Effect of base erosion and profit shifting steps
ON JULY 17 2013 the Davis Tax Committee was established. One of its subcommittees was mandated to investigate base erosion and profit shifting (BEPS).
The Davis Tax Committee submitted its first interim report on BEPS in September 2014. This report dealt with seven of the 15 actions identified by the Organisation for Economic Co-operation and Development (OECD). The Davis Tax Committee then asked for public comments in May last year in respect of its second interim report on the remaining eight actions.
In October last year the OECD released its final report on all 15 actions. This report covers a wide range of topics including hybrid mismatches, permanent establishment issues, transfer pricing as well as other reports on a range of topics.
The question is how these OECD actions will impact on South African taxpayers. There are various ways in which this will occur.
First, to the extent that the OECD actions are endorsed by the Davis Tax Committee and then, if its recommendations are accepted, are enacted into South African domestic tax law by way of amendments to the Income Tax Act.
Second, to the extent that the OECD actions result in amendments to double tax agreements to which SA is a party or result in amendments to the OECD Commentary on the Model Tax Convention. These will affect South African taxpayers as part of the body of public international law.
This will likely occur both by way of amendments to existing double tax agreements as well as the introduction of a multilateral instrument that would have the effect of a re-negotiation of SA’s many double tax agreements. The idea in respect of the multilateral instrument is that it replaces the need for SA to approach each of its tax treaty partners and enter into extensive and lengthy negotiations with each of those parties.
Third, to the extent that the actions are accepted by the jurisdictions in which South African taxpayers have subsidiaries or other forms of taxable presence since the tax treatment of such subsidiaries will be in accordance with the relevant actions.
Take just one of the actions covered by the OECD and Davis Tax Committee, namely “hybrid mismatch arrangements”.
These essentially identified three types of hybrid arrangements — hybrid entities, hybrid transfers and hybrid instruments.
It is interesting that in various respects South African domestic tax law has already taken account of certain hybrid mismatches. For example the definition of a “foreign partnership” essentially provides that if an arrangement is treated as tax transparent in another jurisdiction it will also be transparent from a South African tax law perspective and will therefore constitute a “company” as defined in section 1 of the Income Tax Act.
The definition of a “foreign dividend” also looks to the foreign tax law (or company law) to determine whether a payment is viewed as a dividend or similar payment. If so it will be treated as a foreign dividend for South African tax purposes.
A foreign dividend is not exempt from South African tax in circumstances where that payment is tax deductible in the other jurisdiction.
Section 23M to some extent deals with circumstances where interest is deductible by a South African taxpayer, but such interest is not subject to tax in the jurisdiction of the lender. In these circumstances, where the lender forms part of a controlling group with the South African taxpayer a ratio is applied to limit the quantum of the deduction by the South African taxpayer.
The OECD action on hybrid mismatch arrangements states that, as a primary rule, payments should not be deductible in one jurisdiction if they are not included in the (taxable) income of the taxpayer in the other jurisdiction. As a defensive rule (ie in circumstances where a jurisdiction does allow a deduction for such payments) then the other jurisdiction should not exempt such payments from tax.
Various jurisdictions are in the process of incorporating these rules into their domestic tax law. They will therefore not provide a tax deduction for payments made to South African taxpayers in circumstances where such South African taxpayers are exempt from tax on these payments.
In conclusion, amendments have already been made to the Income Tax Act to deal with hybrid mismatch arrangements and there is no doubt that more amendments will be introduced over time.
However, taxpayers should also keep an eye on amendments in respect of double tax agreements and other amendments to international public law affecting South African taxpayers as well as amendments made by other jurisdictions to their domestic tax law which will impact on multinational groups of companies.
OECD’s report on actions include amendments to double tax agreements
Peter Dachs and Bernard du Plessis are directors and joint heads of ENSafrica’s tax department.