1  

 

MARCH 2015 – ISSUE 186

CONTENTS

COMPANIES

2392. Interest-free shareholder loans

2393. Asset for share transactions

2394. Section 9D rules

TAX ADMINISTRATION ACT

2398. Mitigation of penalties and

interest

DEDUCTIONS

2395. Thin capitalisation and section

23M

2396. Penalties and stolen money

TRANSFER PRICING

2399. Compliance conundrum

2400. OECD’s BEPS action plan

INTERNATIONAL TAX

2397. Dividend payments to Holland

SARS NEWS

2401. Interpretation notes, media

releases and other documents

COMPANIES

2392. Interest-free shareholder loans

Loans between companies and their shareholders, or other group companies, are

a common method of providing finance in the South African corporate

environment. Loans of this nature may, however, give rise to tax implications in

the hands of the lender or the recipient, and careful consideration should therefore

be given to these transactions.

Dividends tax

2  

Dividends declared by a company to its shareholders up until 31 March 2012

were subject to Secondary Tax on Companies (STC) at a rate of 10%. The Income

Tax Act, No. 58 of 1962 (the Act) also contains provisions designed to

circumvent tax avoidance transactions that enabled the shareholder of a company

to benefit in some way even though no cash dividend was actually declared.

Under these provisions, certain types of transactions gave rise to deemed

dividends with the result that STC became payable, subject to certain exemptions.

Dividends tax is levied at the rate of 15% on dividends paid on or after 1 April

2012, subject to certain exemptions, or the application of a lower rate of dividends

tax in certain circumstances. Low-interest loans may also fall within the

dividends tax ambit by virtue of these loans constituting a deemed dividend in

certain circumstances, giving rise to a liability for dividends tax.

Loans or advances from a company to a shareholder (or any person connected to

the shareholders) will automatically be deemed to be dividends in certain

circumstances.

The current deemed dividend provision applies where a debt arises “by virtue of

a share held in the company” and where the following conditions are present: the

debtor is a person other than a company; the debtor is a South African resident

and the debtor is either a connected person in relation to the company, or a

connected person in relation to that person. Broadly speaking, a “connected

person” in relation to a company means any company that forms part of the same

group of companies (where at least 70% of the equity shares in a controlled group

company are held by the controlling group company), or any person, other than a

company, who individually or jointly with any connected person holds, directly

or indirectly, at least 20% of the company’s equity shares or voting rights.

If all of these requirements are met, the company is deemed to have paid a

dividend in specie which is deemed to be an amount equal to the greater of the

“market related interest” in respect of the debt, less the amount of interest payable

3  

to that company in respect of the relevant year of assessment. In other words, the

amount of the dividend is determined by applying an interest rate to the debit

balance on the loan during the year. For purposes of determining the deemed

dividend, the term “market related interest” is the difference between the “official

rate of interest” that applies for fringe benefits tax purposes, and as defined in

paragraph 1 of the Seventh Schedule (currently 6.75% per annum), and the actual

interest rate charged on the loan. Only the interest effectively forgone, and not

the capital amount of the loan, is deemed to be a dividend. If therefore, the loan

bears interest at an acceptable rate, there would be no deemed dividend. This can

be distinguished from the STC regime where the tax in respect of a deemed

dividend was calculated on the principal amount of the loan.

The dividend is deemed to be paid by the company on the last day of the year of

assessment, and the company is required to pay the resulting dividends tax by the

end of the month following its year-end. Since the dividend is deemed to be a

dividend in specie, the company (as opposed to the shareholder) is liable for the

tax.

In order for a shareholder loan to constitute a deemed dividend, the debt has to

arise “by virtue of” a share held in the company. The meaning of the phrase “by

virtue of” is not defined in the Act and guidance can be found in a number of

cases.

The phrase “by virtue of” was considered in the context of employment, in the

case of Stander v CIR [1997] 59 SATC 212, where the court considered the

meaning of the phrase “in respect of or by virtue of any employment or the

holding of any office”. The words “by virtue of” do not, in view of the court, bear

a meaning materially different from the words “in respect of” and referred to ST

v Commissioner of Taxes [1973] 35 SATC 99, at 100 where, in regard to the

phrase “by virtue of” Whitaker P stated at 100:

4  

“ordinarily the phrase (and this was common cause between counsel) means

‘by force of’, ‘by authority of’, ‘by reason of’, ‘because of’, ‘through’ or ‘in

pursuance of’. (See Black’s Law Dictionary 4 ed 252). Each of these

definitions suggests there must be a direct link between the cause and result.”

The principles established in the Stander case were confirmed in the Supreme

Court of Appeal case of Stevens v CIR [2007] 69 SATC 1, where the court held

that there was no material difference between the expressions “in respect of” and

“by virtue of”. They connote a causal relationship between the amount received

and the taxpayer’s services or employment.

It is evident from the above that there has to be a direct causal relationship

between the holding of the relevant shares and the advance of the loan in question

in order for a deemed dividend to arise. The deeming rule will thus only be

triggered when a loan or advance has been made to a South African resident

person that is not a company (e.g. a trust or a natural person) who is a connected

person in relation to that company or a connected person in relation to the

aforementioned person (that is connected to the person who is connected to the

company).

To the extent that the amount owing to a company by a shareholder of that

company or other qualifying person, as set out above, was deemed to be a

dividend that was “subject to STC”, no deemed dividend implications will arise

in terms of the dividends tax regime. In other words, a debt that was deemed to

be a dividend that was subject to STC will not be deemed to be a dividend for

dividends tax purposes.

The term “subject to tax” is not defined in the Act, nor has it been the subject of

any South African court decisions. Guidance can, however, be found from United

Kingdom (UK) judgments in respect of the phrase. In the case of Paul Weiser v

HM Revenue and Customs [2012] UKFTT 501, the First Tier Tribunal considered

5  

the interpretation of the double tax treaty between the UK and Israel and in

particular the meaning of the phrase "subject to tax". The case centred around the

meaning of the phrase "subject to tax" and the difference in international tax

treaties between this phrase and the phrase "liable to tax". In HM Revenue and

Custom's view, the distinction between the two phrases is that the expression

"liable to tax" requires only an abstract liability to tax (i.e. a person is within the

scope of tax generally irrespective of whether the country actually exercises the

right to tax) and therefore has a much broader meaning than the phrase "subject

to tax" which requires that tax is actually levied on the income. The First Tier

Tribunal decided the case in favour of HM Revenue and Customs such that relief

was not available under the UK-Israel tax treaty to exempt the pension from UK

tax because the pension in question was not subjected to tax in Israel.

Income would thus not be regarded as “subject to tax” if the income in question

is exempt from tax in terms of a statutory exemption from tax.

In the context of shareholder’s loans, unless STC was actually paid in respect of

the debt in question, such interest-free or low interest loan would be subject to

dividends tax. This effect appears to create unintended adverse consequences for

taxpayers in that, even though loans of this nature may not have constituted

deemed dividends under the STC regime as a result of the application of an

exemption, excess interest on the loan amount would be subject to dividends tax.

Employees’ tax

For employees’ tax purposes, the issue that requires consideration is whether a

“taxable benefit” as defined in paragraph 2(f) of the Seventh Schedule to the Act,

read with paragraph 11 thereof, arises in consequence of an interest-free or low

interest loan to a shareholder that is a connected person in relation to the lender.

In order to constitute a “taxable benefit”, the debt in question has to arise “in

respect of” the employee’s employment with the employer. As discussed above,

in terms of the applicable case law, there is no material difference between the

6  

expressions “in respect of” and “by virtue of”. With regard to both, if there is an

“unbroken causal relationship between the employment on the one hand and the

receipt on the other”, the payment will be “in respect of services rendered”

(Stevens v CSARS supra). It is submitted that the same principle will apply for

purposes of paragraph 2 of the Seventh Schedule to the Act.

In order to determine whether an interest-free or low interest loan results in a

taxable benefit, one will have to determine the reason or cause for the granting of

the loan.

It is important to bear in mind that an interest-free or low interest loan to a

connected person in relation to the company (or a connected person in relation to

a connected person in relation to the company) will only be subject to either

dividends tax or employees’ tax, and not to both.

ENSafrica

ITA: Sections 64B, 64E and Seventh Schedule’s paragraphs 1, 2 and 11

2393. Asset for share transactions

(Editorial note: Published SARS rulings are necessarily redacted summaries of

the facts and circumstances. Consequently, they (and articles discussing them)

should be treated with care and not simply relied on as they appear.)

The South African Revenue Service (SARS) released Binding Private Ruling No

184 (BPR) on 11 November 2014, which deals with a proposed asset-for-share

transaction in terms of section 42 of the Income Tax Act No. 58 of 1962 (the Act).

7  

The applicant was a resident family trust. The trust held all the issued shares in

Company A and Company B. It was proposed that the applicant dispose of its

shares in Company A to Company B so that Company A could become a wholly-

owned subsidiary of Company B. It was further proposed that, as consideration

for the transfer of the shares in Company A to Company B, Company B would

issue an additional equity share to the applicant.

The issue of the equity share to the trust would solely be to bring the proposed

transaction within the ambit of section 42 of the Act.

Despite the apparent artificiality of issuing an additional equity share to the

applicant, which already held all the issued shares in Company B, SARS ruled

that the proposed transaction would fall within section 42 of the Act.

Section 24BA of the Act is an anti-avoidance provision that potentially applies to

transactions where assets are acquired in exchange for the issue of shares as

consideration, including asset-for-share transactions in terms of section 42 of the

Act. Section 24BA will apply where the consideration is different from the

consideration that would have applied if the transaction were between

independent persons dealing at arm’s length. Where the consideration is not arm’s

length, the application of section 24BA will result in either a deemed capital gain

for the issuing company, or a deemed dividend in specie paid by the issuing

company.

SARS ruled that section 24BA would not apply to the proposed transaction on

the basis that it fell within the exclusion provided for in section 24BA(4)(a)(ii).

The said section provides that section 24BA does not apply where the transferor

of the asset will hold all the shares issued by the issuing company immediately

after the acquisition of the asset by that company.

8  

SARS also ruled that the transfer of the shares in Company A (the assets) and the

issue of the equity share to the applicant, would neither constitute a donation for

purposes of section 54 of the Act, nor a deemed donation for purposes of section

58 of the Act (where there is inadequate consideration in respect of the disposal

of property), and that accordingly the proposed transaction would not have any

donations tax consequences.

Further, SARS ruled that Paragraph 38 of the Eighth Schedule to the Act would

not apply, implying that the proposed transaction would not be seen as a disposal

of an asset to a connected person for a consideration not reflecting an arm’s length

price.

This ruling is interesting in that, on the face of it, the issue of the additional equity

share to the applicant as consideration for the transfer of the shares in Company

A to Company B, does not appear to constitute:

an arm’s length consideration for purposes of section 24BA and Paragraph

38 of the Eighth Schedule to the Act; and

adequate consideration for purposes of section 58 of the Act.

SARS nevertheless ruled that these provisions would not apply.

Cliffe Dekker Hofmeyr

Binding Private Ruling No 184

ITA: Section 24BA, 42, 54, 58 and Paragraph 38 of the Eighth Schedule

2394. Section 9D rules

The Controlled Foreign Company (CFC) provisions seek to reduce the

opportunity for income to be diverted and taxed offshore in the hands of foreign

companies where:

9  

South African tax residents may exercise, directly or indirectly, a majority

of the voting rights in the foreign companies or

where South African tax residents may participate, directly or indirectly,

in the majority of the benefits attached to shares of the foreign companies.

In terms of Section 9D of the Income Tax Act, No. 58 of 1962 (the Act) a

hypothetical taxable income, “net income”, is calculated as if the CFC is a South

African tax resident. This net income may be included in the taxable income of

the South African tax resident shareholders.

Section 9D offers the following relief measures that avoid subjecting the CFC’s

net income to South African income tax:

the net income of the CFC is deemed nil where all foreign tax incurred by

the CFC is at least equal to 75% of the South African income tax computed

on that net income

amounts, other than tainted income, that are attributable to a “foreign

business establishment” (FBE) are excluded from net income.

Where a CFC conducts a genuine business established at premises outside of

South Africa, with sufficient on-site managerial and operational staff, it is usually

evident that the CFC conducts business through a FBE. In contrast, determining

whether foreign taxes incurred by the CFC will reach the 75% threshold can be a

time consuming and complicated computation, especially if the South African

taxpayer has numerous CFCs.

If a FBE exists and no tainted income is attributable to that FBE, no net income

will need to be included in the taxable income of the South African resident

shareholder. This result is regardless of whether foreign taxes incurred by the

CFC meet the 75% threshold.

10  

However, as noted in the Explanatory Memorandum to the 2014 Taxation Laws

Amendment Act of 2014 (the TLAA), the current structure of section 9D still

requires the 75% threshold computation to be performed despite the fact that the

net income of the CFC is attributable to a FBE. This computation would also need

to be declared in an IT10B return that accompanies the annual tax return of the

South African shareholder.

In recognising this unnecessary burden, the TLAA proposes that a CFC’s net

income will also be deemed nil where:

all of the receipts and accruals of the CFC are attributable to a FBE and

none of those receipts or accruals relate to tainted income

This logical amendment removes the compliance burden where CFCs conduct

business through a FBE that does not derive tainted income.

A word of caution – the tainted income provisions of section 9D(9A) are

complicated and therefore should be considered carefully before relying on this

FBE relief. Tainted income includes the following passive and diversionary

income earned by CFCs from South African tax resident connected persons:

interest

royalties in respect of the use of intellectual property

rental of certain movable property

goods sold by the CFC

services performed by the CFC, other than certain services performed

outside of South Africa

In conclusion, now that the amendments in the 2014 TLAB have been enacted by

way of the Taxation Laws Amendment Act No.43 of 2014, the presence of an

FBE can reduce the compliance burdens associated with a CFC. However, careful

11  

consideration must still be given to establish the existence and the impact of

tainted income.

Grant Thornton

ITA: Section 9D

Taxation Laws Amendment Act No. 43 of 2014

DEDUCTIONS

2395. Thin capitalisation and section 23M

In line with recent pronouncements by the OECD relating to the so-called Base

Erosion and Profit Shifting Project (BEPS), section 23M was introduced by the

Taxation Laws Amendment Act No.31 of 2013 (the TLAA). Section 23M of the

Income Tax Act No. 58 of 1962 (the Act) took effect on 1 January 2015 and has

a similar purpose to the thin capitalisation provisions of section 31 of the Act.

The Taxation Laws Amendment Bill No.13 Act of 2014 (TLAB), as tabled in

parliament contains a number of substantial amendments to the current provisions

of section 23M. The TLAB was subsequently enacted as the Taxation Laws

Amendment Act, No. 43 of 2014. A summary of the provisions of section 23M

following these amendments is set out below.

Section 23M sets an interest deduction limitation for a debtor and will apply if a

“controlling relationship” exists between the debtor and the creditor. A

controlling relationship will exist where a person directly or indirectly holds at

least 50 per cent of the equity shares or voting rights in a company. The interest

deduction limitation will also apply in respect of a debt owed to a creditor that is

not in a controlling relationship with the debtor where the creditor obtained the

funding for the debt advanced from a person that is in a controlling relationship

with the debtor. The interest deduction limitation will, however, only apply if the

12  

amount of interest is not subject to tax in the hands of the recipient or not included

in the net income of a controlled foreign company and also not disallowed under

the provisions of section 23N dealing with the limitation of interest deductions in

respect of reorganisation and acquisition transactions.

The interest deduction limitation will be calculated on the aggregate of:

• the amount of interest received by or accrued to the debtor; and

• a percentage of the adjusted taxable income of the debtor to be determined

in accordance with a formula which links deductible interest to the average

repo rate for the year.

The formula will, therefore, be adjusted where there is a change to the average

repo rate together with a 400 basis point addition to the average repo rate. The

interest deduction limitation will have a ceiling of 60 per cent of the adjusted

taxable income of the debtor which will exclude the previous year’s assessed loss.

Any interest in excess of the limitation may be carried forward to the following

year. The interest deduction limitation will not apply to any interest incurred by

a debtor in relation to back-to-back loans where the creditor obtained those funds

from an unconnected lending institution in relation to the debtor and the interest

is determined with reference to a rate that does not exceed the official rate of

interest as defined in the Seventh Schedule plus 100 basis points.

National Treasury and SARS are of the opinion that section 23M has a broader

objective than the thin capitalisation provisions of section 31 and that section 31

will first apply to determine the correct pricing of the debt owed. Where the

amount of interest is taken into account in terms of a reorganisation and

acquisition transaction under section 23N, the provisions of section 23M must be

applied to any amount not already disallowed under section 23N.

ENSafrica

ITA: Sections 23M, 23N and 31

13  

Taxation Laws Amendment Act No. 31 of 2013

The Taxation Laws Amendment Act No. 43 of 2014

2396. Penalties and stolen money

The South African Revenue Service (SARS) released Interpretation Note 80 on

5 November 2014 which deals with the income tax treatment of stolen money.

Apart from the fact that it is indicated in the Interpretation Note that stolen monies

must be included in gross income in the year of receipt, it is indicated further that

the stealing of money cannot be described as a trade and that the thief will thus

not qualify for a deduction to the extent that the monies must be repaid. It has

been indicated that, even though certain elements of a trade, for example the

intention to make a profit, repeated activities, planning and organisation, may be

present in the case of a thief, the thief’s activities lack the key commercial

character of a trade when it comes to sourcing the goods. Stolen monies and/or

other goods are not obtained through normal commercial means and are not

received as a reward for the provision of any goods or services.

On that basis the act of embezzlement, fraud or theft does not constitute a trade.

In a South African context a thief has another hurdle to cross, namely section

23(o) of the Income Tax Act No. 58 of 1962 (the Act), which provides that a

taxpayer is not entitled to deduct expenditure that constitutes a fine charged or

penalty imposed as a result of an unlawful activity carried out in South Africa or

in any other country if that activity would be unlawful had it been carried out in

South Africa.

The possibility of deducting penalties was recently considered by the Upper

Tribunal (Tax and Chancery Chamber) in the United Kingdom in the case of

McLaren Racing Ltd v Revenue and Customs Commissioners [2014] STC 2417.

14  

The McLaren motor racing team participates in the Formula One grand prix

events that take place throughout the world. All teams participating in Formula

One have concluded an agreement between themselves and the International

Automobile Federation (the sport’s governing body) and the Formula One

Association (a company engaged in the promotion of the Formula One world

championship). This agreement is called the so-called Concorde Agreement.

McLaren was held to have breached the International Sporting Code as its chief

designer allegedly received confidential information pertaining to another

Formula One racing team. Pursuant to this allegation, the McLaren racing team

was ordered to pay a penalty of US$100 million in respect of a breach, less

income which was lost as a result of it losing points in the so-called Formula One

constructors’ championship. The ultimate penalty that was paid amounted to

approximately £32 million. The question arose whether this penalty was

deductible by the McLaren racing team on the basis of it constituting a

disbursement or expense wholly and exclusively laid out or expended for the

purposes of its trade or profession.

In holding that the penalty was not wholly and exclusively laid out or expended

for the purposes of McLaren’s trade, it was acknowledged that the penalty

constituted a disbursement or expense. However, it was indicated that a deliberate

activity which was not an unavoidable consequence of carrying on a trade did not

constitute an activity carried on in the course of that trade. It was said:

"In our view, a deliberate activity which is contrary to contractual obligations and

the rules and regulations governing the conduct of the trade, which is not an

unavoidable consequence of carrying on a trade and which could lead to the

destruction of the trade, is not an activity carried on in the course of that trade."

However, McLaren raised a different argument. It submitted that its trade

constituted the design, manufacture and racing of motor cars. As part of such

15  

trade it employs designers and engineers. It was a so-called 'occupational hazard'

that employees might sometimes overstep the mark and act outside their scope of

employment. This argument was also dismissed. The court refused to accept that,

because an employer incurs a liability as a result of the acts of an employee, such

liability is incurred in the course of the employer’s trade. This was based on the

fact that the use of the confidential information did not constitute a normal or

ordinary activity of McLaren. It did not become such an activity simply because

it was carried out by an employee.

It was furthermore held that the reason the McLaren racing team paid the penalty

was not because it risked being excluded from the world championship (which

might have destroyed its business operations) but because the McLaren racing

team engaged in conduct that did not form part of its trade.

Accordingly, the deduction of the penalty was refused. It is probable that a South

African court might come to the same conclusion even though section 23(g) of

the Act, which previously required deductible expenditure to have been laid out

'wholly and exclusively' for purposes of trade, similar to the requirement in the

UK, has been amended. The section currently provides that expenses are

deductible to the extent incurred for purposes of trade. Given the facts of the

McLaren case, it would be unlikely that McLaren would be able to discharge the

burden of proof that at least some amount was incurred for purposes of its trade.

Since the penalty was intended to be a punishment, it still does not form part of

the expenditure laid out for the trade of the taxpayer.

Cliffe Dekker Hofmeyr

Interpretation Note No. 80

ITA: Sections 23(g) and 23(o)

16  

INTERNATIONAL TAX

2397. Dividend payments to Holland

Dividends paid by a South African company to a resident of the Netherlands may

be subject to a dividend tax rate of 0% in South Africa. The premise of this

interpretation is based on Article 10(10) of the Protocol issued under the

Netherlands/South Africa double tax agreement (DTA), which provides as

follows:

“If under any convention for the avoidance of double taxation concluded after the

date of conclusion of this Convention between the Republic of South Africa and

a third country, South Africa limits its taxation on dividends as contemplated in

subparagraph a) of paragraph 2 of this Article to a rate lower, including exemption

from taxation or taxation on a reduced taxable base, than the rate provided for in

subparagraph a) of paragraph 2 of this Article, the same rate, the same exemption

or the same reduced taxable base as provided for in the convention with that third

State shall automatically apply in both Contracting States under this Convention

as from the date of the entry into force of the convention with that third State.”

What this section means is that where South Africa has concluded a DTA with

any other country after the date of conclusion of the Netherlands/South Africa

DTA, and such other DTA provides for, inter alia, the complete exemption of

dividends from dividends tax, the provisions of such DTA will automatically

apply to the Netherlands/South Africa DTA, with the result that the dividends

will similarly be exempt from dividend tax in SA.

There are currently only 3 DTAs to which SA is a party to and which provide for

the complete exemption of dividend tax, namely the DTAs with Cyprus, Kuwait

and Oman. The test, therefore, is to determine whether any of these DTAs were

concluded after the conclusion of the Netherlands/South Africa DTA.

17  

The definition of the word “concluded” is absent from the DTAs, and the

Netherlands/South Africa DTA does not shed any light on when the document is

deemed to be “concluded”. According to the Netherlands/South Africa DTA, the

document was signed on 10 October 2005, and the date of entry into force is 28

December 2008, with the provisions of the Convention having effect for taxable

years and periods beginning on or after 1 January 2009. Having regard to the

SARS website, the publication date of the document is 23 January 2009.

The Kuwait/South Africa DTA, on which reliance is placed, was signed on 17

February 2004 and it was, according to the SARS website, published on 20 April

2007. In terms of Article 29 of the DTA itself, the date of entry into force is 25

April 2006.

As a result of this confusion between all these dates, a view has been expressed

that, because the actual convention between SA and Netherlands was concluded

in 2005, and because the DTA between SA and Kuwait came into force 25 April

2006, which is after this conclusion date, it may have the result that reliance can

be placed on the Kuwait/South Africa DTA to reduce the South

Africa/Netherlands dividends tax rate to 0%.

The writers have, in their previous article, issued a word of caution in that it is

likely that this position will not be attainable. After having had further discussions

with SARS, SARS’ view is that this is indeed the case.

As stated above, it is evident from Article 10(10) that reliance can only be placed

on the date of conclusion of a DTA. From a legal perspective, there are reported

judgments in SA that have held that word ‘concluded’, along with other common

usage variants, including the words “signed” and “reached”, all have to be

interpreted in the context of the notion of finality, i.e. when the agreement or

contract becomes ‘a binding act’ or a ‘final determination’. If this view is to be

accepted in the context of any DTA, the date of conclusion of any DTA would be

18  

the date when such DTA reaches “finality”. Such date could either be the date

when the DTA was signed or the date of entry into force, depending on the facts

and interpretation of each DTA, which would certainly require further, detailed

analysis of each DTA.

SARS’ interpretation, however, seems to be that the date of ‘conclusion’ of both

the Kuwait/South Africa and South Africa/Netherlands DTAs are regarded as the

date when they were signed and, therefore, the 0% tax rate in the Kuwait/South

Africa DTA cannot apply to Article 10(10).

Interestingly, however, similar to Article 10(10) of the Netherlands/SA DTA,

Article 10(6) of the Sweden/South Africa DTA has a catch-all clause that “if any

agreement or convention between South Africa and a third state provides that

South Africa shall exempt from tax dividends (either generally or in respect of

specific categories of dividends) arising in South Africa, or limit the tax charged

in South Africa on such dividends (either generally or in respect of specific

categories of dividends) to a rate lower than that provided for …. such exemption

or lower rate shall automatically apply to dividends arising in South Africa and

beneficially owned by a resident of Sweden … under the same conditions as if

such exemption or lower rate had been specified…”

What is notable is that Article 10(6) in the Sweden/South Africa DTA does not

have any reference to the date of conclusion of the relevant DTA. This,

undoubtedly, will create arguments that a 0% dividends tax rate should apply to

dividends paid by a SA company to a Swedish resident shareholder which is the

beneficial owner of such dividend.

Of course articles of this nature are not intended to constitute advice, but rather

to air important tax issues in order to stimulate debate. Prior to entering into any

transactions it is, unquestionably, necessary to take detailed advice in relation

both to the law and also to the taxpayer’s particular factual circumstances. A

relevant issue in relation to the above legal analysis is that the public is not privy

19  

to the bilateral negotiations involving DTAs, and therefore does not necessarily

have all the information pertaining to what was intended by these clauses.

It is also important to gauge the position of SARS in relation to such issues and

part of the debate which our articles are intended to stimulate involves gaining

insight into SARS’ position on these points. To this end our understanding of

SARS’ position is that, as set out above, the Kuwait/South Africa DTA was not

concluded after the South Africa/Netherlands DTA.

(Editorial Comment: This article highlights the need for DTAs to be examined

very carefully before application of their rules.)

ENSafrica

DTA : South Africa /Netherlands and South Africa / Kuwait

TAX ADMINISTRATION ACT

2398. Mitigation of penalties and interest

Judgment was handed down in the Tax Court on 18 November 2014 in the case

of Z v The Commissioner for the South African Revenue Service (case number

13472), as yet unreported.

The dispute concerned the calculation by the taxpayer of his capital gains tax

liability arising pursuant to the disposal of shares. In 2007 the taxpayer disposed

of his shares in a company for R841 million. In and around the time of the

disposal of the shares, a company (A) instituted a damages claim against the

taxpayer for an amount of R925 million which related to a transaction that took

20  

place in 2003. Shortly after the damages action was instituted, the taxpayer agreed

to pay A an amount of almost R700 million in full and final settlement of its

claim.

In determining his capital gains tax liability for the 2008 year of assessment, the

taxpayer deducted a portion of the settlement amount paid to A from the purchase

price received for the disposal of his shares, which the taxpayer regarded as his

proceeds for purposes of paragraph 35 of the Eighth Schedule to the Income Tax

Act No. 58 of 1962 (the Act). The Commissioner for the South African Revenue

Service (Commissioner) disagreed with the taxpayer’s adjustment to the proceeds

from the disposal of the shares and increased the proceeds by the portion of the

settlement amount to arrive at the original proceeds of R841 million.

Various technical arguments were raised by the taxpayer as to why the proceeds

from the disposal of the shares should be reduced by a portion of the settlement

amount paid to A.

However, the Court agreed with the Commissioner’s findings that the inclusion

of the full amount received by the taxpayer for the sale of the shares for the 2008

year of assessment is unassailable and the appeal must be dismissed.

The purpose of this article is not to discuss the technical arguments surrounding

the application of paragraph 35 of the Eighth Schedule. The interesting aspect of

the case relates to the imposition of understatement penalties in terms of section

221 of the Tax Administration Act No. 28 of 2011 (the TAA) and interest in terms

of section 89quat of the Act (as it read at the time).

In the context of the understatement penalties imposed under the TAA, the

Commissioner had imposed a penalty of R47 million on the basis of “reasonable

care not taken” by the taxpayer or “no reasonable grounds existing for the tax

21  

position taken”. The reasons cited by the Commissioner for reaching this decision

was that “the legislation and the facts are clear”.

The Court indicated that it was common cause that the TAA operates

retrospectively and its provisions, including section 270(6D), should apply. It

appears that the question of whether these provisions of the TAA and the decision

to impose such penalty may be unconstitutional and / or subject to an

administrative review application were not dealt with by the Court.

In any event, if these issues were to be raised it would most likely have to be

dealt with in a separate application to the High Court.

The Court concluded that the taxpayer's conduct constituted a “substantial

understatement” (as defined in the TAA) and the penalty falls to be reduced from

70% to 10%. In reaching this conclusion, we note that:

the Court held at paragraph 40 that it was of the view that “having received

advice, there were reasonable grounds for the appellant to take the tax

position which it did. Nor can it be said that he did not take reasonable

care – he did so by consulting the experts”;

the Court referred to the Tax Court, in the United States of America case

of Estate of Spruill v Commissioner [1987] 88 TC 1197, which had to

determine whether the fraud penalty was appropriately applied to an

understatement of estate tax resulting from a large under evaluation of

property. The valuation in turn was determined with the advice of an

attorney and an accountant and was based on an independent appraisal.

The court, in rejecting the penalty, had the following to say (88 TC 1197:

1245):

“When an accountant or attorney advises a taxpayer on a matter of tax

law, such as whether a liability exists, it is reasonable for the taxpayer to

rely on that advice. Most taxpayers are not competent to discern error in

the substantive advice of an accountant or attorney. To require a taxpayer

to challenge the attorney, to seek a “second opinion”, would nullify the

22  

very purpose of seeking the advice of a presumed expert in the first place.

. . .’

the Court held that while section 270(6D) provides that in certain limited

circumstances, a senior South African Revenue Service official must, in

considering an objection against the imposition of an understatement

penalty, reduce the penalty in whole or in part if satisfied that there were

extenuating circumstances, there was no evidence that there were

extenuating circumstances which would warrant the reduction to below the

understatement penalty.

If one has regard to how Wepener J sought to apply the understatement penalty

provisions in sections 221 and 270(6D), it is noted that:

the Court firstly considered the taxpayer’s behaviour against the

understatement penalty percentage table in section 223. Having regard to

the penalty percentage table:

o It was never contended that there was “gross negligence” or

“intentional tax evasion” by the taxpayer.

o On the basis that the taxpayer obtained professional advice, it was

held that there were “reasonable grounds for the tax position taken”

and it cannot be said that “reasonable care was not taken in

completing the return”.

o The tax return contained a “substantial understatement” as

defined and, as result of the other behaviours being excluded - the

penalty of 10% was imposed.

Only after the Court had tested the taxpayer’s behaviour against the

understatement penalty percentage table did it consider the application of

section 270(6D);

It may be debatable whether the correct approach is to consider section

270(6D) on its own (i.e. without first having regard to the penalty

percentage table).

23  

However, the approach adopted by Wepener J appears to be the most practical

approach and avoids a judicial officer from having an unfettered discretion when

making a determination as to the extent of the reduction of the penalty in terms

of section 270(6D) (i.e. having regard to any extenuating circumstances).

In the context of the request for remission of interest in terms of section 89quat

of the Act (as it read at the time) it was also held that there is no reason not to

find that the taxpayer’s reliance on advice was reasonable and any interest must

be waived in full. It must be appreciated that the wording of section 89quat no

longer refers to “reasonable grounds” being contended by the taxpayer. Section

89quat interest may now only be remitted in “circumstances beyond the control

of the taxpayer”, which is far narrower than the previous wording of section

89quat.

These findings by Wepener J that having received professional advice it cannot

be said that there are “no reasonable grounds for the tax position tax” nor can it

be said that “reasonable care [was] not taken in completing [a] return” should

assist taxpayers when objecting to any understatement penalties imposed in terms

of the TAA.

Cliffe Dekker Hofmeyr

ITA: Section 89quat and Paragraph 35 of the Eighth Schedule

TAA: Sections 221, 223 and 270(6D)

TRANSFER PRICING

2399. Compliance conundrum

By now, most South African taxpayers should be aware that when they enter into

transactions with related parties who are not South African taxpayers, such

transactions should be concluded on terms and prices that are at arm’s length in

nature. The term “arm’s length” essentially indicates a position that two unrelated

24  

parties would adopt in an open market transaction, as a willing buyer and willing

seller. Critical to managing tax risk for any taxpayer that has transactions of this

nature is being able to defend the transfer pricing (TP) position that they have

adopted and the only way to adequately do so is through the preparation of TP

policy documentation.

What is Transfer Pricing documentation?

As a starting point, it is important to highlight that, for now, it is not a statutory

requirement to prepare TP documentation in South Africa – but there is a sting in

the tail, and more on that later. Many years ago, SARS issued Practice Note 7 that

provided guidance on their approach to TP and what TP documentation should

cover.

This Practice Note was largely based on the Organisation for Economic

Cooperation and Development’s (OECD) guidelines. In this process, SARS also

pointed out that TP documentation should be relevant to each taxpayer’s

circumstances and that it was not expected that a taxpayer should spend a

disproportionate amount of money preparing TP documentation.

Unfortunately, many taxpayers have taken a very aggressive position and have

compiled a one or two page document that simply states what price they charge

their related parties – although this may deal with inter-group pricing, it is not

what the OECD and SARS would consider to be a TP document. TP

documentation should provide the user (in most cases, SARS or the South African

Reserve Bank) with insight into the following:

the company and the group it forms part of, what products or services the

group sells and some financial and statistical information like revenue,

profit, number of employees, key locations etc.

the industry the company and group operate in, the regional and global

factors that affect that industry, the competitive landscape, etc.

25  

the functions that the company undertakes, the various risks it assumes and

the assets it uses to perform the said functions

the TP methodology that the taxpayer has elected to use in determining and

setting its prices and why it has not used any of the other recognised TP

methods

if appropriate (which in most cases it is), an economic analysis supported

by benchmarking studies and analysis, the outcome of which is a pricing

range commonly referred to as the inter-quartile arm’s length range.

In the context of what SARS expects to see when a taxpayer says that they

have prepared a TP document, when a taxpayer presents a one-page

document to SARS, they arguably compromise their position even further.

Critically, a taxpayer needs to discharge the onus of proof on why their

pricing is considered to be at arm’s length and merely stating that one

thinks that the price is fair does not do so. SARS, and any other revenue

authority, will want to see objective data or market information that

provides appropriate support. Coming back to the sting in the tail – when

submitting an ITR14 tax return, the taxpayer is required to do so on an

arm’s length basis. When answering questions relating to related party

transactions with non-residents, the taxpayer is asked to confirm whether

they have a TP policy document.

If the taxpayer answers “no”, there is an immediate red flag, as SARS will

question how the taxpayer knows that the tax return is submitted on an arm’s

length basis when he has not prepared TP documentation. By not having adequate

documentation or any documentation at all, the taxpayer is immediately on the

back foot – a precarious position from which to engage with SARS! The

alternative is to prepare appropriate TP documentation that could also serve to

reduce any potential penalties that SARS may wish to impose on the finalisation

of any TP audit by SARS.

26  

Grant Thornton

ITA: Section 31

2400. OECD’s BEPS Action Plan

Transfer pricing and the concept of the Organisation for Economic Co-operation

and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Action

Plan have been receiving attention in the South African media and Parliament for

quite some time. Recently, on 19 November 2014, a session on transfer pricing

was held during a meeting of Parliament’s mineral resources and finance

committees. Presentations by the National Treasury and the South African

Revenue Service (SARS) during this session provide insight into possible future

transfer pricing legislation in South Africa. Most notably:

Over the last three years, the SARS Transfer Pricing unit has audited more

than 30 cases and made transfer pricing adjustments of over R20 billion

with an income tax impact of R5 billion.

A similar number of cases are currently in progress and others are in the

process of being risk assessed.

Legislative requirements for multinational enterprises (MNEs) to maintain

specific transfer pricing documentation is to be considered.

Legislative measures to address outcomes of the BEPS Action Plan (e.g.

country-by-country reporting) are to be considered.

Legislative framework for Advance Pricing Agreements (APAs) is to be

considered, as such advance agreements on transfer pricing between

taxpayers and SARS could alleviate the enforcement burden and encourage

compliance.

While tighter legislation may be needed, SARS recognizes the vital

importance of a balanced response within the confines of domestic and

international law, while not posing a deterrent to foreign direct investment.

27  

Detailed discussion

Background

Over the past few months, transfer pricing and BEPS have been the subject of

discussions by Members of Parliament on various occasions. In September 2014,

one Member of Parliament called for a “comprehensive and clearly articulated

law which forbids transfer pricing” during a beneficiation colloquium of

Parliament’s portfolio committee on trade and industry.1 Earlier last year, transfer

pricing and the possible instances of BEPS in the mining sector were a topic of

discussion during a meeting of the Portfolio Committee on Mineral Resources.2

Against this background, the National Treasury and a research executive of SARS

presented on South Africa’s Tax Policy Structure and Transfer Pricing and BEPS

respectively during the meeting of Parliament’s mineral resources and finance

committees on 19 November 2014.

Corporate Income Tax, BEPS and Transfer Pricing

The presentation by National Treasury on South Africa’s tax policy structure

(with a focus on corporate income tax) and the presentation by the SARS research

executive provided a brief overview of the current corporate income tax base and

an explanation of what transfer pricing entails. While the presentations were part

of the meeting of the mineral resources and finance committees, it was noted that

the extractive industry, from a transfer pricing and BEPS perspective is

essentially no different than any other sector and is therefore not the sole cause

of concern.

Measures against BEPS

The issues of transfer pricing and BEPS were touched upon in the context of

South Africa’s need for foreign investment in light of the twin budget and current

account deficits. Most significant foreign investment comes from MNEs, which

are inherently engaged in cross-border transactions with related parties, e.g.

through the sale of goods, intangibles transactions, the provision of services and

the provision of funding. While such cross-border transactions are in principle

28  

beneficial, they can result in abuse when used to shift profits in order to exploit

differences in tax rates between the countries involved. In other words, transfer

pricing itself is an essential feature of cross-border activities of MNEs and only

“transfer mispricing” is not acceptable.

The threat of BEPS for the corporate income tax base and the tax implications of

cross-border transactions and international taxation were addressed. It was noted

that South Africa plays a key role as a member of the BEPS Bureau Plus and that

a number of measures have already been implemented to address BEPS, some

even before the BEPS Action Plan was released by the OECD in July 2013.3 Such

measures include rules and regulations regarding transfer pricing, controlled

foreign companies, interest deduction limitations, hybrid instruments and entities,

the digital economy and exchange of tax information.

In addition, the Transfer Pricing unit established at the Large Business Centre of

SARS was mentioned as one of the responses to the threat of BEPS. In this regard,

it was noted that:

Audits require scarce skills, are resource intensive, requiring understanding

of company, industry, global value chain, strategic decision making,

business models, etc. and take at least 18 months.

As a result of limited resources there is a focus on strategic auditing – high

risk, high value transactions.

Over the last three years the Transfer Pricing unit has audited more than 30

cases and made transfer pricing adjustments of just over R20 billion (as a

conservative measure) with an income tax impact of R5 billion.

A similar number of cases are currently in progress and others are in the

process of being risk assessed.

The extractive industry is no different to any other sector and the industry

is not the sole cause of concern. However, due to the size and significance

of this sector in South Africa, it remains a key area of focus for SARS.

29  

Implications

SARS indicated it takes the protection of the South African tax base seriously and

there will be an ongoing focus on strengthening SARS capacity and capability.

At the same time, there will be a continual review of audit and risk assessment

processes and an ongoing dialogue with MNEs on levels of tax compliance. On

an international level, SARS will continue its participation in and co-operation

with inter alia the OECD, the United Nations, the African Tax Administration

Forum (ATAF) and the World Bank. It will also continue its co-operation with

other tax administrations and review international approaches to the extractive

industry.

With respect to the future of transfer pricing and possible measures against BEPS,

it was specifically mentioned that:

Legislative requirements for MNEs to maintain specific transfer pricing

documentation is to be considered.

Legislative measures to address outcomes of the BEPS Action Plan (e.g.

country-by-country reporting) are to be considered.

Legislative framework for Advance Pricing Agreements (APAs) is to be

considered, as such advance agreements on transfer pricing between

taxpayers and SARS could alleviate the enforcement burden and encourage

compliance.

As a closing remark, SARS noted there is no easy solution and it has to work

within the confines of both domestic and international law. While tighter

legislation may be needed, SARS recognized it is vitally important to respond in

a manner that is balanced and does not pose a deterrent to foreign direct

investment. In this regard, it is worth noting that additional measures may come

from the Davis Tax Committee following its review of the corporate tax system

with special reference to tax avoidance (e.g., base erosion, income splitting and

profit shifting).4

30  

Endnotes

1. Clamour to end transfer pricing abuse, Linda Ensor, 4 September 2014.

See http://www.bdlive.co.za/business/2014/09/04/clamour-to-end-

transfer-pricing-abuse.

2. Portfolio Committee on Mineral Resources, National Assembly,

Wednesday 2 July 2014.

3. See http://www.oecd.org/ctp/BEPSActionPlan.pdf for more information.

4. On 17 July 2013, the South African Minister of Finance announced the

members of a tax review committee (the Davis Tax Committee) to inquire

into the role of the tax system in the promotion of inclusive economic

growth, employment creation, development and fiscal sustainability. See

http://www.taxcom.org.za/ for more information.

Ernst & Young Inc.

ITA: Section 31

SARS NEWS

2401. Interpretation notes, media releases and other documents

Readers are reminded that the latest developments at SARS can be accessed on

their website http://www.sars.gov.za.

Editor: Mr P Nel

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof

KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC Foster

The Integritax Newsletter is published as a service to members and associates of

The South African Institute of Chartered Accountants (SAICA) and includes

31  

items selected from the newsletters of firms in public practice and commerce and

industry, as well as other contributors. The information contained herein is for

general guidance only and should not be used as a basis for action without further

research or specialist advice. The views of the authors are not necessarily the

views of SAICA.