Ruling where a sense of place is important
Local tax law should follow OECD model in defining where effective management takes place
THE concept of effective management is of fundamental importance in determining whether a company is a resident of a contracting state in terms of a double tax agreement.
However, no single internationally accepted meaning of the term “place of effective management” exists and the Income Tax Act does not contain a definition of this term.
This concept has been the subject of foreign court decisions and the South African Revenue Service (SARS) has also issued guidelines.
Paragraph 24 of the Commentary of the Organisation for Economic Co-operation and Development on Article 4 of the OECD Model Tax Convention on Income and Capital states that the term “effective management” essentially refers to the “place where key management and commercial decisions necessary for the conduct of the entity’s business are in substance made”.
In terms of the OECD guidelines, the place of effective management is determined with reference to, amongst others, the following:
The place where the “real” board of directors (as opposed to appointed “straw men”) actually make decisions on important business affairs of the company;
The place where important decisions are taken as opposed to the place where they are formally resolved (ie rubber-stamped); and
The place where important management decisions are taken and/or exercised as opposed to dayto-day administrative management.
While the meaning of the term “place of effective management” has not been analysed in detail by South African courts, the High Court acknowledged in The Oceanic Trust Co Ltd NO and the Commissioner for SARS (Case 22556/09) that the place of effective management of a person, other than a natural person, is the place where key management and commercial decisions that are necessary for the conduct of a person’s business are in substance made. This is in line with international precedent.
However, SARS’s interpretation of the concept of “effective management”, as set out in the Income Tax Interpretation Note No 6, issued by SARS on March 26 2002 (“Interpretation Note 6”), does not accord with international precedent or the Oceanic case. SARS outlines its general approach as follows:
The place of effective management is the place where the company is managed on a regular or day-to-day basis by directors or senior managers of the company, irrespective of where the overriding control is exercised or where the board meets; and
Management by these directors or senior managers refers to the execution and implementation of policy and strategic decisions made by the board and it can also be referred to as the place of implementation of the entity’s overall group vision and objectives.
If these management functions are executed at a single location, then the effective management of the company will be located in that jurisdiction. However, if these functions are not executed in the same jurisdiction (ie where directors or senior managers manage via distance communication), Interpretation Note 6 states that the effective management would be best reflected where the day-to-day operational management and commercial decisions taken by the senior managers are implemented, ie the place where the business operations/activities are carried out or conducted. This is the strongest indication of a “tie-breaker” where elements of (effective) management occur in more than one jurisdiction.
SARS then goes on to say there is no hard and fast rule and effective management will be determined on a case by case basis with reference, among others, to the various factors listed in Interpretation Note 6.
During September 2011, SARS released a discussion paper on Interpretation Note 6. The discussion paper notes that Interpretation Note 6 has been subject to criticism in a number of areas. In particular, the “general approach” followed therein, namely to focus on the place where strategic decisions and policies are executed and implemented, as opposed to the place where those decisions are taken or adopted, is criticised. It is acknowledged in the discussion paper that Interpretation Note 6 has caused uncertainty by “adopting an approach that appears to conflict with the weight of international authority insofar as the general approach focuses on the place where strategic decisions are ‘executed and implemented’ rather than on the place where the decisionmaking, in substance, takes place”. Accordingly, it is indicated that to more closely align the approach of Interpretation Note 6 with international norms, references to “implementation of strategy” are to be deleted.
A proposal made in the discussion paper is to refine, without abandoning, the general approach of Interpretation Note 6. The general approach is to continue focusing on the “second level of management” although it is to be clarified that the primary emphasis is to be on top personnel exercising “realistic positive management”. It is stated that such individuals would be senior officers or executives who are responsible for:
Actually developing or formulating key operational or commercial strategies and policies for, or taking decisions on, key operational or commercial actions by the company;
Ensuring that those strategies and policies are carried out.
In considering whether a company is effectively managed in a particular jurisdiction from a South African perspective, having regard to the OECD guidelines, South African case law, Interpretation Note 6 and the discussion paper, it is necessary to cobble together a composite test. In particular it is necessary to have reference to the place where:
The important management decisions for the company are actually taken (excluding shareholder decisions);
The day-to-day decisions by senior management and directors are taken;
The place where decisions are taken which relate to the development or formulation of the key operational or commercial strategies and policies and ensuring that these strategies and policies are carried out and implemented.
The South African domestic tax law concept of effective management should follow the OECD guidelines and focus on the place where key management and commercial decisions are in substance made.
Peter Dachs and Bernard du Plessis are directors and joint heads of ENSafrica’s tax department.