Mar­ket pon­ders wide-rang­ing tax changes

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW -

LAST year was a tu­mul­tuous one for South African tax­pay­ers. The Fe­bru­ary Bud­get speech an­nounced sig­nif­i­cant tax law changes. These in­cluded clamp­ing down on tax ar­bi­trage in the form of div­i­dends.

SA’S tax sys­tem ex­empts div­i­dends from nor­mal tax. In terms of the div­i­dend tax pro­vi­sions that will come into ef­fect in April this year such div­i­dends will be sub­ject to a with­hold­ing tax at the rate of 10%. How­ever, in terms of SA’S tax law a full de­duc­tion is al­lowed for in­ter­est pay­ments. This gives rise to tax ar­bi­trage.

The 2011 tax leg­is­la­tion has been the most ag­gres­sive in terms of clamp­ing down on such ar­range­ments. Div­i­dends which are ceded will in fu­ture not ben­e­fit from ex­emp­tion from tax. Fur­ther, where a share­holder does not take eq­uity risk but has se­cu­rity over his share­hold­ing in or­der to pro­tect against un­de­clared or un­paid div­i­dends, all div­i­dends de­clared in re­spect of those shares will be tax­able.

In the mid­dle of 2011 the main in­ter­group rollover pro­vi­sions were sus­pended with im­me­di­ately ef­fect. Shortly there­after they were “un­sus­pended”, but now re­quire preap­proval from the tax au­thor­i­ties in cir­cum­stances where an en­tity is ob­tain­ing an in­ter­est de­duc­tion as a re­sult of the rollover trans­ac­tion. This is in or­der, among oth­ers, to pre­vent trans­ac­tions whereby a com­pany bor­rows money and buys a busi­ness from a group en­tity for cash. The seller then in­vests the cash in, for ex­am­ple, tax ex­empt pref­er­ence shares.

The case which had the most sig­nif­i­cant ef­fect on busi­ness dur­ing the course of the year was C:SARS v NWK Ltd. The facts are com­plex; how­ever, the mes­sage from the Supreme Court of Ap­peal is sim­ple. It is that ev­ery trans­ac­tion, in­clud­ing ev­ery step of a trans­ac­tion, must have a com­mer­cial pur­pose. The court stated that:

“In my view the test to de­ter­mine sim­u­la­tion can­not sim­ply be whether there is an in­ten­tion to give ef­fect to a con­tract in ac­cor­dance with its terms. In­vari­ably where par­ties struc­ture a trans­ac­tion to achieve an ob­jec­tive other than the one os­ten­si­bly achieved they will in­tend to give ef­fect to the trans­ac­tion on the terms agreed. The test should thus go fur­ther and re­quire an ex­am­i­na­tion of the com­mer­cial sense of the trans­ac­tion: of its real sub­stance and pur­pose.”

The mar­ket has been try­ing to come to terms with what this means since it changes ex­ist­ing tax law prin­ci­ple. In par­tic­u­lar the sham doc­trine pre­vi­ously pro­vided that where the par­ties to an ar­range­ment never in­tended to en­force the rights and obli­ga­tions on the same ba­sis that those rights and obli­ga­tions were pre­sented to oth­ers, then the form of the ar­range­ment could be ig­nored and ef­fect be given to the true in­ten­tion of the par­ties. In ad­di­tion, the sub­stance over form doc­trine re­quired the courts not to be bound by the la­bel that par­ties gave to their agree­ment or to their sub­jec­tive per­cep­tion as to the na­ture of the agree­ment, but rather to de­ter­mine the le­gal con­se­quences of any agree­ment by hav­ing re­gard to the true na­ture of the rights and obli­ga­tions agreed to by the par­ties.

Af­ter the NWK case a fur­ther ex­am­i­na­tion is now re­quired as to whether there is a com­mer­cial pur­pose for a par­tic­u­lar trans­ac­tion or leg of a trans­ac­tion.

In 2011 the South African Rev­enue Ser­vice (SARS) won a re­sound­ing vic­tory in the Founders Hill case, where it was held that a re­al­i­sa­tion com­pany did not hold prop­erty on cap­i­tal but rather on a trad­ing ac­count. Tax prac­ti­tion­ers are still de­bat­ing whether and to what ex­tent this overturns ex­ist­ing tax prin­ci­ple that a com­pany may act as a re­al­i­sa­tion com­pany for prop­erty held by an­other en­tity on cap­i­tal ac­count and es­sen­tially in­herit the cap­i­tal in­ten­tion of the orig­i­nal en­tity. The court held that a re­al­i­sa­tion com­pany is not of it­self a de­fence to an at­tack by SARS that the sale of its as­sets gives rise to pro­ceeds of a rev­enue na­ture. The court held that a re­al­i­sa­tion com­pany can hold as­sets as cap­i­tal in spe­cial cir­cum­stances set out in the Berea West case or where there is a need to pro­tect as­sets from the orig­i­nal holder.

The con­trolled for­eign com­pany rules have also been re­vised as SARS looks to sim­plify and con­sol­i­date ex­ist­ing rules re­lat­ing to for­eign com­pa­nies and the cir­cum­stances in which in­come will be al­lo­cated from for­eign sub­sidiaries to their South African share­hold­ers.

Sec­ondary tax on com­pa­nies is be­ing re­placed by div­i­dends tax from April 1 this year. Tax­pay­ers are now gear­ing up for this change. How­ever there is sig­nif­i­cant “grand­fa­ther­ing” al­lowed in that ex­ist­ing sec­ondary tax on com­pa­nies cred­its may be used to off­set against any div­i­dends tax li­a­bil­ity, even though the tax li­a­bil­ity is that of a dif­fer­ent party. The Trea­sury should be com­mended for this con­ces­sion, which has as­sisted in a smooth tran­si­tion from sec­ondary tax on com­pa­nies to div­i­dends tax.

The ad­vance tax rul­ing unit at SARS has be­come an im­por­tant role­player in the South African tax sys­tem. It has proved to be com­mer­cial in its ap­proach to tax prob­lems and its abil­ity to pro­vide bind­ing tax rul­ings has proved in­sight in cir­cum­stances where tax law is un­clear on a par­tic­u­lar point.

2011 has been a year where talk of sim­u­la­tion, the tran­si­tion from sec­ondary tax on com­pa­nies to div­i­dends tax, in­clud­ing the tax­a­tion of div­i­dends in var­i­ous anti-avoid­ance con­texts, has taken the fore­front for tax prac­ti­tion­ers and clients. The other topic on the agenda has been the sus­pen­sion and then amend­ment of the rollover pro­vi­sions.

Peter Dachs and Bernard du Plessis are tax di­rec­tors in the tax di­vi­sion at ENS.

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