Few international and multinational companies in South Africa have escaped a section 31 transfer pricing examination by the South African Revenue Service ("SARS"). A South African company which falls foul of that section faces not only a tax liability under that section but also under section 64C, which deems a section 31 adjustment to be a dividend subject to Secondary Tax on Companies ("STC"). For the purposes of this article I have restricted the discussion to sections 31(2) and 64C(2)(e) only.
Take the example of a group where company L ("Lco") owns all the shares in company H ("Hco"), which in turn owns all the shares in its offshore subsidiary, company F ("Fco"). Both Lco and Hco are South African companies. Hco has advanced an interest free loan to Fco and SARS successfully applies section 31(2) to impute interest income into Hco's hands for making the loan monies available. Furthermore SARS invokes section 64C(2)(e) to levy STC on the amount of imputed interest on the basis that the section 31(2) adjustment is a deemed dividend by Hco to Lco.
The question that begs itself is whether the anti-avoidance measures as applied by SARS go too far.
Section 64C(2)(e) provides - "For the purposes of section 64B, an amount shall, ….. be deemed to be a dividend declared by a company to a shareholder, where —
(e) that amount represents additional taxable income ….. of that company by virtue of any transaction with the shareholder or connected person in relation to such a shareholder, the consideration of which is adjusted in accordance with the provisions of section 31;" (Underlining added)
Section 64B(2) provides - " There shall be levied and paid …. a … secondary tax on companies, … calculated at the rate of 12,5 per cent … of any dividend declared ….." (Underlining added)
"Dividend" is defined in section 1 as "..any amount distributed by a company … to its shareholders…." and "declared" is defined in section 64B(1) as - "in relation to any dividend …. means the approval of the payment or distribution thereof by the directors of the company …. under authority conferred by the memorandum and articles of association of that company."
A dividend comprises a distribution of reserves by a company to its shareholder for the latter's economic benefit. In what way did Lco benefit through Hco omitting to charge interest to Fco? How does section 64C(2)(e) by causing a dividend to be deemed to be declared when a section 31 adjustment is made, somehow correct a mischief relating to dividends?
One can understand how the imputation of interest in Hco's hands corrects the mischief of Hco failing to account for interest income, which it correctly should have in the first place but in what way has the Fisc been deprived of STC on a dividend, which somehow has not been declared through the non-charging of interest?
I understand SARS to argue that Hco's failure to charge interest depleted its reserves by that omission, which could have been declared as a dividend to Lco. This argument is defective on two fronts. Firstly the receipt or accrual of interest income in Hco's hands does not automatically mean that a dividend must be declared out of that interest income. That decision lies with the directors (refer the definition of "declared"). Secondly to the extent that Hco's reserves have suffered, the reserves of Fco have benefited. The overall reserves of the group have not changed one iota and are still available for distribution to Lco. In fact when the reserves are eventually actually distributed to Lco, no regard is given to the STC already paid on the "section 31" deemed dividends. The "net amount" referred to in section 64B(3) only takes into account dividends "declared" and not dividends deemed to be declared. This apparently means, on winding up of the group, that STC will ultimately be levied on an aggregate amount which exceeds actual reserves available for distribution?
Failure to charge interest on a loan cannot, in my view, represent a distribution of reserves by Hco to its shareholder. Hco is in effect taxed twice on the same transaction, namely the granting of an interest free loan to Fco, once through the imputation of interest and again when STC is raised on a deemed dividend.
There is a general presumption that double taxation on the same transaction is anathema, refer COT v Emanuel, 33 SATC 149, where Lewis AJP said at page 158:"At the same time, it could be said that he was offending against the principle which prohibits double taxation." and ITC 1328 (1980), 43 SATC 56, where President, Milne J, said at page 62:"In the first place it is not the intention of the Act to impose double taxation …….."
I grant that 64C(2)(e) if read in a purely mechanical fashion, may allow SARS to act as it does but our courts have consistently held that where the language of a statute is ambiguous and the ambiguity leads to an absurdity that was not contemplated by the legislature, the courts will ignore the ambiguity, refer - Brownstein vs. Commissioner for Inland Revenue, 10 SATC 199 at page 209 ; Commissioner of Taxes vs. Paice, 25 SATC 385, at page 396 and Commissioner for South African Revenue Service vs. Dunblane (Transkei) (Pty) Ltd, 64 SATC 51, (Supreme Court of Appeal) (2001) at page 57.
So let us ask again "how can an economic benefit granted by a company to its subsidiary (a downward benefit) ever result in an upward economic benefit to that company's shareholder?" As a final comment, SARS also refuses Hco relief under section 64B(5)(f) as their view is that the relief only applies in respect of dividends declared and not dividends deemed to be declared, but that is a discussion for another day.
It seems to me that the current application of section 64C(2)(e) by SARS should not go unchallenged.
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