By Ralph Wichtmann , MD at the Sovereign Group and Irma Lategan, International Tax: Head of Private Clients at Regan van Rooy

Home to seven out of 10 of the world’s fastest growing economies, Africa’s outlook is promising. The International Monetary Fund (IMF) predicts that no other continent will compete in growth in the near future and, with 70% of its population under the age of 35, Africa will enjoy extraordinary demographic dividends as this energy and talent drives economic growth and development. Governments across the continent are committed to improving the business climate and creating employment and business opportunities. A growing number of multinational enterprises are seeing entry into and expansion within Africa as essential to their continued existence, and South Africa has long been considered the ‘gateway’ to doing business in the rest of Africa¹.

Conducting business from South Africa with other countries can be a legal and tax minefield. Transfer pricing (TP) has its own requirements and implications that impact cross-continental operations.

TP is considered a developing financing issue because, without adequate tax revenue, a country’s ability to mobilise domestic resources for development might be hampered. The United Nations, the Organisation for Economic Cooperation and Development, and the European Commission, as well as many African governments, have placed significant focus on getting transfer pricing established in Africa. In South Africa, the TP rules were legislated in 1995, in section 31 of the Income Tax Act 58 of 1962.

Arm’s length terms

Essentially, the TP legislative framework requires that all connected-party cross-border transactions must be entered into on arm’s length terms (ALs) and, most simply, this means that the parties must transact as if they were doing so with unconnected parties. According to the South African Revenue Service (SARS) ALs can broadly be understood as prices negotiated on the open market between willing buyers and willing sellers.

In order to determine the ALs, contracting parties must determine what the contract would have looked like if they were contracting with third parties, or unrelated parties. Many factors should be  taken into account to determine the ALs, including the value added by the different contracting parties to group transactions, the jurisdiction of the parties, the number of employees that it takes to add the value to the transaction by each contracting party, the creditworthiness of the contracting parties, and more.

ALs also apply to cross-border loans between subsidiaries of multinationals. The pricing of intra-group loans includes a consideration of both the amount of debt and the cost of the debt, and as such would be incorrectly priced if either or both of these amounts are excessive compared to ALs. On 17 January 2023, SARS issued Interpretation Note 127 to provide guidance to taxpayers on determining the taxable income on inter-group loans.

Advance pricing

Tweaks made late in 2023 to draft legislation introducing an advance pricing agreement (APA) programme for South Africa have been widely welcomed. The legislation is in line with international trends and will create more certainty around large-scale international transactions that have TP implications. Lack of clarity in this complex area has been a major contributor to tax disputes, double taxation, and additional assessments.

In summary, Transfer Pricing is an unavoidable part of doing business with Africa – but even with amendments, it remains a complex field with, in addition to the aspects discussed above, many clauses specific to the jurisdictions being transacted with. Multinationals would do well to compile a TP policy that aligns with the ALs and demonstrates their compliance and correct implementation should the taxman come knocking. As such, it is always advisable to consult with a transfer pricing specialist before expanding your business into Africa.

1 Bowman Gilfillan