The Untested Waters of Transfer Pricing Disputes
Yet, only three South African courts have dealt with transfer pricing. In none of these cases, however, was it necessary for witnesses to testify about the impugned transaction. It follows that this limited transfer pricing jurisprudence does not deal with the evidentiary aspects that may necessarily arise in such a dispute.
A case in point is the evidentiary value of comparable transactions. A comparability analysis typically involves a comparison between the taxpayer’s transaction with third-party transactions which are comparable. Taxpayers usually rely on such a comparison to show that they transacted at arm’s length.
But in transfer pricing matters, SARS often rejects the taxpayer’s benchmarking study (advanced in support of the arm’s length nature of its transaction) and then issues an additional assessment based on its own analysis.
This raises a few interesting questions.
In Africa Cash & Carry (Pty) Ltd v C:SARS, the taxpayer argued that the gross margin reconstructed by SARS (which formed the basis of SARS’ estimated assessments) was too high when compared with that of Massmart, a similar type of business. The SCA noted obiter that evidence of Massmart’s earnings was in the nature of similar fact evidence. Thus, it was incumbent on the taxpayer to prove (factually) that its comparison was valid. Although this dispute did not relate to transfer pricing, would the same considerations not apply in a transfer pricing dispute? If so, SARS must present factual evidence to show its benchmark is valid.
Foreign case law has shown difficulties with this proposition. For example, in CoT v Glencore Investments (Pty) Ltd, the Federal Court of Australia (“FCA”) ruled that the process of examining agreements concluded by other parties, although necessary in a transfer pricing dispute, is an “unsatisfactory task”. This is because, according to the court, a witness can only say so much about a contract he had nothing to do with; so, their observations may amount to inadmissible “speculation” or “severe hearsay”.
Similarly, in SNF (Australia) (Pty) Ltd’s transfer pricing dispute against the Commissioner of Taxes, the FCA ruled that the testimony of some of the taxpayer’s witnesses, who lead evidence about the comparable companies, was inadmissible hearsay.
Because of these difficulties, the FCA in the Glencore matter found that comparable contracts were no more than “reference points” or “illustrations of arm’s length terms”. But could South African courts also adopt such a practical approach?
Tax Court Rule 44(2)(a) explicitly states that the normal rules of evidence, which include the rules about similar fact evidence, must be observed in the Tax Court. In that instance, it would be incumbent on the party (whether SARS or the taxpayer) that relies on a benchmark to prove (factually) that its comparison is valid.
There is another aspect to consider. If SARS makes a transfer pricing adjustment to a taxpayer’s taxable income by way of issuing an additional assessment, and such additional assessment is based on SARS’ own benchmarking study, is the additional assessment an estimated assessment under section 95 of the Tax Administration Act, 2011 (as amended) (the “TAA”)? Section 95(1)(b) allows SARS to issue an assessment, based on whole or in part on an “estimate” if the taxpayer submitted a return or information that is, according to SARS, incorrect or inadequate.
Thus (or so SARS argues), it uses its study as a benchmark to estimate what it considers an arm’s length consideration. Interestingly, the OECD Transfer Pricing Guidelines and SARS’ Practice Note 7 both state that transfer pricing methods are used to determine an “estimate” of an arm’s length outcome.
If an assessment is an estimated assessment for purposes of section 95 of the TAA, the outcome is that the burden is on SARS, and not the taxpayer, to prove the estimate is reasonable. But, if the onus is on SARS, does it have the duty to give evidence first? If coupled with the rules that apply to similar fact evidence, it may be difficult for SARS to prove, in the Tax Court, the basis of its additional assessment adjusting the taxpayer’s taxable income.
More anomalies may be revealed as transfer pricing enforcement increases. These will supplement our existing case law and potentially compel the legislature to allow for carve-outs.
Dealing with tax disputes requires a multi-layered approach. This cannot be overemphasised in the context of transfer pricing. Engaging with SARS on these matters requires an in-depth knowledge of not only the legislative provisions but also the law of evidence.
These aspects must be considered from the beginning when SARS commences a transfer pricing audit. So, taxpayers should, from the commencement of a transfer pricing audit, consult and involve tax lawyers with knowledge of not only transfer pricing but tax procedural law and the law of evidence too.
Senior Associate Tax
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