Secondary adjustments, change in regulation

moneyNational Treasury of the Republic of South Africa has released its Taxation Laws Amendment Bill at the end of October 2014. There is a noteworthy change from a transfer pricing perspective which is in relation to the treatment of secondary adjustments.


If you already know exactly how the South African transfer pricing regulations work you can skip to the next heading. For those of you who don’t I used the definition from the Income Tax Act below which can be a little detailed but is very descriptive.

Section 31 of the Income Tax Act authorises the South African Revenue Service (“SARS”) to consider whether any term or condition imposed as part of any transaction, operation, scheme, agreement or arrangement differed to the terms and conditions that would have been agreed if the parties to the transaction were independent. Any difference in price from what was charged between the connected persons and what would have been charged between independent parties needs to be adjusted for in the tax return of the taxpayer. This is often referred to as the primary adjustment.

To the extent that the taxpayer has not recovered the difference between the arm’s length charge and the actual charge from the foreign related party, a deemed loan will arise and as a result interest will accrue on this deemed loan as per the current section 31 of the Income Tax Act. This is often referred to as the secondary adjustment.

Secondary adjustments in South Africa

While the secondary adjustment is a well-established practice adopted by many countries, secondary adjustment in the form of a deemed loan is an administrative burden both for the taxpayer and the Revenue Administration such as SARS. In practice, it is impossible for the foreign company to repay the loan and the deemed interest because the loan is a deemed loan and there are no contractual legal obligations supporting the settlement of the loan. It also creates difficulties in relation to the accounting treatment of the deemed loan and the relevant currency of the deemed loan and deemed interest.

Further, due to exchange control restrictions in the country (this is more typical in African countries) of the connected person it may be impossible to repatriate the funds resulting in an ongoing interest charge for tax purposes.

Please note that the same principles apply to financial assistance.

Change to the treatment of secondary adjustments

In view of the above, National Treasury proposed that the current form of a deemed loan as a secondary adjustment be revised. The amount of the secondary adjustment as of 1 January 2015 will be deemed to be a dividend in specie for companies (or a donation for persons and trusts). The deemed dividend in specie will be deemed to have been declared and paid on the last day of a period of six months following the end of the year of assessment in which the adjustment is made (the same timing is applicable for a deemed donation).

Deemed loans still in existences as of 1 January 2015 will be deemed to be a dividend in specie declared and paid (or a donation paid) on 1 January 2015.

The change is welcome in South Africa for the administrative reasons given above. However, one point that I am still not clear on is what if the secondary adjustment is in relation to interest or other charges that attract withholding tax. So for argument we paid 100 of interest but should have only paid 80. From this example the secondary adjustment will be the difference i.e. 20. This 20 will now be treated as a dividend in specie. This means the dividend will incur withholding tax. But we have already paid withholding tax for the interest paid. There is no mention whether the withholding tax will be offset or if this is double tax.