SA moves in line with global tax prin­ci­ples

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

THE con­cept of res­i­dency is an im­por­tant tax con­cept glob­ally as many coun­tries fol­low a res­i­dence-based tax sys­tem. For South African tax pur­poses, a cor­po­rate per­son like a com­pany or a trust is re­garded as a res­i­dent if it is in­cor­po­rated, es­tab­lished or formed in SA or if it has its place of ef­fec­tive man­age­ment in SA.

Ef­fec­tive man­age­ment of an en­tity (mostly trusts or com­pa­nies) has given rise to some con­tentious is­sues about its mean­ing as it is not de­fined in SA’s tax leg­is­la­tion. The South African Rev­enue Ser­vice (SARS) is­sued In­ter­pre­ta­tion Note: No 6 — 26 March 2002 (the IN6) to pro­vide guid­ance as to the mean­ing of the con­cept of “place of ef­fec­tive man­age­ment” from a South African tax per­spec­tive.

Although IN6 pro­vides some much needed guid­ance on this con­cept, it also iron­i­cally pro­vides a mean­ing that is vastly dif­fer­ent from the mean­ing given to the con­cept by the rest (or most) of the in­ter­na­tional tax com­mu­nity and in par­tic­u­lar, the Or­gan­i­sa­tion for Eco­nomic Co-Op­er­a­tion and De­vel­op­ment (OECD). This has of­ten lead to chal­leng­ing assess­ments of risk where South African do­mes­tic law in­ter­pre­ta­tion on ef­fec­tive man­age­ment was at odds with a treaty in­ter­pre­ta­tion.

In re­cent years, SARS has been the re­gional leader on is­sues of in­ter­na­tional tax, in­clud­ing is­sues re­lat­ing to base ero­sion and prof­it­shift­ing. More re­cently, the Davis Tax Com­mit­tee was ap­pointed with the goal of as­sess­ing SA’s tax pol­icy frame­work. It there­fore came as no sur­prise when SARS re­cently pub­lished a draft sec­ond is­sue of the IN which now pro­vides an in­ter­pre­ta­tion of the con­cept of place of ef­fec­tive man­age­ment which is more aligned with in­ter­na­tional tax prin­ci­ples.

Un­der IN6, the con­cept of place of ef­fec­tive man­age­ment was stated to be the place where the en­tity is man­aged on a reg­u­lar or day-to-day ba­sis by the di­rec­tors or se­nior man­agers of the en­tity ir­re­spec­tive of where the over­rid­ing con­trol is ex­er­cised, or where the board of di­rec­tors meets. The ref­er­ence to man­age­ment by the di­rec­tors or se­nior man­agers is to the ex­e­cu­tion and im­ple­men­ta­tion of pol­icy and strat­egy de­ci­sions (ie the place of im­ple­men­ta­tion of the en­tity’s over­all group vi­sion and ob­jec­tives).

Some of the facts to be taken into ac­count in de­ter­min­ing the place of ef­fec­tive man­age­ment in­clude, but are not lim­ited to:

Where the busi­ness oper­a­tions are ac­tu­ally con­ducted;

Where the di­rec­tors or se­nior man­agers or the des­ig­nated man­ager, who are re­spon­si­ble for the day-to-day man­age­ment re­side;

The ac­tual ac­tiv­i­ties and phys­i­cal lo­ca­tion of se­nior em­ploy­ees;

The fre­quency of the meet­ings of the en­tity’s di­rec­tors or se­nior man­agers and where they take place; and

The scale of on­shore as op­posed to off­shore oper­a­tions.

Un­der the Draft IN, the place of ef­fec­tive man­age­ment is now con­sid­ered to be the place where key man­age­ment and com­mer­cial de­ci­sions that are nec­es­sary for the con­duct of its busi­ness as a whole are in sub­stance made. The Draft IN goes on to state that the place of ef­fec­tive man­age­ment test is one of sub­stance over form which looks to those per­sons who ac­tu­ally “call the shots” and ex­er­cise re­al­is­tic pos­i­tive man­age­ment. This in­ter­pre­ta­tion is in con­trast to the in­ter­pre­ta­tion un­der IN6 which fo­cuses on the place where de­ci­sions are im­ple­mented. The ap­proach un­der the Draft IN is now con­sis­tent with the com­men­tary of the OECD which looks to the place where key de­ci­sions are made.

Some of the key facts and cir­cum­stances that must be ex­am­ined in de­ter­min­ing an en­tity’s ef­fec­tive man­age­ment in­clude, but are not lim­ited to:

The lo­ca­tion of the en­tity’s head of­fice, be­ing the place where the en­tity’s se­nior man­age­ment are pre­dom­i­nantly lo­cated. This fact will gen­er­ally be a ma­jor fac­tor in de­ter­min­ing an en­tity’s place of ef­fec­tive man­age­ment as the head of­fice of an en­tity gen­er­ally rep­re­sents the place where key de­ci­sions are made by the MD and fi­nan­cial di­rec­tor of the en­tity.

The lo­ca­tion where the board of the en­tity regularly meets and makes de­ci­sions. Fac­tors such as whether the di­rec­tors are suit­ably qual­i­fied and ex­pe­ri­enced and whether they have suf­fi­cient knowl­edge and in­for­ma­tion at hand to make de­ci­sions may be taken into ac­count in de­ter­min­ing whether the di­rec­tors are the ac­tual de­ci­sion­mak­ers or are merely rub­ber­stamp­ing de­ci­sions made by oth­ers. In ad­di­tion, is­sues con­cern­ing the mod­erni­sa­tion of com­mu­ni­ca­tions, in­for­ma­tion tech­nol­ogy and global travel may be taken into ac­count, for ex­am­ple, the use and fre­quency of round robin vot­ing.

The lo­ca­tion where the mem­bers of ex­ec­u­tive com­mit­tees to whom the board has del­e­gated some or all of its au­thor­ity to, sits.

The place where the top level man­age­ment as op­posed to the op­er­a­tional man­age­ment sits. This is be­cause op­er­a­tional man­age­ment gen­er­ally con­cerns the over­sight of day-to-day busi­ness oper­a­tions and ac­tiv­i­ties of an en­tity whereas key man­age­ment deal with broader strate­gic and pol­icy de­ci­sions.

Is­sues such as the en­tity’s place of in­cor­po­ra­tion and the lo­ca­tion of its reg­is­tered of­fice will gen­er­ally not be rel­e­vant in the de­ter­mi­na­tion of an en­tity’s place of ef­fec­tive man­age­ment. Sim­i­larly, nor will the ex­tent of an en­tity’s eco­nomic nexus with a coun­try.

SARS notes that it does not an­tic­i­pate that the ap­pli­ca­tion of the Draft IN will re­sult in many, if any, en­ti­ties pre­vi­ously held to have their place of ef­fec­tive man­age­ment out­side SA now be­ing held to have it in SA, and vice versa. In our view, this re­mains to be seen and all com­pa­nies with for­eign sub­sidiaries and in­vest­ments will be well ad­vised to re­assess the ef­fec­tive man­age­ment of all off­shore com­pa­nies, es­pe­cially given the sub­stance over form ap­proach to be adopted. The onus of proof will be on the tax­payer and the abil­ity to prove, with doc­u­men­tary ev­i­dence, where the com­pany was in sub­stance man­aged and com­mer­cial de­ci­sions were made is also likely to re­quire spe­cial plan­ning. This change will also pave the way for SARS to add a much more ef­fec­tive weapon to their ar­moury when at­tack­ing off­shore struc­tures.

South African do­mes­tic law in­ter­pre­ta­tion on ef­fec­tive man­age­ment to align with in­ter­na­tional prin­ci­ples

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

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