Transfer Pricing and Tax Avoidance: Is the Arm’s-length Principle Still Relevant in the e-Commerce Era?

• Jurisdiction: South Africa
• Citation: (2006) 18 SA Merc LJ 138
• Date: 16 August 2019
• Published date: 16 August 2019
• Pages: 138-158

Transfer Pricing and Tax Avoidance:

Is the Arm’s-length Principle Still Relevant in

the e-Commerce Era?

ANNET WANYANA OGUTTU*

University of South Africa

1 Introduction

The arm’s-length principle is internationally used as a means of curbing

tax avoidance through transfer pricing. However, when trade is conducted

electronically, the application of this principle faces major challenges. The

purpose of this paper is to analyse our law so as to determine whether this

principle is still relevant in curbing transfer principle in the e-commerce era.

The article will begin by explaining the meaning of certain concepts. Then

an explanation will be offered of what the arm’s-length principle entails

and how it has been challenged by e-commerce. The article will also point

out international views about transfer pricing and e-commerce. Finally,

recommendations will be made after considering the relevance of South

Africa’s Electronic Communications and Transactions Act 25 of 2002.

2 Background Information and Def‌i nition of Concepts

Tax avoidance refers to the use of perfectly legal methods of arranging one’s

affairs so as to pay less tax.1 This is contrasted with tax evasion which is illegal

and usually involves the non-disclosure of income, the rendering of false

returns, and the claiming of unwarranted deductions. Tax avoidance involves

utilising loopholes in tax laws and exploiting them within legal parameters.2 In

this regard, the courts have held the view that no legal obligation rests upon a

taxpayer to pay a greater amount of tax than is legally due under the applicable

taxing legislation.3 For instance, in the celebrated case of Duke of Westminster

v IRC,4 Lord Tomlin held that ‘every man is entitled if he can to order his

* LLB (Makerere, Uganda) LLM (Unisa). Lecturer in the Department of Mercantile Law, School of

Law, University of South Africa.

1 Vern Krishna Tax Avoidance: The General Anti-avoidance Rule (1990) at 9; Organisation for

Economic Co-operation and Development (‘OECD’) Issues in International Taxation No 1: International

Tax Avoidance and Evasion: Four Related Studies (1987) at 1; David Meyerowitz Meyerowitz on Income

Tax (2002-3) at 29.1; Alwyn de Koker Silke on Income Tax vol 3 (2003) in par 19.1.

2 United Nations International Cooperation in Tax Matters: Guidelines for International Cooperation

against the Evasion and Avoidance of Taxes (with Specif‌i c Reference to Taxes on Income, Prof‌i ts, Capital

and Capital Gains) (1984) at 11; Meyerowitz op cit note 1 at 29.1; De Koker op cit note 1 in par 19.1.

3 Levene v IRC [1928] AC 217 (HL) at 227; Ayrshire Pullman Motor Services & DM Ritchie v IRC

(1929) 14 TC 754; Hicklin v SIR 1980 (1) SA 481 (A); CIR v Estate Kohler & Others 1953 (2) SA 584

(A) at 591F-592H; CIR v Sunnyside Centre (Pty) Ltd 1997(1) SA 68 (A) at 77F.

4 [1936] AC 1 (HL) at19-20.

138

(2006) 18 SA Merc LJ 138

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TRANSFER PRICING AND TAX AVOIDANCE: THE ARM’S-LENGTH PRINCIPLE 139

5 South African Revenue Service (‘SARS’) Practice Note No 7: Determination of Taxable Income of

Certain Persons from International Taxation (Section 31 of the Income Tax Act 58 of 1962 (6 Aug 1999)

in par 2.1 (transfer pricing).

6 The Second Interim Report of the Commission of Inquiry into Certain Tax Structures of South

Africa Thin Capitalisation Rules (1995) in par 1.3b. See also Brian J Arnold & Michael J McIntyre

International Tax Primer (2002) at 53; Nathan Boldman ‘International Tax Avoidance’ (1981) 35 Bulletin

for International Fiscal Documentation 443; Allan Stoud & Collin Masters Transfer Pricing (1991) at

10; Rotterdam Institute for Fiscal Studies International Tax Avoidance vol A (1979) at 45; Julian Ware &

Paul Roper Offshore Insight (2001) at 178.

7 Arnold & McIyntyre op cit note 6 at 55.

8 SARS Practice Note No 7 op cit note 5 at 7.1; art 9 of the OECD Model Tax Convention on Income

and on Capital (2003 condensed version). See also Diane Hay, Frances Horner & Jeffrey Owens ‘Past

and Present Work in the OECD on Transfer Pricing and Selected Issues’ (1994) 10 Intertax 424; OECD

Issues in International Taxation No 2 Thin Capitalisation: Taxation of Entertainers, Artists and Sportsmen

(1987) at 17; Victor H Miesel, Harlow H Higinbotham & Chun W Yi ‘International Transfer Pricing:

Practical Solutions for Inter-company Pricing – Part II’ (2003) 29 International Tax J 1.

9 Marius van Blerck ‘Transfer Pricing and Thin Capitalisation: The Basics’ (1995) 8 SA Tax Review

44.

10 Report of the OECD Committee on Fiscal Affairs ‘Transfer Pricing Guidelines for Multinational

Enterprises and Tax Administrators’ (1994) 172 Intertax at 318 in par 12; Vito Tanzi, writing in International

Monetary Fund Working Paper Globalization, Tax Competition and the Future of Tax Systems (1996) at

6, notes that statistics show that a signif‌i cant and growing part of current world trade is among different

parts of the same multinational enterprise which have the different aspects of their production process in

different countries. For instance raw materials are obtained in one country, converted into intermediate

products in another, and f‌i nished in yet another country.

11 Sylvian RF Plasschaert Transfer Pricing and Multinational Corporations: An Overview of

Concepts, Mechanisms and Regulations (1979) at 3-4. See also SARS Practice Note No 7 op cit note 5

in par 1.2.3 which def‌i nes a multinational as any group of connected persons with members or business

activities in more than one country.

affairs so that the tax attaching under the appropriate Act is less than it would

otherwise be’.

One of the mechanisms employed by taxpayers to avoid taxes is transfer

pricing. The term ‘transfer pricing’ describes the process by which related

entities set prices at which they transfer goods or services between one another.5

Transfer pricing is also described as the systematic manipulation of prices in

order to reduce or increase prof‌i ts artif‌i cially or to cause losses and avoid taxes

in a specif‌i c country.6 A transfer price is a price set by a taxpayer when selling

to, buying from, or sharing resources with a related or connected person. It is

usually contrasted with a market price, which is the price set in the marketplace

for the transfer of goods and services between unrelated persons7 where each

party strives to get the utmost possible benef‌i t from the transaction.8 Transfer

prices are usually not negotiated in a free, open market and so they may

deviate from prices agreed upon by non-related trading partners in comparable

transactions under the same circumstances.9

Transfer pricing between subsidiaries of one enterprise which are all resident

in one country usually poses minimum tax-avoidance problems since the

relevant national law is the same for all the subsidiaries in the group. Transfer

pricing is most problematic when it comes to multinational corporations trading

in various jurisdictions.10 A multinational corporation is usually composed of

a number of legally autonomous but interrelated companies or subsidiaries

operating in different countries but being directed by a single parent company.11

Since the related companies operate in different countries, they are not subject

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