Rul­ing where a sense of place is im­por­tant

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Peter Dachs & Bernard du Plessis

Lo­cal tax law should fol­low OECD model in defin­ing where ef­fec­tive man­age­ment takes place

THE con­cept of ef­fec­tive man­age­ment is of fun­da­men­tal im­por­tance in de­ter­min­ing whether a com­pany is a res­i­dent of a con­tract­ing state in terms of a dou­ble tax agree­ment.

How­ever, no sin­gle in­ter­na­tion­ally ac­cepted mean­ing of the term “place of ef­fec­tive man­age­ment” ex­ists and the In­come Tax Act does not con­tain a def­i­ni­tion of this term.

This con­cept has been the sub­ject of for­eign court de­ci­sions and the South African Rev­enue Ser­vice (SARS) has also is­sued guide­lines.

Para­graph 24 of the Commentary of the Or­gan­i­sa­tion for Eco­nomic Co-op­er­a­tion and Devel­op­ment on Ar­ti­cle 4 of the OECD Model Tax Con­ven­tion on In­come and Cap­i­tal states that the term “ef­fec­tive man­age­ment” es­sen­tially refers to the “place where key man­age­ment and com­mer­cial de­ci­sions nec­es­sary for the con­duct of the en­tity’s busi­ness are in sub­stance made”.

In terms of the OECD guide­lines, the place of ef­fec­tive man­age­ment is de­ter­mined with ref­er­ence to, amongst oth­ers, the fol­low­ing:

The place where the “real” board of di­rec­tors (as op­posed to ap­pointed “straw men”) ac­tu­ally make de­ci­sions on im­por­tant busi­ness af­fairs of the com­pany;

The place where im­por­tant de­ci­sions are taken as op­posed to the place where they are for­mally re­solved (ie rub­ber-stamped); and

The place where im­por­tant man­age­ment de­ci­sions are taken and/or ex­er­cised as op­posed to dayto-day ad­min­is­tra­tive man­age­ment.

While the mean­ing of the term “place of ef­fec­tive man­age­ment” has not been an­a­lysed in de­tail by South African courts, the High Court ac­knowl­edged in The Oceanic Trust Co Ltd NO and the Com­mis­sioner for SARS (Case 22556/09) that the place of ef­fec­tive man­age­ment of a person, other than a nat­u­ral person, is the place where key man­age­ment and com­mer­cial de­ci­sions that are nec­es­sary for the con­duct of a person’s busi­ness are in sub­stance made. This is in line with in­ter­na­tional prece­dent.

How­ever, SARS’s in­ter­pre­ta­tion of the con­cept of “ef­fec­tive man­age­ment”, as set out in the In­come Tax In­ter­pre­ta­tion Note No 6, is­sued by SARS on March 26 2002 (“In­ter­pre­ta­tion Note 6”), does not ac­cord with in­ter­na­tional prece­dent or the Oceanic case. SARS out­lines its gen­eral ap­proach as fol­lows:

The place of ef­fec­tive man­age­ment is the place where the com­pany is man­aged on a reg­u­lar or day-to-day ba­sis by di­rec­tors or se­nior man­agers of the com­pany, ir­re­spec­tive of where the over­rid­ing con­trol is ex­er­cised or where the board meets; and

Man­age­ment by these di­rec­tors or se­nior man­agers refers to the ex­e­cu­tion and im­ple­men­ta­tion of pol­icy and strate­gic de­ci­sions made by the board and it can also be re­ferred to as the place of im­ple­men­ta­tion of the en­tity’s over­all group vi­sion and ob­jec­tives.

If these man­age­ment func­tions are ex­e­cuted at a sin­gle lo­ca­tion, then the ef­fec­tive man­age­ment of the com­pany will be lo­cated in that ju­ris­dic­tion. How­ever, if these func­tions are not ex­e­cuted in the same ju­ris­dic­tion (ie where di­rec­tors or se­nior man­agers man­age via dis­tance com­mu­ni­ca­tion), In­ter­pre­ta­tion Note 6 states that the ef­fec­tive man­age­ment would be best re­flected where the day-to-day op­er­a­tional man­age­ment and com­mer­cial de­ci­sions taken by the se­nior man­agers are im­ple­mented, ie the place where the busi­ness op­er­a­tions/ac­tiv­i­ties are car­ried out or con­ducted. This is the strong­est in­di­ca­tion of a “tie-breaker” where el­e­ments of (ef­fec­tive) man­age­ment oc­cur in more than one ju­ris­dic­tion.

SARS then goes on to say there is no hard and fast rule and ef­fec­tive man­age­ment will be de­ter­mined on a case by case ba­sis with ref­er­ence, among oth­ers, to the var­i­ous fac­tors listed in In­ter­pre­ta­tion Note 6.

Dur­ing Septem­ber 2011, SARS re­leased a dis­cus­sion pa­per on In­ter­pre­ta­tion Note 6. The dis­cus­sion pa­per notes that In­ter­pre­ta­tion Note 6 has been sub­ject to crit­i­cism in a num­ber of ar­eas. In par­tic­u­lar, the “gen­eral ap­proach” fol­lowed therein, namely to fo­cus on the place where strate­gic de­ci­sions and poli­cies are ex­e­cuted and im­ple­mented, as op­posed to the place where those de­ci­sions are taken or adopted, is crit­i­cised. It is ac­knowl­edged in the dis­cus­sion pa­per that In­ter­pre­ta­tion Note 6 has caused un­cer­tainty by “adopt­ing an ap­proach that ap­pears to con­flict with the weight of in­ter­na­tional au­thor­ity in­so­far as the gen­eral ap­proach fo­cuses on the place where strate­gic de­ci­sions are ‘ex­e­cuted and im­ple­mented’ rather than on the place where the de­ci­sion­mak­ing, in sub­stance, takes place”. Ac­cord­ingly, it is in­di­cated that to more closely align the ap­proach of In­ter­pre­ta­tion Note 6 with in­ter­na­tional norms, ref­er­ences to “im­ple­men­ta­tion of strat­egy” are to be deleted.

A pro­posal made in the dis­cus­sion pa­per is to re­fine, with­out aban­don­ing, the gen­eral ap­proach of In­ter­pre­ta­tion Note 6. The gen­eral ap­proach is to con­tinue fo­cus­ing on the “sec­ond level of man­age­ment” although it is to be clar­i­fied that the pri­mary em­pha­sis is to be on top per­son­nel ex­er­cis­ing “re­al­is­tic pos­i­tive man­age­ment”. It is stated that such in­di­vid­u­als would be se­nior of­fi­cers or ex­ec­u­tives who are re­spon­si­ble for:

Ac­tu­ally de­vel­op­ing or for­mu­lat­ing key op­er­a­tional or com­mer­cial strate­gies and poli­cies for, or tak­ing de­ci­sions on, key op­er­a­tional or com­mer­cial ac­tions by the com­pany;

En­sur­ing that those strate­gies and poli­cies are car­ried out.

In con­sid­er­ing whether a com­pany is ef­fec­tively man­aged in a par­tic­u­lar ju­ris­dic­tion from a South African per­spec­tive, hav­ing re­gard to the OECD guide­lines, South African case law, In­ter­pre­ta­tion Note 6 and the dis­cus­sion pa­per, it is nec­es­sary to cob­ble to­gether a com­pos­ite test. In par­tic­u­lar it is nec­es­sary to have ref­er­ence to the place where:

The im­por­tant man­age­ment de­ci­sions for the com­pany are ac­tu­ally taken (ex­clud­ing share­holder de­ci­sions);

The day-to-day de­ci­sions by se­nior man­age­ment and di­rec­tors are taken;

The place where de­ci­sions are taken which re­late to the devel­op­ment or for­mu­la­tion of the key op­er­a­tional or com­mer­cial strate­gies and poli­cies and en­sur­ing that these strate­gies and poli­cies are car­ried out and im­ple­mented.

The South African do­mes­tic tax law con­cept of ef­fec­tive man­age­ment should fol­low the OECD guide­lines and fo­cus on the place where key man­age­ment and com­mer­cial de­ci­sions are in sub­stance made.

Peter Dachs and Bernard du Plessis are di­rec­tors and joint heads of ENSafrica’s tax de­part­ment.

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