Treaty shop­ping — should SA even care?

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

THE Or­gan­i­sa­tion for Eco­nomic Co-op­er­a­tion and De­vel­op­ment (OECD) re­leased its re­port on base ero­sion and profit shift­ing last month. This re­port ad­dresses 15 ac­tion points iden­ti­fied by the OECD un­der its base ero­sion and profit-shift­ing (BEPS) man­date.

From a South African per­spec­tive, the Davis Tax Com­mit­tee has been set up, in­ter alia, to ad­dress the is­sue of BEPS in a South African con­text.

An is­sue con­sid­ered by the OECD as part of its BEPS re­ports is that of “treaty shop­ping”. This is also be­ing dealt with by the Davis Tax Com­mit­tee.

Ac­cord­ing to the OECD, “treaty shop­ping” is an abuse or an im­proper use of a tax treaty, be­ing con­trary to the ob­jec­tives of the treaty. “Treaty shop­ping” oc­curs where tax­pay­ers who are not res­i­dents of con­tract­ing states seek to ob­tain the ben­e­fits of a tax treaty by plac­ing a com­pany or an­other type of le­gal en­tity in one of the coun­tries to serve as a con­duit for in­come earned in the other coun­try.

The UN Com­men­tary on ar­ti­cle 1 of the UN Model Con­ven­tion states: “A guid­ing prin­ci­ple is that the ben­e­fits of a dou­ble tax­a­tion con­ven­tion should not be avail­able where a main pur­pose for en­ter­ing into cer­tain trans­ac­tions or ar­range­ments was to se­cure a more favourable tax po­si­tion and ob­tain­ing that more favourable treat­ment in th­ese cir­cum­stances would be con­trary to the ob­ject and pur­pose of the rel­e­vant pro­vi­sions.”

In a South African con­text, treaty shop­ping could ap­ply in the con­text of, for ex­am­ple, a par­ent com­pany with a South African sub­sidiary where the par­ent com­pany has ad­vanced in­ter­est­bear­ing loan fund­ing to its sub­sidiary. How­ever, due to the in­tro­duc­tion of the new in­ter­est with­hold­ing tax, the par­ent com­pany now looks to route its loan fund­ing to its South African sub­sidiary through a com­pany in an in­ter­me­di­ate ju­ris­dic­tion which has a more favourable dou­ble tax agree­ment with SA. Such an agree­ment would then not al­low SA to im­pose its in­ter­est with­hold­ing tax on in­ter­est paid by the South African sub­sidiary to the com­pany in the in­ter­me­di­ate ju­ris­dic­tion.

The ques­tion arises whether and to what ex­tent SA should care about treaty shop­ping. As set out in the ex­am­ple above, if a par­ent com­pany chooses to in­vest into SA through an in­ter­me­di­ate ju­ris­dic­tion with a more ben­e­fi­cial agree­ment, is such par­ent com­pany not sim­ply struc­tur­ing its in­vest­ment in a tax ef­fi­cient man­ner, as per­mit­ted in terms of South African case law?

In this re­gard there is sig­nif­i­cant com­pe­ti­tion for tax rev­enues on a world­wide ba­sis. Ju­ris­dic­tions are in­cen­tivised to en­ter into as many dou­ble tax agree­ments as pos­si­ble and then also to of­fer tax in­cen­tives, in­ter alia, to at­tract multi­na­tion­als into their ju­ris­dic­tions.

It is not in SA’s in­ter­est if SA at­tacked for­eign in­vestors for in­vest­ing in SA via an in­ter­me­di­ate ju­ris­dic­tion with a favourable agree­ment. In terms of SA’s head­quar­ter com­pany regime, SA en­cour­ages for­eign in­vestors who wish to in­vest in, in­ter alia, var­i­ous African ju­ris­dic­tions to in­vest in th­ese ju­ris­dic­tions via SA and thereby take ad­van­tage of SA’s agree­ments with such African states. This will have the ef­fect of re­duc­ing the amount of tax paid by such for­eign in­vestors in the African ju­ris­dic­tions and will in­crease the amount of tax rev­enue gen­er­ated by the South African fisc.

South African tax law al­ready pro­vides sev­eral de­fences against treaty shop­ping. Three im­por­tant de­fences in this re­gard are the con­cepts of “ben­e­fi­cial own­er­ship” and “ef­fec­tive man­age­ment” as well as the use of this coun­try’s do­mes­tic anti tax-avoid­ance rules.

Take the above ex­am­ple of the par­ent com­pany look­ing to route its loan fund­ing to its South African sub­sidiary through a com­pany in an in­ter­me­di­ate ju­ris­dic­tion with a favourable agree­ments with SA. If the com­pany set up in the in­ter­me­di­ate ju­ris­dic­tion does not qual­ify as the “ben­e­fi­cial owner” of the in­ter­est re­ceived from the South African sub­sidiary then the terms of the rel­e­vant agree­ments will not be ap­pli­ca­ble. SA can there­fore at­test whether such com­pany qual­i­fies as the ben­e­fi­cial owner of the in­ter­est.

A fur­ther is­sue is whether the com­pany in the in­ter­me­di­ate ju­ris­dic­tion is “ef­fec­tively man­aged” in that ju­ris­dic­tion. If it is a “post box com­pany” with no sub­stance then it is likely that it will not be “ef­fec­tively man­aged” in that in­ter­me­di­ate ju­ris­dic­tion and SA can then ig­nore the pro­vi­sions of the rel­e­vant agree­ment and im­pose its in­ter­est with­hold­ing tax on the pay­ments made to that com­pany.

SA also has anti tax-avoid­ance pro­vi­sions. In terms of th­ese rules if the “sole or main pur­pose” of a tax­payer was to ob­tain a “tax ben­e­fit” and cer­tain ab­nor­mal fea­tures ex­ist in re­spect of such ar­range­ment, the anti tax-avoid­ance rules can be ap­plied to dis­re­gard the trans­ac­tion en­tered into by the par­ties.

It is not in our in­ter­est to at­tack for­eign in­vestors for in­vest­ing in this coun­try via an in­ter­me­di­ate ju­ris­dic­tion

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

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