From Functional Analysis to Value Chain Analysis
MNEs operating in South Africa provide information to SARS in various forms such as annual Corporate Income Tax returns, Country-by-Country reports as well as the extensive Transfer Pricing documentation. It is therefore important to ensure that all information submitted to SARS in these various formats is aligned as any difference could assist SARS in challenging not only the Transfer Pricing policies but ultimately also the tax structure of the group as well as the substance of how a group operates across the globe.
While a Functional Analysis identifies the functions performed, the risks assumed and the assets utilsed by various members of an MNE, it has also become important to do a proper Value Chain Analysis (“VCA”) in order to identify the jurisdictions where the key functions are performed, where the real value is created and where the actual profit is. A proper VCA will provide a much clearer picture as to whether the profits of an MNE are actually generated in those jurisdictions where the real value is added, critical information for preparing a response to any attack from SARS on the transfer pricing policies of the MNE.
Intangibles vs value enhancers vs synergies
In conducting a VCA, it is important to distinguish between intangibles, value enhancers and synergies.
Intangibles are defined as physical or financial assets that are owned or controlled for use in commercial activities and the use or transfer thereof will be compensated had it been a transaction between independent parties.
Value enhancers are generally hard to identify, not registered or protected and not recognised for accounting purposes (off balance sheet item).
Group synergies could contribute to the amount of income earned by an MNE and could include:
Synergies should, however, not be confused with passive associations, as incidental benefits arising solely by virtue of group affiliation and in the absence of deliberate concerted action need to be separately compensated or allocated. Where synergy is indeed the result of deliberate concerted action, it is necessary to evaluate:
The benefits of synergies should, in general, be shared by members of an MNE group in proportion to the contribution each member makes in the creation of the synergy. For instance, benefits from large scale purchasing synergies should be shared in proportion to purchase volumes.
Location savings vs market characteristics
Local market features include aspects such as disposable income of households and the size and competitiveness of the market. Location savings should be differentiated from market features and are not considered to be an intangible. Location savings include cost savings through operating the same business in different markets as well as additional profits derived by operating in a jurisdiction with unique qualities, impacting on the sale and demand of the services or products offered by an MNE group. Such location savings should be allocated among the members of an MNE based on functions performed, risk assumed and assets utilised.
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