Transfer Pricing and Customs Valuation: Developments Through an African Lens

Related-party transactions concerning trade across South African borders are subject to scrutiny by the South African Revenue Service (SARS). Pivotal to these transactions are transfer pricing (TP) principles and customs valuation rules. TP rules require related-party transactions to be at arm’s length (ie, on par with similar transactions between unrelated parties), while customs valuation involves the determination of the customs value of imported goods, which must be declared to the customs authorities upon the importation of goods. In simple terms, when it comes to the importation of goods, transfer pricing aims to ensure that the goods are not overvalued; whereas customs valuation rules are aimed at ensuring that the goods are not undervalued. Therein lies the tension between the two tax types.

Despite their differences, there is a fundamental link between these two concepts, since TP requires that parties transact at arm’s length, and in terms of the South African Customs and Excise Act, 1964 (the “SA Customs Act”) it must be determined whether the relationship between the parties influenced the price.

Section 39(1)(a) of the SA Customs Act specifically requires the delivery of a bill of entry containing full and correct particulars when importing goods into the country. Undoubtedly, importers are expected to declare the correct customs value at the time of importation to account for value-added tax and any customs duties (ie, import taxes) accurately. However, where the exact customs value is not determinable at the time of importation, the Supreme Court of Appeal (SCA), in Levi Strauss SA (Pty) Ltd v The Commissioner for the South African Revenue Service (the “Levi case”), held that subsequent adjustments could be made since SARS is empowered to amend a value determination.

Companies in related-party transactions typically aim for an operating margin in line with their TP study. If this margin is not met, a downward or upward adjustment is made to the transfer price of the imported goods, which impacts on the customs value declared. In terms of Section 41(4)(b)(ii) of the SA Customs Act, importers must report the adjustments to SARS within one month of receiving a relevant credit or debit note, an amended invoice or a certificate from the exporter. Currently, it is the practice of SARS to request further information from the importer to validate the adjustment, although this step is not yet legislated.

Separately, the payment of royalties is common with multinational companies, but there is uncertainty about when royalty amounts are dutiable – ie, when they are ripe for declaration to SARS or when the import taxes attributable to the royalty portion are payable to SARS. Section 65 of the SA Customs Act states that the value for duty purposes on any imported goods is the price actually paid or payable for the goods (ie, transaction value), subject to adjustments in terms of Section 67. Indeed, Section 67(1)(c) requires the addition of royalty payments that are due by the buyer (all requirements being met) to the transaction value if they are not included. Section 67(1)(a) requires the addition of certain commissions, other than a buying commission, to the transaction value. The failure to make these adjustments when required would result in the underpayment of import taxes and, if unresolved, could put the importer at risk of a SARS audit as well as potential penalties and interest.

In the Levi case, other issues included whether royalty payments and certain commissions were dutiable. Following an audit, SARS determined that the transaction value of the imported goods should include certain commissions and royalties paid by the importer. This gave rise to the importer’s liability for underpaid import taxes.

The SCA categorically ruled that the obligation to pay a royalty need not arise from the contract between the seller and purchaser. Therefore, royalties may be due where the nature of the relationship between the exporter, importer and licensor, when viewed holistically, demonstrates that the sale would not have occurred without the obligation to pay a royalty. Moreover, the subsequent determination of royalty payments (ie, where they are computed based on third-party net sales and the royalty amount is unknown at the time of importation) did not imply that they were not dutiable.

Regarding commissions, the SCA held that the range of functions undertaken by the agent and the fact of earning a commission are not decisive in determining whether that representative is acting as a buying agent. The nature of the relationship between the agent and importer must be considered, and where the importer is not in control of the agent, the commissions do not qualify as “buying commissions” thus dutiable.

Recently, SARS published proposed amendments to the Customs Rules (the “Rules”). The proposed Rules seek to implement a procedure to adjust a bill of entry that is amended subsequent to a TP adjustment as set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. South Africa already has this as standard procedure. These proposed Rules aim to enhance the current reporting process by requiring a wide list of information in the first place.

To further validate TP adjustments, SARS usually requests some of this information after the importer has reported the adjustment. However, this is not always the case since it is not yet a legal requirement. If the proposed Rules take effect, importers will face a bigger burden to comply with their reporting obligations. This aligns with the focus of the OECD on base erosion and profit shifting (BEPS), whereby TP compliance will become more burdensome with the introduction of Pillar Two rules.

The SA Customs Act gives importers clarity and certainty regarding their reporting requirements, in contrast to Nigeria and Kenya. In Nigeria, customs legislation does not require the revision of the customs value following a TP adjustment. Taxpayers in Kenya are similarly not required to disclose TP adjustments unless the Kenya Revenue Authority discovers these adjustments during audits. However, in both countries, the importer may request refunds for overpaid duties. 

We hope to see legal developments in Nigeria and Kenya that promote taxpayer compliance and provide certainty for importers, especially as there is appetite for multinationals to expand their business operations into Africa.