Global tax symmetry can gnaw at vital national tax bases
There is no doubt that we live in a time of economic nationalism. Trump’s “America first” slogan swept him to victory in the 2016 presidential election and he is now making good on that rhetoric by, for example, imposing tariffs on the import of steel to the US.
Similarly, the UK is hinting at using tax as a threat in its Brexit negotiations, in terms of which it would compete with the EU jurisdictions using tax rates and incentives.
SA’s 2018 budget commented that our current corporate tax rate of 28% is relatively high when compared to, for example, the US at 21% (down from 35%), the UK at 19% (down from 30%) and the Netherlands at 21% (down from 26%). As pointed out in the budget, various African jurisdictions may have a comparable or even slightly higher corporate tax rates than SA, but this is often offset or reduced by incentives and tax holidays.
There is a global competition for tax base and one way of increasing this is to stimulate investment and economic growth. This is important for SA as we emerge from a decade of low growth, political instability and wasteful expenditure.
At odds with this concept of economic nationalism are the Organisation for Economic Co-operation and Development’s (OECD’s) reports, aimed at curbing base erosion and profit shifting (Beps). Certain of these reports are aimed at achieving global tax symmetry.
For example, in terms of the hybrid mismatch rules, it is recommended that before a country grants a tax deduction to a taxpayer in respect of certain financial instruments, it should check to see whether the payment is taxable in the recipient’s jurisdiction.
This means that another jurisdiction has a say in the application of our domestic tax rules.
The submission of the Beps reports has led to the implementation of the multilateral instrument. This amends many of SA’s double tax agreements with other jurisdictions in order to implement various Beps action plans.
The multilateral instrument has a so-called minimum standard that requires signatory countries such as SA to prevent the abuse of tax treaties and impose improved dispute resolution mechanisms.
The prevention of treaty abuse is interesting. In terms of these new provisions, which will apply to many of SA’s double tax agreements, the “principal purpose test” will be adopted. In terms of this test, in order to obtain benefits under a double tax agreement, a taxpayer will have to demonstrate that obtaining the relevant benefit was not one of its principal purposes. What does this mean in practice?
Say a South African company has invested in another jurisdiction with which SA has a double tax agreement that reduces the foreign withholding tax from 20% to 0%. The foreign jurisdiction may now argue that one of the principal purposes of the South African taxpayer entering into the transaction was to achieve such a reduction. They may then impose their withholding tax at 20% and not 0%.
SA would then lose this tax revenue to the foreign jurisdiction, as it would have to grant a tax credit for the withholding tax suffered in the foreign jurisdiction. Alternatively, the taxpayer would suffer double tax until this matter is resolved.
In a globally competitive world where tax is one element of that competition, should we be concerned about global tax symmetry and how other jurisdictions apply their tax rules, or should we be primarily concerned with obtaining our share of the global tax take?
COMPETITION FOR TAX BASE IS ONE ELEMENT OF THAT COMPETITION, AND PERHAPS SA SHOULD DO ALL IT CAN TO MAXIMISE ITS SHARE
We could concentrate on becoming the gateway into Africa. We already have tax rules providing incentives for foreigners to invest into African jurisdictions through SA. Part of the idea is that these investors use SA’s favourable double tax agreements with various African jurisdictions to reduce the withholding taxes paid in such jurisdictions. However, these foreign investors are now at risk that the African jurisdictions will apply the principal purpose test in respect of their double tax agreements with SA, thereby negating the very benefits SA seeks to offer such investors.
The world is a competitive place. Competition for tax base is one element of that competition, and perhaps SA should do all it can to maximise its share of the global tax base.