation of the pie’s size but agreed with his division of it.
