South Africa’s do­mes­tic law — treaty over­ride?

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

WITH the re­cent an­nounce­ment of the in­ten­tion to in­tro­duce a uni­form tax with­hold­ing rate of 15% for div­i­dends, in­ter­est and roy­al­ties, the re­duc­tion of these taxes by for­eign in­vestors into SA will be an in­creas­ingly prom­i­nent fea­ture in plan­ning in­ward in­vest­ment. Ac­cess to, and the use of, SA’S dou­ble tax treaties will play an im­por­tant role in the quest to re­duce these taxes.

Given in­ter­na­tional case law de­vel­oped on treaty shop­ping and re­lated tax plan­ning in re­cent years, as well as the re­cent over­turn­ing of In­dia’s at­tempts in the Voda­fone case, to tax prof­its re­alised through the dis­posal of an in­ter­me­di­ary, the ques­tion arises what the likely stance of the South African Rev­enue Ser­vice (SARS) will be in the event of per­ceived treaty shop­ping and use of in­ter­me­di­ary en­ti­ties in the South African con­text.

Treaty shop­ping en­tails in­ter­pos­ing an in­ter­me­di­ate com­pany in an in­vest­ment or trans­ac­tion struc­ture where the in­ter­me­di­ary en­tity will be able to avail of tax ben­e­fits of the treaty be­tween SA and an­other ju­ris­dic­tion, thereby re­duc­ing with­hold­ing or other taxes that would oth­er­wise have been payable by the ul­ti­mate in­vest­ing en­tity.

Treaty reme­dies avail­able to SARS vary and will de­pend on the terms of the spe­cific treaty. A SARS chal­lenge may be in terms of a lim­i­ta­tion of ben­e­fits clause. These clauses are con­tained in some treaties and would seek to deny the treaty ben­e­fits in cer­tain cir­cum­stances. Al­ter­na­tively the res­i­dence of the in­ter­me­di­ate en­tity in the other treaty ju­ris­dic­tion, or the ben­e­fi­cial own­er­ship by the in­ter­me­di­ary of the amounts re­ceived un­der the treaty, may be chal­lenged. Other spe­cific anti-avoid­ance treaty pro­vi­sions such as the as­so­ci­ated en­ter­prise pro­vi­sions or ex­pan­sive treaty pro­vi­sions al­low­ing do­mes­tic law anti-avoid­ance pro­vi­sions to ap­ply, may also be used.

In ex­treme cases of ex­ten­sive use (or per­ceived abuse) of a treaty, SA may seek to ne­go­ti­ate a pro­to­col to the treaty or even a re­vi­sion of the treaty in its en­tirety. Many treaties in­clude a ter­mi­na­tion clause in terms of which SA can ter­mi­nate a treaty in the event of an un­sat­is­fac­tory out­come to this process. Both of the lat­ter op­tions are, how­ever, long-term reme­dies and would not af­fect on spe­cific trans­ac­tions.

Un­der the In­come Tax Act, SARS can also seek to use the sub­stance over form doc­trine, as ap­plied in the NWK case in 2010, or use the Gen­eral Anti-avoid­ance Rules (“GAAR”). South Africa’s tax treaties, once Gazetted, be­come ef­fec­tive “as if en­acted in this Act”. The Model Tax Con­ven­tion on In­come and on Cap­i­tal raises the ques­tion whether sub­stance over form or gen­eral an­tiabuse rules con­flict with tax treaties. It points out that such rules are part of the ba­sic do­mes­tic tax laws for de­ter­min­ing which facts give rise to a tax li­a­bil­ity. It states that, as a gen­eral rule, there will be no con­flict be­tween these rules and the pro­vi­sions of the rel­e­vant dou­ble tax agree­ment. For ex­am­ple, to the ex­tent that the ap­pli­ca­tion of these rules re­sults in a rechar­ac­ter­i­sa­tion of in­come or in a re­de­ter­mi­na­tion of the rel­e­vant tax­payer who is con­sid­ered to de­rive such in­come, the pro­vi­sions of the dou­ble tax agree­ment will be ap­plied tak­ing into ac­count these changes. How­ever it goes on to state that while these rules do not con­flict with dou­ble tax agree­ments, mem­ber coun­tries should care­fully ob­serve the spe­cific obli­ga­tions en­shrined in dou­ble tax agree­ments to re­lieve dou­ble tax­a­tion where there is no clear ev­i­dence that the dou­ble tax agree­ments are be­ing abused. As such, there is no rea­son why GAAR could not be ap­plied in cir­cum­stances where an in­vest­ment struc­ture into SA, or a cross bor­der trans­ac­tion, con­sti­tutes an im­per­mis­si­ble tax avoid­ance ar­range­ment as con­tem­plated in the GAAR. Philo­soph­i­cally the ap­pli­ca­tion of GAAR in these cir­cum­stances may be more dif­fi­cult for SARS to pur­sue as this will ef­fec­tively amount to the use of SA’S do­mes­tic law pro­vi­sions to “over­ride” treaty ap­pli­ca­tion.

Sim­i­larly, the prin­ci­ple that a tax­payer may ar­range his af­fairs in a man­ner that is most tax ef­fi­cient (for ex­am­ple, as held in the Con­hage case) will be equally ap­pli­ca­ble in the struc­tur­ing of in­ter­na­tional trans­ac­tions and in­vest­ment.

In our ex­pe­ri­ence SARS has to date been a lot more com­fort­able in chal­leng­ing per­ceived in­ter­na­tional tax avoid­ance ar­range­ments based on ap­pli­ca­ble do­mes­tic law pro­vi­sions than un­der the treaties. As­sum­ing a trans­ac­tion or struc­ture has suf­fi­cient sub­stance and com­mer­cial pur­pose (i.e. it would not be vul­ner­a­ble to a sub­stance over form chal­lenge), how­ever, it will be in­ter­est­ing to see whether SARS would seek to fol­low the GAAR route or in­crease its fo­cus on chal­leng­ing the ap­pli­ca­tions of treaty pro­vi­sions un­der the treaties as the pre­ferred rem­edy for per­ceived tax avoid­ance. For ex­am­ple, will SARS ar­gue that an in­ter­me­di­ate en­tity is not the “ben­e­fi­cial owner” of the rel­e­vant in­come and on this ba­sis deny a re­duc­tion in the rel­e­vant with­hold­ing tax. Given some of the con­straints of us­ing do­mes­tic law pro­vi­sions to chal­lenge the use of treaties it is likely one can ex­pect in­creas­ing treaty-based chal­lenges from SARS. While there has not been sub­stan­tial prece­dent in the lo­cal con­text of treaty shop­ping cases, SA is likely to fol­low in­ter­na­tional prece­dent.

It is clear that with the in­tro­duc­tion of the higher with­hold­ing taxes the in­ci­dences where SARS may chal­lenge the ap­pli­ca­tion of re­duced treaty with­hold­ing tax rates are likely to in­crease. Tax­pay­ers that seek to struc­ture their af­fairs in the most tax ef­fi­cient man­ner must com­pre­hen­sively con­sider the likely means of at­tack by SARS in the con­text in­vest­ment and in­ter­na­tional trans­ac­tions.

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

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