New weapon in the war on tax erosion
SOUTH Africa is now one of 70 countries that will use an internationally developed instrument to implement taxtreaty measures to prevent the erosion of its tax base.
The multilateral instrument (MLI), which was signed into use by the countries earlier this month, is one of 15 action plans developed by the Organisation for Economic Co-operation and Development (OECD) to prevent base erosion and profit shifting.
The instrument amends all of South Africa’s double-taxation treaties and aims to eliminate “treaty shopping”, whereby taxpayers arrange their affairs in order to derive the most benefit from a tax treaty without having a substantive presence in a country.
Ernest Mazansky, a director at Werksmans Tax, says the instrument will produce a “momentous change” to the way in which international tax planning and structuring is undertaken.
There are still many unanswered questions, but it will be a new world for international tax planners, says Mazansky.
Robyn Berger, the international corporate tax director at KMPG, says the MLI sets minimum standards to prevent abuses and defines what constitutes a taxable presence in a treaty country.
“South African businesses need to urgently review all of their cross-border transactions where they rely on the provisions of an existing doubletax agreement to avoid double taxation, or which may impact the rate of tax payable. This is to ensure their international operations are not adversely impacted by the changes.”
The G20 finance ministers mandated the OECD several years ago to address base erosion and profit shifting.
The organisation developed the 15 action plans to assist governments with domestic and international instruments to address tax avoidance and to ensure that profits are taxed where economic activities generate the profits. The MLI is one of those action plans.Mazansky says that, from a South African perspective, the most significant change will probably be the much stricter provisions against treaty shopping.
“Hitherto it has not been difficult to reduce withholding taxes by interposing companies in tax-friendly jurisdictions with favourable tax treaties,” Mazansky says.
“Now, through one or other method, the tax authority in the paying country could deny the lower withholding rate under the treaty concluded with the country of the interposed entity, if it (the company) was interposed as a treaty-shopping exercise.”
Mazansky says that South Africa has adopted the “principal purpose test”, in terms of which if one of the principal purposes of interposing the foreign shareholder, creditor or licensor company was to benefit from the treaty, as opposed to having a commercial purpose, the treaty’s benefits can be denied.
The OECD says the instrument allows countries to update tax treaties with provisions reflecting internationally agreed standards on tax avoidance.
More than 1 100 of the 2 300 treaties between the signatory countries will be modified by the MLI. It is likely that the first modifications will become effective next year.
Berger says if countries had to renegotiate each double-taxation agreement separately, it would take years. “The MLI has the effect of amending all the agreements subject to it. This allows for a quick solution to introduce base erosion and profit-shifting changes into double-tax agreements.”
She says the MLI introduces measures that curb abuse by taxpayers who implement artificial structures principally to access double-taxation agreements to eliminate or reduce tax. Although South Africa already has effective anti-avoidance measures to curb such structures, the MLI provides more specific measures.
Berger says the application of the MLI is complex, resulting in uncertainty.
“Not all double-tax agreement partners agree to institute the same base erosion and profit-shifting measures. Countries have the option to opt out of certain measures, or to select specific ways in which to introduce other measures.”