Dissecting avoidance framework
Davis committee forced into an OECD straitjacket to find base erosion through OECD lens
THE Davis Tax Committee is to be commended for performing the Herculean task of fully reviewing the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) reports despite the short time frame and lack of extensive staff support.
The scale of the project is massive, and one can see that the committee has made an exhaustive attempt to cover all aspects of the OECD work. The committee is also to be commended for seeking local economic data.
Although the committee worked hard to contextualise the BEPS debate so that the debate had a South African flavour, the real problem for the committee was the mandate itself. The action points of the OECD clearly have a strong European flavour. For instance, the committee rightfully points out that management and technical fees pose a greater threat to the South African tax base than the OECD focus on intellectual property fees.
As a result, the committee was wrongfully forced into an OECD straitjacket to find base erosion through an OECD lens. This is not to say that SA does not have base erosion — just that South African base erosion is probably occurring from a different source.
Indeed, the committee’s information on management and related service fees highlights this fact, but the OECD action points unfortunately do not specifically address these concerns beyond improved general documentation associated with transfer pricing.
The committee’s focus on tax treaties was rightfully identified as a probable concern. However, the actual avoidance at stake within SA needs to be clarified. For instance, treaty shopping in terms of dividend payments via countries such as Mauritius are not really an issue because the Mauritian treaty dividend rates match the rates found in most treaties (and dividends do not cause base erosion in the OECD sense because dividend payments by a South African company are not deductible). The bigger concern is interest, service and royalty payments when applied in the case of tax treaties involving low-tax jurisdictions. If revenue is to be protected, a more comprehensive policy strategy needs to be considered, focusing specifically on low-tax jurisdictions that have an adverse impact on the South African tax base, and specific information relating to these outflows would have been helpful. Unfortunately, the format of the OECD action points do not facilitate this approach — instead seeking a generic response for all tax treaties.
That said, the committee’s overall emphasis on clarifying the application of the domestic general anti-avoidance rule and support of subjective antiavoidance rules within treaties themselves probably can be supported as a reasonable generic response.
Within the introductory note, the committee strongly raises the point that anti-avoidance must be measured against South Africa’s need for competitiveness. Most practitioners will undoubtedly take comfort that the committee recognises the need for this balance and, indeed, the overall tone of the report takes a very measured response. Nonetheless, I expect some commentators to criticise the report for its failure to discuss the issue of tax and competitiveness (other than a brief discussion of the headquarter company issue). To be fair to the committee, the issue of competitiveness is outside the core mandate of the OECD report, meaning that the issue of tax and competitiveness has to be an item reserved for another day. The line between antiavoidance and competitiveness can be preserved as long as anti-avoidance measures do not inadvertently impact non-tax motivated commercial transactions (easier said than done).
In terms of transfer pricing, the committee again took a balanced approach. While SA will clearly follow international trends in this regard, many businesses will undoubtedly support an approach that provides documentation relief in terms of materiality. The international “paper/systems burden” of compliance in the tax and regulatory arena is quickly becoming a heavy expense for many companies, and company resources dedicated to these efforts are falling short of international demand. The question is how to simplify information requests while enhancing government access to useful information, something clearly requiring an enhanced dialogue between government and taxpayers.
All-in-all, practitioners should welcome the committee’s thoughtful and open approach in the debate even if certain points may be of concern. One would hope that practitioners will respond constructively with additional information and that the government will properly take into account the measured nature of the committee’s approach when formalising proposals (without one-sided cherry-picking).
From a larger perspective though, one does wonder whether the BEPS report was the best use of committee resources in a time-period when the government is seeking to raise significant revenues via closing loopholes. Although the closure of some loopholes raised by the committee using the OECD lens may raise small pockets of revenue, a committee mandate starting with a more South African-centric factual/legal paradigm would probably have been more fruitful.