Special Economic Zones (SEZs) exist for one reason: to encourage investment. By offering qualifying companies a reduced corporate income tax rate of 15%, South Africa sought to make designated manufacturing and industrial hubs more attractive to investors. Yet, like many tax incentives, the concession has always carried a concern—how do you encourage genuine investment without opening the door to artificial profit shifting?

When section 12R was introduced, the legislature answered that question with a relatively simple rule. The 2026 Draft Taxation Laws Amendment Bill now proposes replacing that rule with something far more familiar to tax practitioners: a domestic transfer pricing regime. The proposed section 31B represents a significant policy shift, even if its practical effect is more evolutionary than revolutionary.

The original safeguard

To qualify for the reduced tax rate, a company must satisfy several requirements. It must carry on a qualifying trade within an approved SEZ, operate from a fixed place of business within the zone, derive at least 90% of its income from activities carried on in one or more approved SEZs, and satisfy various other qualifying criteria. Certain industries are excluded altogether.

From the outset, Government recognised that a lower tax rate could encourage companies to divert profits from ordinary taxable entities to related companies located within an SEZ. The response, introduced in 2016, was section 12R(4)(c).

Rather than examining whether prices between related parties reflected market value, the provision imposed a bright-line limitation. If more than 20% of a qualifying company's deductible expenditure or income arose from transactions with a connected South African resident (or a South African permanent establishment of a non-resident), the company ceased to qualify for the incentive altogether.

The attraction of such a rule is its simplicity. Unfortunately, simplicity often comes at the expense of commercial reality.

When anti-avoidance becomes anti-business

The 2026 Draft Explanatory Memorandum openly acknowledges concerns raised by taxpayers over the years. Modern business groups rarely operate as a single integrated company. Manufacturing, procurement, logistics, intellectual property, sales and marketing are frequently housed in different group entities.

Likewise, multinational businesses generally locate only part of their supply chain within an SEZ rather than relocating an entire business operation.

The existing 20% rule, therefore, creates an awkward outcome. Companies may lose the SEZ incentive not because profits have been manipulated, but simply because they engage in ordinary commercial transactions with related South African companies. In effect, the rule can discourage precisely the investment the incentive was designed to attract.

A more targeted approach

The proposed section 31B adopts a fundamentally different philosophy.

Instead of denying the incentive once related-party transactions exceed an arbitrary threshold, the new provision asks a much narrower question: Were the transactions conducted on arm's length terms?

The proposed section applies where there is a domestic transaction between:

• a qualifying company operating within an approved SEZ; and
• a connected South African resident that is not itself a qualifying SEZ company.

If the terms or conditions differ from those that independent parties would have agreed, and that difference results in a tax benefit, the taxable income of the party receiving that tax benefit must be recalculated as though the transaction had occurred on arm's length terms.

In other words, the focus shifts away from the mere existence of related-party transactions and towards whether those transactions distort taxable income.

Bringing domestic transactions into the transfer pricing fold

South African transfer pricing rules have traditionally targeted cross-border transactions. The rationale was obvious: differences in tax jurisdictions create opportunities to move profits offshore.

Section 31B is different. Both parties are South African taxpayers. What creates the incentive to manipulate prices is not geography, but the difference in tax rates. One company enjoys the preferential 15% SEZ rate while the other remains subject to the ordinary corporate tax rate.

In this respect, the proposed provision resembles a domestic transfer pricing rule rather than a conventional international transfer pricing measure. Importantly, the Draft Explanatory Memorandum states that section 31B is intended to operate consistently with the OECD Transfer Pricing Guidelines and the United Nations Practical Manual on Transfer Pricing.

A welcome policy refinement

Perhaps the most noteworthy aspect of the proposal is what it says about the government's broader policy direction.

The explanatory memorandum notes that an international comparison of fourteen jurisdictions with SEZ regimes found that countries generally rely on transfer pricing principles and substance requirements, rather than denying incentives outright because of related-party transactions.

Seen in that light, proposed section 31B is less about introducing a new anti-avoidance measure than replacing an inflexible one with a more proportionate response.

The existing section 12R rule effectively assumes that related-party transactions are inherently problematic once they exceed a numerical threshold. Section 31B instead recognises that related-party transactions are often an ordinary feature of modern business. The concern is not that they exist, but whether they are priced as independent parties would have agreed.

That distinction is important. It protects the fiscus from artificial profit shifting while allowing legitimate commercial structures to benefit from the SEZ incentive.

For taxpayers operating within Special Economic Zones, the proposed amendment is therefore likely to be welcomed. The compliance burden may increase through the need to demonstrate arm's length pricing, but that is arguably a fair trade-off for replacing a rule that could deny the entire tax incentive simply because an arbitrary percentage had been exceeded.

Sometimes tax policy matures not by becoming more complicated, but by becoming more precise. Proposed section 31B appears to be an example of exactly that.