Treaty shopping — should SA even care?
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.