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CCSSection 140A of Income Tax Act 1967: The DGIR’s Power to Substitute Prices and Disallow Interest
Updated: Sep 8
Introduction
The Director General of Inland Revenue (DGIR) has the authority granted to them by section 140A of the Income Tax Act 1967 (ITA 1967), which allows them to substitute prices and prohibit interest on transactions or financial assistance between associated persons.
According to section 140A(2) of the Income Tax Act of 1967, a person who conducts a transaction with associated persons to acquire or supply property or services must determine and apply the arm’s length price for such transactions.
Alternatively, if the DGIR has reason to believe that the property or services are acquired or supplied at a price that is lower or higher than the arm's length price, he may substitute the price in respect of the transaction to reflect an arm's length price under section 140A(3) of the Income Tax Act of 1967.
To make the word "control" mean more
To broaden the meaning of "control" as described in section 139, subsection 5A of section 140A was added on January 1, 2019, and became effective immediately.
The definition of control for the purposes of transfer pricing has been weakened as a result of the enactment of section 140A(5A), which stipulates that only a 20% shareholding is necessary for a person to be considered in control of an entity if that person exercises substantive control over the company in any of the ways that are described in subsection 5A.
For the purposes of transfer pricing, the number of transactions that could be considered to be those that take place between associated persons would increase as a result of this.
Concerning the DGIR's "power to substitute the price on certain transactions," section 140A has been amended as of January 1, 2021, to grant the DGIR the "power to substitute the price, disregard the structure, and impose a surcharge on certain transactions."
If the DGIR disregards a transaction under subsection (3A), it may apply a 5% surcharge
This modification to section 140A is accomplished by the addition of subsection (3A), which states that the DGIR may disregard any structure of a transaction in the following circumstances:
the economic substance of that transaction differs from its form; or
the form and substance of that transaction are the same but the arrangements made in relation to the transaction, when viewed in totality, differ from those which would have been adopted by independent persons behaving in a commercially rational manner, and the structure impedes the DGIR from determining the appropriate transfer price.
If the DGIR chooses to disregard the structure of the transaction to exercise his powers under subsection (3A), then he is required, under the new subsection (3B), to make adjustments to the structure to reflect what, in his opinion, would be an arm's length structure taking into consideration the economic and commercial reality.
If the DGIR has disregarded a transaction under subsection (3A), the DGIR may, by notice in writing, impose the taxpayer on paying a surcharge of not more than 5% on the amount of any increase in income or reduction in any deduction or loss. This will be provided for in the new subs (3C).
Definitions
Associated Persons refer to:
persons, one of whom has control over the other
individuals who are relatives of each other, or
persons, both of whom are controlled by some other persons [s 140A(5) of the ITA 1967].
A transaction means any trust, grant, covenant, agreement, arrangement, or other disposition or transaction made or entered into orally or in writing and includes a transaction entered into by two or more persons with another person or persons [s 140A(6); 140(8) of the ITA 1967].
A relative is defined to mean a parent, a child (including a stepchild and a child adopted under any law), a brother, a sister, an uncle, an aunt, a nephew, a niece, a cousin, an ancestor or a lineal descendant [sections 140A(6); 140(8) of the ITA 1967].
Income Tax Act 1967
Section 140A power to substitute price, disregard structure and impose surcharge
140A(1) [Application of section]
This section shall apply notwithstanding section 140 and subject to any rules prescribed under this Act.
140A(2) [Transaction with associated person]
Subject to subsection (3), where a person in the basis period for a year of assessment enters into a transaction with an associated person for that year for the acquisition or supply of property or services, then, for all purposes of this Act, that person shall determine and apply the arm’s length price for such acquisition or supply.
140A(3) [Price may be substituted for arm’s length price]
Where the Director General has reason to believe that any property or services referred to in subsection (2) is acquired or supplied at a price which is either less than or greater than the price which it might have been expected to fetch if the parties to the transaction had been independent persons dealing at arm’s length, he may in the determination of the gross income, adjusted income or adjusted loss, statutory income, total income or chargeable income of the person, substitute the price in respect of the transaction to reflect an arm’s length price for the transaction.
140A(3A) [Where transaction differs]
The Director General may disregard any structure adopted by a person in entering into a transaction if—
the economic substance of that transaction differs from its form; or
the form and substance of that transaction are the same but the arrangement made in relation to the transaction, viewed in totality, differs from those which would have been adopted by independent persons behaving in a commercially rational manner, and the actual structure impedes the Director General from determining an appropriate transfer price.
140A(3B) [Transaction adjusted to arm’s length]
Where the Director General disregards any structure adopted by a person entering into a transaction under subsection (3A), the Director General shall make adjustments to the structure of that transaction as he thinks fit to reflect the structure that would have been adopted by an independent person dealing at arm’s length having regard to the economic and commercial reality.
140A(3C) [Director General may impose surcharge]
Where this section and any rules made under paragraph 154(1)(ed) apply, the Director General may, by notice in writing, require that person to pay a surcharge of not more than five per cent of the amount of increase of any income generally, or reduction of any deduction or loss, as the case may be, as a consequence of exercising his powers to substitute the price in respect of a transaction entered into by a person to reflect an arm’s length price for that transaction or to disregard any structure adopted by a person in entering into a transaction.
140A(3D) [Surcharge as tax]
Any surcharge required to be paid by a person under subsection (3C) shall be collected by the Director General as if it were tax payable by that person but shall not be treated as tax so payable for the purposes of any provision of this Act other than sections 103 to 106.
140A(4) (Deleted by Act 801 of 2017, s. 11(c))
140A(5) [Transaction between associated person]
The transactions referred to in subsections (2) and (3A) shall be construed as a transaction between—
persons one of whom has control over the other;
individuals who are relatives of each other; or
persons both of whom are controlled by some other person (in this section, referred to as “third person”).
140A(5A) [Meaning of “control” by a person or third person for share capital more than twenty per cent]
Without prejudice to the generality of section 139, for the purpose of subsection (5), “control” refers to persons, one of whom owns shares of the other person or a third person who owns shares of both persons, where the percentage of the share capital held in either situation is twenty per cent or more and—
the business operations of that person depend on the proprietary rights, such as patents, non-patented technological know-how, trademarks, or copyrights, provided by the other person or a third person;
the business activities, such as purchases, sales, receipt of services, and provision of services, of that person are specified by the other person, and the prices and other conditions relating to the supply are influenced by such other person or a third person; or
where one or more of the directors or members of the board of directors of a person are appointed by the other person or a third person.
140A(6) [Meaning of “relative” and “transaction”]
In this section, “relative” and “transaction” have the same meanings assigned to them under subsection 140(8).
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