SA moves in line with global tax principles
THE concept of residency is an important tax concept globally as many countries follow a residence-based tax system. For South African tax purposes, a corporate person like a company or a trust is regarded as a resident if it is incorporated, established or formed in SA or if it has its place of effective management in SA.
Effective management of an entity (mostly trusts or companies) has given rise to some contentious issues about its meaning as it is not defined in SA’s tax legislation. The South African Revenue Service (SARS) issued Interpretation Note: No 6 — 26 March 2002 (the IN6) to provide guidance as to the meaning of the concept of “place of effective management” from a South African tax perspective.
Although IN6 provides some much needed guidance on this concept, it also ironically provides a meaning that is vastly different from the meaning given to the concept by the rest (or most) of the international tax community and in particular, the Organisation for Economic Co-Operation and Development (OECD). This has often lead to challenging assessments of risk where South African domestic law interpretation on effective management was at odds with a treaty interpretation.
In recent years, SARS has been the regional leader on issues of international tax, including issues relating to base erosion and profitshifting. More recently, the Davis Tax Committee was appointed with the goal of assessing SA’s tax policy framework. It therefore came as no surprise when SARS recently published a draft second issue of the IN which now provides an interpretation of the concept of place of effective management which is more aligned with international tax principles.
Under IN6, the concept of place of effective management was stated to be the place where the entity is managed on a regular or day-to-day basis by the directors or senior managers of the entity irrespective of where the overriding control is exercised, or where the board of directors meets. The reference to management by the directors or senior managers is to the execution and implementation of policy and strategy decisions (ie the place of implementation of the entity’s overall group vision and objectives).
Some of the facts to be taken into account in determining the place of effective management include, but are not limited to:
Where the business operations are actually conducted;
Where the directors or senior managers or the designated manager, who are responsible for the day-to-day management reside;
The actual activities and physical location of senior employees;
The frequency of the meetings of the entity’s directors or senior managers and where they take place; and
The scale of onshore as opposed to offshore operations.
Under the Draft IN, the place of effective management is now considered to be the place where key management and commercial decisions that are necessary for the conduct of its business as a whole are in substance made. The Draft IN goes on to state that the place of effective management test is one of substance over form which looks to those persons who actually “call the shots” and exercise realistic positive management. This interpretation is in contrast to the interpretation under IN6 which focuses on the place where decisions are implemented. The approach under the Draft IN is now consistent with the commentary of the OECD which looks to the place where key decisions are made.
Some of the key facts and circumstances that must be examined in determining an entity’s effective management include, but are not limited to:
The location of the entity’s head office, being the place where the entity’s senior management are predominantly located. This fact will generally be a major factor in determining an entity’s place of effective management as the head office of an entity generally represents the place where key decisions are made by the MD and financial director of the entity.
The location where the board of the entity regularly meets and makes decisions. Factors such as whether the directors are suitably qualified and experienced and whether they have sufficient knowledge and information at hand to make decisions may be taken into account in determining whether the directors are the actual decisionmakers or are merely rubberstamping decisions made by others. In addition, issues concerning the modernisation of communications, information technology and global travel may be taken into account, for example, the use and frequency of round robin voting.
The location where the members of executive committees to whom the board has delegated some or all of its authority to, sits.
The place where the top level management as opposed to the operational management sits. This is because operational management generally concerns the oversight of day-to-day business operations and activities of an entity whereas key management deal with broader strategic and policy decisions.
Issues such as the entity’s place of incorporation and the location of its registered office will generally not be relevant in the determination of an entity’s place of effective management. Similarly, nor will the extent of an entity’s economic nexus with a country.
SARS notes that it does not anticipate that the application of the Draft IN will result in many, if any, entities previously held to have their place of effective management outside SA now being held to have it in SA, and vice versa. In our view, this remains to be seen and all companies with foreign subsidiaries and investments will be well advised to reassess the effective management of all offshore companies, especially given the substance over form approach to be adopted. The onus of proof will be on the taxpayer and the ability to prove, with documentary evidence, where the company was in substance managed and commercial decisions were made is also likely to require special planning. This change will also pave the way for SARS to add a much more effective weapon to their armoury when attacking offshore structures.
South African domestic law interpretation on effective management to align with international principles
Peter Dachs and Bernard du Plessis are directors and joint heads of ENSafrica’s tax department.