SARS Interpretation Note 128: Definition of "associated enterprise" (source: https://www.sars.gov.za/legal-in-128-definition-of-associated-enterprise/)
INTERPRETATION NOTE 128
DATE: 17 April 2023
ACT : INCOME TAX ACT 58 OF 1962
SECTION : SECTION 31
SUBJECT : DEFINITION OF “ASSOCIATED ENTERPRISE”
Contents
Preamble .............................................................................................................................. 1
1. Purpose ..................................................................................................................... 2
2. Background ............................................................................................................... 2
3. The law...................................................................................................................... 3
4. Application of the law................................................................................................. 3
4.1 “Affected transaction” and its relationship to connected persons and associated
enterprises ................................................................................................................ 3
4.2 Requirements pertaining to associated enterprises ................................................... 4
4.2.1 Direct or indirect participation in management ........................................................... 4
4.2.2 Direct or indirect participation in control ..................................................................... 8
4.2.3 Direct or indirect participation in capital ................................................................... 14
5. Conclusion .............................................................................................................. 15
Annexure – The law ............................................................................................................ 16
Preamble
In this Note unless the context indicates otherwise –
• “Article” means an Article of the OECD Model Tax Convention;
• “OECD” means the Organisation for Economic Co-operation and
Development;
• “OECD Model Tax Convention” means the OECD Model Tax Convention on
Income and on Capital, Condensed Version (as it read on 21 November 2017);
• “resident” means a resident as defined in section 1(1);
• “section” means a section of the Act;
• “South Africa” means the Republic of South Africa;
• “the Act” means the Income Tax Act 58 of 1962; and
• any other word or expression bears the meaning ascribed to it in the Act.
All interpretation notes referred to in this Note are available on the SARS website at
should be consulted.
1. Purpose
This Note provides guidance on the interpretation of the definition of “associated
enterprise” in section 31(1).
Section 66(1) of the Taxation Laws Amendment Act 20 of 2021 amended the effective
date such that the inclusion of an “associated enterprise” in section 31 comes into
operation on 1 January 2023 and applies in respect of years of assessment
commencing on or after that date.
2. Background
The Act contains rules in section 31 which are aimed at preventing a reduction in the
South African tax base as a result of the mispricing or incorrect characterisation of
specified transactions, operations, schemes, agreements or understandings. Broadly,
this is achieved by applying the arm’s length principle to affected transactions, as
defined in section 31(1), and requiring the persons specified in section 31(2) to
calculate their taxable income or tax payable as if transactions, operations, schemes,
agreements or understandings had been entered into on terms and conditions that
would have existed had the persons been independent persons dealing at arm’s
length. In summary, affected transactions are transactions, operations, schemes,
agreements or understandings directly or indirectly entered into or effected between
or for the benefit of specified parties 1 that are connected persons, 2 or, for years of
assessment commencing on or after 1 January 2023, associated enterprises, in
relation to one another and that contain any terms or conditions that differ from those
that would have existed had the parties been independent persons dealing at arm’s
length.
Previously the definition of “affected transaction” only included transactions,
operations, schemes, agreements or understandings directly or indirectly entered
between the specified parties that were connected persons in relation to one another.
As such, the application of the transfer pricing rules contained in section 31 had the
unintended consequence of not always capturing transactions between “associated
enterprises” which may not have fallen within the “connected persons” definition. To
correct this unintended consequence and to bring the legislation in line with
international standards, the term “associated enterprise” as contemplated in
Article 9(1) has been inserted into section 31(1) and into the definition of an affected
transaction with effect from years of assessment commencing on or after 1 January
2023. 3 This will result in “affected transactions” applying to both associated enterprises
and connected persons in respect of years of assessment commencing on or after this
date.
1 See the definition of “affected transaction” in Annexure for detail.
2 The definition of connected person is included in section 1(1) – see Interpretation Note 67
“Connected Persons” for a full consideration of connected persons – read with section 31(4).
3 Section 66(1) of the Taxation Laws Amendment Act 20 of 2021 amended section 37(1)(b) of the
Taxation Laws Amendment Act 34 of 2019 such that the amendment comes into operation on
1 January 2023 and is applicable in respect of years of assessment commencing on or after that
date.
3. The law
The relevant sections of the Act are quoted in the Annexure.
4. Application of the law
4.1 “Affected transaction” and its relationship to connected persons and associated
enterprises
The definition of “affected transaction” 4 in section 31(1) contains two paragraphs:
• Paragraph (a) of the definition relates to the specified persons between which
any transaction, operation, scheme, agreement or understanding must be
entered, and
• Paragraph (b) of the definition relates to any term or condition that differs from
any term or condition that would have existed if the persons had been
independent persons dealing at arm’s length.
For a transaction, operation, scheme, agreement or understanding to be an “affected
transaction”, both paragraph (a) and paragraph (b) must be met.
Paragraph (a) of the definition of “affected transaction” essentially means any
transaction, operation, scheme, agreement or understanding directly or indirectly
entered into or effected between or for the benefit of either or both –
• a resident and a non-resident;
• a non-resident and another non-resident that has a permanent establishment
in South Africa to which the transaction, operation, scheme, agreement or
understanding relates;
• a resident and another resident that has a permanent establishment outside
South Africa to which the transaction, operation, scheme, agreement or
understanding relates; and
• a non-resident and any other person that is a controlled foreign company in
relation to any resident;
if those persons are connected persons or, in respect of years of assessment
commencing on or after 1 January 2023, associated enterprises in relation to one
another.
As mentioned above, paragraph (a) of the definition of “affected transaction” includes
transactions, operations, schemes, agreements or understandings between specified
persons that are connected persons in relation to one another and, for years of
assessment commencing on or after 1 January 2023, between specified persons that
are connected persons or associated enterprises in relation to one another. Depending
on the facts, a person could be classified as a connected person, an associated
enterprise or both a connected person and associated enterprise. In other words,
connected persons and associated enterprises are not mutually exclusive.
4 See the Annexure for the full definition of “affected transaction”.
In establishing the relationship between the specified persons, often one will practically
first determine whether these parties are “connected persons” as defined. If the
specified persons are not connected persons, it is then necessary to determine
whether the parties nevertheless meet the wider definition of “associated enterprise”.
In the event that the parties are found to be associated enterprises, the provisions of
section 31 may apply, that is, there does not have to be a connected person
relationship.
4.2 Requirements pertaining to associated enterprises
An “associated enterprise” is defined in section 31 as “an associated enterprise as
contemplated in Article 9 …”.
Article 9 describes two enterprises as being “associated enterprises” where –
• an enterprise of a Contracting State participates directly or indirectly in the
management, control or capital of an enterprise of the other Contracting State;
or
• the same persons participate directly or indirectly in the management, control
or capital of an enterprise of a Contracting State and an enterprise of the other
Contracting State.
Article 3 provides that "the term ‘enterprise’ applies to the carrying on of any business”.
For example, if one or more persons participates in the management of an enterprise
of a Contracting State (see 4.2.1) and the same person or persons participates in the
management of an enterprise of the other Contracting State, the two enterprises are
associated enterprises in relation to one another.
In the context of section 31, the use of “Contracting State” in the definition of
“associated enterprise”, does not imply that in order for the definition to apply the two
enterprises must have concluded an applicable double tax agreement. “Contracting
State” and “other Contracting State” refers to different countries.
To be classified as an associated enterprise in relation to another enterprise, any of
the three criteria, namely participation in management, participation in control or
participation in capital must be met.
4.2.1 Direct or indirect participation in management
The terms “management” and “manage” are defined in the Merriam Webster Dictionary
as –
“the act or art of managing: the conducting or supervising of something (such as a
business)” 5
“to exercise executive, administrative, and supervisory direction of” 6
The term “management” is very broad and it is not possible to provide an exhaustive
list of activities that do or do not constitute management. Instead, when assessing
whether a particular person is managing a transaction, operation, scheme, agreement
or understanding, it is necessary to consider all the facts of the particular case taking
into account the activities for which the person is responsible, the person’s level of
5 www.merriam-webster.com/dictionary/management [Accessed 17 April 2023].
6 www.merriam-webster.com/dictionary/manage [Accessed 17 April 2023].
seniority and the scope of the person’s responsibilities in relation to influencing the
terms or conditions of the transaction, operation, scheme, agreement or understanding
especially the pricing.
Persons may be viewed as participating in the management of an entity if they
participate in the appointment, dismissal or reassignment of the entity’s key
management personnel, or if they share resources, or if direction in entering into
significant transactions, operations, schemes, agreements or understandings exists.
Management often has decision making powers and that power is the ability to
influence the operations of an entity. A person need not participate in the control or
capital of an entity or entities to participate in the entity’s or entities’ management.
In assessing whether participation in management results in the parties to the
transaction, operation, scheme, agreement or understanding being considered
“associated enterprises”, for the purposes of section 31, the outcome of such
participation in management must result in or have the consequence of controlling,
effecting or influencing the terms or conditions, which includes pricing, of any
transaction, operation, scheme, agreement or understanding, directly or indirectly
entered into or effected between or for the benefit of either or both resident or non-
resident party. 7 This is relevant considering that there is no such control, effect or
influence on the terms or conditions, including pricing, of a transaction, operation,
scheme, agreement or understanding negotiated between independent parties that are
acting in their own best interest. Further explained and distinguished, for example, A
is a director of Company B and C is a director of Company D, A plays no role in
Company D and C plays no role in Company B. Company B and Company D trade
with each other and, as directors of the two companies, A and C negotiate the pricing
of the transactions between Company B and Company D. The process of negotiation
between independent parties, Company B (represented by A) and Company D
(represented by C), would impact on the price ultimately agreed but A’s impact on the
pricing would not have been through participation in the management of Company D
and C’s impact on pricing would not have been through the participation in the
management of Company B.
An assessment of whether participation in management resulted in or has the
consequence of controlling, effecting or influencing the terms or conditions, including
pricing, as mentioned above is very fact specific and can only be determined on a
case-by-case basis.
An entity might be economically dependent on a single customer or supplier, leading
to the customer or supplier having significant influence over the entity’s operation or a
specific transaction, operation, scheme, agreement or understanding. This is not to
say that the transfer pricing provisions apply to all transactions, operations, schemes,
agreements or understandings between a party and a supplier or customer on which
that party is economically dependent. There is a difference between an independent
supplier or customer using their economic dominance to negotiate the best position for
their own interest and a supplier or customer that crosses the line into participating in
management and, through their participation in management, controlling, effecting or
influencing the terms or conditions, including pricing, of transactions, operations,
schemes, agreements or understandings. Whether or not the line is crossed must be
determined on a case-by-case basis. For example, a major customer having the right
7 Or one of the other parties specified in the definition of “affected transaction”.
of first refusal and influencing the price charged to any other customer buying the
remaining products or the only supplier having the right to change pricing if the take
up of material is lower than budgeted by the supplier, will often indicate participation in
management resulting in the potential application of the transfer pricing provisions.
Example 1 – Same persons participate directly in the management of two
companies
Facts:
CyprusCo1 holds 100% interest in CyprusCo2. CyprusCo2, a Cyprus resident entity,
holds a 49% and 100% interest in SACo (a South African resident) and CyprusCo3 (a
Cyprus resident) respectively.
CyprusCo3 holds 51% interest in SwitzerlandCo, a Switzerland tax resident entity and
SACo’s major customer.
SwitzerlandCo receives technical, management, financial and marketing services from
CyprusCo2.
The diagram below provides a relevant extract of the group structure:
CyprusCo1
Keys:
Shareholding
100% ------- Transaction
CyprusCo2
49% 100%
SACo CyprusCo3
51%
SwitzerlandCo
The SACo shareholders’ agreement provides that the management and control of
SACo lies with the board of directors and that the appointment of the management
team and the board of directors is the sole responsibility of CyprusCo2. CyprusCo2 is
also the sole advisor to SACo’s CEO and CFO.
SwitzerlandCo’s board of directors, CEO and CFO are appointed by CyprusCo2.
CyprusCo2 is also the sole advisor to SwitzerlandCo’s CEO and CFO.
SACo sells the majority of its goods to SwitzerlandCo. Goods sold by SACo to
SwitzerlandCo are sold at a discount of 50% compared to sales to other customers.
The pricing of all SACo’s major sales transactions and purchase transactions is
formally set by SACo’s CFO, however the prices can only be set under the guidance
and at the prices approved by its advisor (CyprusCo2). After setting the prices, the
CFO tables the prices set to the board of directors for approval. Based on history,
transaction pricing set by the CFO of SACo (under the guidance and approval of
CyprusCo2) are guaranteed approval by the board of directors of SACo.
Similarly, SwitzerlandCo’s CFO approves the pricing for purchases from SACo based
on the advice and approval of CyprusCo2.
Result:
The same person (CyprusCo2) participates directly in the management of SACo and
SwitzerlandCo with an influence on pricing and accordingly SACo and SwitzerlandCo
are associated enterprises in relation to each other. The participation in management
by CyprusCo2 is evident in the role it plays in influencing the pricing of transactions
between SACo and SwitzerlandCo which in turn is evident from the fact that:
• CyprusCo2 appoints the board of directors and management of both SACo and
SwitzerlandCo.
• CyprusCo2 is SACo’s and SwitzerlandCo’s advisor.
• SACo’s CFO and SwitzerlandCo’s CFO approve the pricing of transactions
between SACo and SwiterzerlandCo based on advice and at prices which have
been approved by CyprusCo2.
• CyprusCo2’s influence is evident in the different prices applicable to
transactions with SwitzerlandCo and other customers.
• The board of directors formally approve the prices, however evidence shows
that the approval is in substance more of a notification process as the prices
submitted are always approved by the SACo and SwitzerlandCo’s respective
board of directors.
Possible sources of information which confirm the associated enterprise relationship
noted above may include:
• The shareholder agreement.
• Purchase/sale agreements.
• Minutes of the meeting of the board of directors.
• Employee interviews and other evidence regarding the structure of the group
and how it operates.
4.2.2 Direct or indirect participation in control
Generally, there are two types of control that exist when it comes to authority, de facto
control and de jure control. De facto means a state of affairs that is true in fact, but that
may or may not be officially sanctioned. In contrast, de jure means a state of affairs
that is in accordance with law. 8
The concept of control is related to the structure of decision-making within an entity
with the relevant persons having the ability to and being involved in directing the
strategic financing and operating policies of the entity.
In the context of the definition of an “associated enterprise”, the type of control which
is relevant is de facto control and relates to the ability of a person, and the exercise of
that ability, to directly or indirectly materially influence the terms or conditions of the
transaction, operation, scheme, agreement or understanding, especially the pricing. In
the context of a company, de facto control is generally but not necessarily held and
exercised by the board of directors of a company. However, the facts and
circumstances of each case are critical in determining who is participating in the control
of a company by influencing the terms or conditions of a transaction, operation,
scheme, agreement or understanding, because the presence and influence of a
controlling person or persons can have a significant impact on the terms or conditions
of a transaction, operation, scheme, agreement or understanding. For example, the
board of directors of Company A could set the pricing for another company in the group
(Company B), notwithstanding that Company B has its own board of directors
consisting of different persons, with the result that Company A’s board of directors are
regarded as participating in the control of Company B. In another set of facts two
companies may have one common director on the board of directors, that does or does
not have any shareholding in either of the companies, who influences the pricing of
both companies9 and is therefore regarded as participating in the control of both
companies under the definition of an “associated enterprise”. The facts and
circumstances of each case are critical in determining who has de facto control
because the presence and influence of controlling persons can have a significant
impact on the terms or conditions.
Control may be obtained in many ways, such as the participation in the governing body
by having the ability to appoint the board of directors, having a contract to administer
and control the assets or liabilities of the entities, the ability to appoint management
personnel, or dominating major contracts of the entity, and using that participation,
contract or ability to influence the terms or conditions of the transaction, operation,
scheme, agreement or understanding, especially the pricing.
In assessing whether participation in control results in the parties to the transaction,
operation, scheme, agreement or understanding being considered “associated
enterprises” for the purposes of section 31, the outcome of the direct or indirect
participation in control must result in or have the consequence of controlling, effecting
or influencing the terms or conditions, including the pricing, of any transaction,
operation, scheme, agreement or understanding, directly or indirectly entered into or
effected between or for the benefit of either or both resident or non-resident party. 10
This is relevant considering that there is no such control, effect or influence on the
8 https://onlinelaw.wustl.edu/blog/legal-english-de-factode-jure/ [Accessed 17 April 2023].
9 Whether the terms and conditions, including pricing, are arm’s length is a separate consideration
that will only be considered after satisfying the requirements of the associated enterprises definition
10 Or one of the other parties specified in the definition of “affected transaction”.
terms or conditions, including pricing, of a transaction, operation, scheme, agreement
or understanding negotiated between independent parties that are acting in their own
best interest. An assessment of whether participation in control resulted in or has the
consequence of controlling, effecting or influencing the terms or conditions, including
the pricing, as mentioned above is very fact specific and can only be determined on a
case-by-case basis. If common participation in the control of two enterprises did not
impact on the aspects mentioned in the preceding sentence, then that common
participation in control would not result in the entities being regarded associated
enterprises under section 31. For example, if two companies had a common director
responsible for the companies’ corporate social investment programs and who had no
input on the terms or conditions, including the pricing, of any transactions of the
companies, then that common directorship will not result in the two companies being
regarded as associated enterprises for purposes of section 31.
Example 2 – Same persons participate directly in the control of two companies
Facts:
SACo3 is a South African tax resident entity which is ultimately held by a Chinese
Consortium. SACo3 sells all its export products to ChinaCo1 and ChinaCo2, members
of the Consortium making up the majority of the Chinese Consortium’s interest. Hong
KongCo is a Chinese tax resident that sources customers and markets for SACo3’s
products in China, charging SACo3 a sales commission for its efforts. ChinaCo1 and
ChinaCo2, with the assistance of Hong KongCo, is responsible for setting the pricing
policy for the group.
The diagram below provides a relevant extract of the group structure:
Chinese consortium
40% ChinaCo1
27% ChinaCo2
Hong KongCo
18% ChinaCo3
80% 15%
ChinaCo4
SACo5
MauritiusCo
20% 80%
SACo1
100%
SACo2
73%
SACo3
100% 100% 60%
IrelandCo SurinameCo IndiaCo
90%
RussiaCo
SACo3 products are priced based on a listed price, however only ChinaCo1 and
ChinaCo2 have an option for a discounted price based on their assessment of the
“quality” of the products received. The discounts are considered unjustifiable as export
sales are of a higher quality than local sales. ChinaCo1 and ChinaCo2 also require
SACo3 to use Hong KongCo as its sales agent in selling the products to ChinaCo1
and ChinaCo2, resulting in sales commission payable to Hong KongCo.
Result:
ChinaCo1 and ChinaCo2 are associated enterprises in relation to SACo3 because
ChinaCo1 and ChinaCo2 participate directly in the control of SACo3 in a manner which
has a direct impact on the determination of the terms and conditions including pricing
of the export sales between SACo3 and ChinaCo1, and SACo3 and ChinaCo2,
respectively. This participation is evident in the following:
• The setting of the pricing policy for the group is the responsibility of ChinaCo1
and ChinaCo2 with assistance from Hong KongCo.
• ChinaCo1 and ChinaCo2 are the majority shareholders of Hong KongCo,
ultimately being the majority shareholders of SACo3. ChinaCo1 and ChinaCo2
are the only export customers which means SACo3 inherently accepts
operational and pricing related proposal and amendments from ChinaCo1 and
ChinaCo2.
• All domestic sales by SACo3 to local independent parties are based on a listed
price with no option of a discount or premium, whereas ChinaCo1 and
ChinaCo2 have the option of a discounted price based on their assessment of
and dissatisfaction with the quality of the product.
• ChinaCo1 and ChinaCo2 also require that SACo3 pays a sales commission to
Hong KongCo for its export sales even though SACo3 may only sell its export
product to ChinaCo1 and ChinaCo2 in terms of a pre-established agreement.
Possible sources of information which confirm the associated enterprise relationship
noted above may include:
• Sales agreements.
• Minutes of the meeting of the board of directors.
• Transfer Pricing policy for the group.
• Price determination and relevant financial analysis.
• Employee interviews and other evidence regarding the structure of the group
and how it operates.
Example 3 – Same persons participate indirectly in the management, control or
capital of both resident and non-resident entities
Facts:
SACo is a South African tax resident entity. SACo sold products to LuxembourgCo, a
company incorporated and tax resident in Luxembourg. LuxembourgCo is a worldwide
marketing and distribution company for the Distribution group (which includes all the
companies on the diagram below).
The diagram below provides for a relevant extract of the group structure:
New York
London Stock
Stock
Exchange
Exchange
Shareholders
Shareholders
UK HoldCo US HoldCo
United Kingdom United States
100% 60%
CyprusCo DutchCo
20%
Cyprus Netherlands
100% 80%
SACo LuxemburgCo
South Africa Luxemburg
Indirect shareholding
Direct shareholding
SACo and LuxembourgCo are subsidiaries of two different ultimate holding
companies, namely UK HoldCo and US HoldCo, that are not connected persons in
relation to one another.
Both UK HoldCo and US HoldCo have entered into a Dual Listed Company
arrangement. In terms of this arrangement:
(i) the two companies operate as a single unified economic entity, through Boards
of Directors that comprised of the same individuals and a unified senior
executive management team which is involved in setting the price for goods
sold to LuxembourgCo by SACo.
(ii) certain equalisation principles were to be observed, which ensured the
economic and voting interests in the combined Distribution Group resulting
from the holding of one US HoldCo share were equivalent to that resulting from
one UK HoldCo share.
Pricing for the Distribution Group is managed and controlled by the unified senior
executive management team operating for UK HoldCo and US HoldCo, through a
centralised pricing policy for the group that each member of the group must adhere to
for transactions entered into between one another.
Result:
SACo and LuxembourgCo are associated enterprises in relation to each other because
the same persons in the form of the senior executive management team participate
indirectly in the management of SACo and LuxembourgCo in a manner which has a
direct impact on the determination of the terms and conditions which includes pricing
of the export sales between SACo and LuxembourgCo. The fact that the same persons
in the form of the Board of directors for the ultimate holding entities, US HoldCo and
UK HoldCo, participate indirectly in the management and the control of both SACo and
LuxembourgCo in a way which influences the terms and conditions such as the price
determination of transactions entered into between SACo and LuxembourgCo, is
another reason why SACo and LuxembourgCo are associated enterprises in relation
to each other.
This above-mentioned participation is evident in that both ultimate holding entities –
• operate as a unified economic entity;
• have boards of directors comprised of the same individuals;
• comprise of the same unified senior executive management involved in price
setting for the sale and purchases of goods for all companies in the Distribution
Group; and
• have equal economic and voting interest in the Distribution Group.
Possible sources of information which confirm the associated enterprise relationship
noted above may include:
• The dual listing company agreement.
• The board meeting attendance registers of both entities identifying individuals
serving in both entities at the same time.
• List of employees from the payroll.
• Board minutes and pack or minutes and packs of other Board or operational
committees within the group.
• Pricing policies of the group and those specifically applied by LuxembourgCo
and SACo.
• Transfer pricing documentation for the group or specifically for SACo and
LuxembourgCo.
• Any other document indicating possible influence over the terms and conditions
of the transaction, including the pricing, as result of the participation in
management or control of LuxembourgCo and SACo.
• Employee interviews and other evidence regarding the structure of the group
and how it operates.
4.2.3 Direct or indirect participation in capital
Direct or indirect participation in the capital of an entity refers to the direct or indirect
beneficial ownership of shares in an entity. In assessing whether participation in capital
results in the parties to the transaction, operation, scheme, agreement or
understanding being considered “associated enterprises” for the purposes of
section 31, the outcome of the direct or indirect participation in capital must result in
or have the consequence of controlling, effecting or influencing the terms or conditions,
which includes the pricing, of any transaction, operation, scheme, agreement or
understanding, directly or indirectly entered into or effected between or for the benefit
of either or both resident or non-resident party. 11 This is relevant considering that there
is no such control, effect or influence on the terms or conditions of a transaction,
operation, scheme, agreement or understanding, negotiated between independent
parties that are acting in their own best interest. An assessment of whether
participation in capital resulted in or has the consequence of controlling, effecting or
influencing the terms or conditions, including the pricing, as mentioned above is very
fact specific and can only be determined on a case-by-case basis.
Generally, shareholders with sufficient shares are capable of influencing the decisions
of an entity’s operations. This influence can be exercised through shareholders
meetings during which shareholders debate with each other and vote on resolutions
put forward to them.
Article 9 refers to a participation in capital without specifying a percentage holding of
shares which would be regarded as participation having an ability to sufficiently
influence terms or conditions, including the pricing, for purposes of transfer pricing.
Therefore, a facts and circumstances test applies. Generally speaking, if the holding
of shares is very low it is unlikely to indicate an ability to influence the terms or
conditions through participation in capital. It is anticipated that it is unlikely that the
percentages relating to the holding of shares which are below those specified in the
definition of “connected person” will result in a participation in capital that results in or
has the consequence of controlling, effecting or influencing the terms or conditions of
any transaction, operation, scheme, agreement or understanding. See paragraph (iv)
of the definition of “connected person” section 1(1) for an example of the percentages
specified. 12
However, although shareholding percentages which are below that specified in the
connected person definition in the appropriate circumstances are unlikely to result in a
person being an “associated enterprise”, the test to determine whether a person
participates directly or indirectly in the capital of another person, or the same person
directly or indirectly participates in the capital of two entities, at a level sufficient to
influence the terms or conditions remains a facts and circumstances test. Accordingly,
if the facts demonstrate that notwithstanding, for example, a low shareholding
11 Or one of the other parties specified in the definition of “affected transaction”.
12 See Interpretation Note 67 “Connected Persons” for commentary on the definition of “connected
person”.
percentage, a shareholder uses their shareholding to influence the terms and
conditions, including the pricing of a transaction, operation, scheme, agreement or
understanding then the criteria of “participation in capital” will be met.
5. Conclusion
Broadly, section 31 deals with the tax payable by persons in respect of international
transactions, operations, schemes, agreements or understandings and requires such
transactions, operation, scheme, agreement or understanding to be based on the
arm’s length principle. Prior to the amendment of this section which included a
definition of “associated enterprise” and included that term in the definition of “affected
transaction”, section 31 and the definition of “affected transaction” only covered
connected persons.
The exclusion of associated enterprises from section 31 effectively created a potential
anomaly and unfair reduction in the tax base. 13 As such, the “associated enterprise”
definition was inserted in section 31 in order to correct this potential irregularity.
Leveraged Legal Products
SOUTH AFRICAN REVENUE SERVICE
13 Explanatory Memorandum on the Taxation Laws Amendment Act, 2019 in para 5.4.
Annexure – The law
Section 31
31. Tax payable in respect of international transactions to be based on arm’s length
principle.—(1) For the purposes of this section—
“affected transaction” means any transaction, operation, scheme, agreement or understanding
where—
(a) that transaction, operation, scheme, agreement or understanding has been directly or
indirectly entered into or effected between or for the benefit of either or both—
(i) (aa) a person that is a resident; and
(bb) any other person that is not a resident;
(ii) (aa) a person that is not a resident; and
(bb) any other person that is not a resident that has a permanent establishment
in the Republic to which the transaction, operation, scheme, agreement or
understanding relates;
(iii) (aa) a person that is a resident; and
(bb) any other person that is a resident that has a permanent establishment
outside the Republic to which the transaction, operation, scheme,
agreement or understanding relates; or
(iv) (aa) a person that is not a resident; and
(bb) any other person that is a controlled foreign company in relation to any
resident,
and those persons are connected persons or associated enterprises 14 in relation to one
another; and
(b) any term or condition of that transaction, operation, scheme, agreement or
understanding is different from any term or condition that would have existed had those
persons been independent persons dealing at arm’s length;
“associated enterprise” means an associated enterprise as contemplated in article 9 of the Model
Tax Convention on Income and on Capital of the Organisation for Economic Co-operation and
Development
Article 3(1)(c) of the OECD Model Tax Convention
c) the term “enterprise” applies to the carrying on of any business;
14 Associated enterprise is effective for years of assessment commencing on or after 1 January 2023.
Article 9 of the OECD Model Tax Convention
1. Where:
(a) an enterprise of a Contracting State participates directly or indirectly in the
management, control or capital of an enterprise of the other Contracting State; or
(b) the same persons participate directly or indirectly in the management, control or capital
of an enterprise of a Contracting State and an enterprise of the other Contracting State,
and in either case conditions are made or imposed between the two enterprises in their commercial or
financial relations which differ from those which would be made between independent enterprises, then
any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason
of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed
accordingly.
2. Where a Contracting State includes in the profits of an enterprise of that State – and taxes
accordingly – profits on which an enterprise of the other Contracting State has been charged to tax
in that other State and the profits so included are profits which would have accrued to
the enterprise of the first-mentioned State if the conditions made between the two enterprises had
been those which would have been made between independent enterprises, then that other State
shall make such an appropriate adjustment to the amount of the tax charged therein on those profits.
In determining such adjustment, due regard shall be had to the other provisions of this Agreement
and the competent authorities of the Contracting States shall if necessary consult each other.
Diamond Export Levy Act, 2007
