Non-residents must beware taxman’s bite
WHERE a foreign company renders professional services to a South African company, it is important that the foreign entity considers whether, as a result of rendering such services, the foreign company will create a permanent establishment in SA. The reason why this becomes important is that where a foreign company creates a permanent establishment in SA, SA will under the provisions of a double taxation agreement (DTA) concluded with another country, be entitled to subject that foreign entity to tax on the profit attributable to that permanent establishment created in SA.
In the case of X LLC, case number 13276 heard in February 2015, as yet unreported, the Tax Court had to determine whether X had created a permanent establishment in SA, and as a result thereof, was liable to tax in SA. The case involved a corporation incorporated in the US and the court therefore had to consider the provisions of the DTA concluded by SA and the US.
Article 7(1) of the DTA provides that the profits of an enterprise of the US shall be taxable only in the US, unless that enterprise conducts business in SA through a permanent establishment located in SA. The DTA also provides that where business is carried on through a permanent establishment, the profits of the enterprise may be taxed in SA, but only to the extent that they are attributable to that permanent establishment.
Article 5(1) of the DTA in turn provides as follows:
“…for the purposes of this Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on”.
In addition, Article 5(2) of the DTA provides that the term “permanent establishment” includes especially:
“(k) the furnishing of services, including consultancy services, within a contracting state by an enterprise through employees or other personnel engaged by the enterprise for such purposes, but only if activities of that nature continue (for the same or connected project) within that state for a period or periods aggregating more than 183 days in any 12-month period commencing or ending in the taxable year concerned.”
The court had to decide how the DTA should be interpreted and whether it was necessary for X to have met the requirements of both Articles 5(1) and 5(2)(k) of the DTA.
The taxpayer contended that it is necessary that a permanent establishment be created first and only once that has occurred, is it then necessary to take account of the provisions of Article 5(2)(k) of the DTA. SARS on the other hand, argued that if X fell within the provisions of Article 5(2)(k) a permanent establishment exists and it is not necessary that X met the requirements of Article 5(1).
Judge Vally in his judgment handed down on 15 May 2015 reached the conclusion that Articles 5(1) and 5(2)(k) cannot be read disjunctively. He expressed the view that as a result of the usage of the words “includes especially” Article 5(2)(k) of the DTA should be read as specifying those specific activities which will be regarded as creating a permanent establishment in SA. The Tax Court reached the decision that taking account of the number of days spent by X’s staff in SA, it met the time requirement specified in Article 5(2)(k) of the DTA and for that reason a permanent establishment had been created in SA. The court also concluded that X had a fixed base in the boardroom of its client in SA, and had thus established a fixed place of business in SA while rendering services to its client in SA.
In assessing X to tax in SA, SARS levied tax on the fees derived by X in SA, after deducting therefrom attributable expenditure and imposed additional tax of 100% and interest on the underpayment of provisional tax in accordance with section 89quat(2) of the Income Tax Act. The court reached the decision that the additional tax was not disproportionately punitive and therefore dismissed the appeal against the additional tax. Insofar as the imposition of interest is concerned, the court expressed the view that X should have familiarised itself with the taxation laws of the country within which it conducts its operations, and for that reason it was decided that X had been negligent in not seeking advice regarding the tax consequences of the contract concluded with its client. The court therefore came to the conclusion that SARS was correct in imposing interest on the underpayment of provisional tax.
Based on the above case, which admittedly deals with the interpretation of articles contained in the SA and US tax agreement, it is important that non-residents rendering services to clients in SA must evaluate whether they will create a permanent establishment in SA, thereby triggering income tax on the profit attributable to the services rendered in SA.
If the non-resident creates an enterprise as envisaged under the provisions of the VAT Act, it would also be necessary to register for VAT purposes, and charge VAT on the fees received from the resident client and pay that to SARS. Where persons from abroad are sent to SA to render the services that may, depending on the circumstances and the provisions of the DTA in question, give rise to the nonresident entity being required to register as an employer in SA with the obligation to withhold and deduct PAYE from amounts paid to the persons sent to SA.
Clearly, any South African tax paid by the non-resident entity, would under the terms of the DTA be recognised as a credit claimable against tax paid in the home jurisdiction of the entity. Nonresident employees who become liable to tax in SA should also be entitled to claim such tax as a credit in their home jurisdiction under the DTA in question.
It is important therefore that non-resident entities rendering services into SA carefully consider how to plan and structure their affairs in SA, so that they do not fall foul of the provisions of the Income Tax Act read together with any applicable DTA.
Creation of a permanent establishment leaves foreign firms servicing local companies open to tax liabilities
Dr Beric Croome is a tax executive at ENSafrica.