During November 2005 a discussion paper was released by the South African Revenue Service ("SARS") with a view to tightening the provisions of the current general anti-avoidance rule ("GAAR") in a South African context. It is indicated that the current GAAR has proven to be an inconsistent and sometimes ineffective deterrent to the increasingly complex and sophisticated tax products that are being marketed by South African financial institutions. In particular, transactions incorporating the use of circular flows of funds, special purpose vehicles and other accommodating parties and the use of derivatives have been identified as being the source of anti-avoidance transactions. A distinction is made between impermissible tax avoidance and legitimate tax planning. Legitimate tax planning entails a transaction where a taxpayer takes advantage of a fiscally attractive option afforded to him by the tax legislation and generally suffers the economic consequences that the legislature intended to be suffered by those taking advantage of the option. An example of this type of transaction would be whether or not a new business would be operated through means of a company or a sole proprietorship. The concept of impermissible tax avoidance has been indicated to include the manipulation of the law and the focus on form and legal effect rather than substance. These transactions generally have little or no actual economic impact upon the taxpayer. The so-called badges of anti-avoidance schemes have been said to be –
- the lack of economic substance;
- the use of tax indifferent accommodating parties or special purpose vehicles;
- unnecessary steps and complexity;
- inconsistent treatment for tax and financial accounting purpose;
- high transaction costs;
- fee variation clauses or contingent fee provisions;
- tax haven arrangements;
- the use of derivatives.
The current GAAR contains four provisions, namely –
- a transaction, operation or scheme;
- a tax effect;
- a sole or main purpose to obtain a tax benefit.
Although it is envisaged that these four requirements will be retained, a number of amendments have been proposed, especially in view of the Enron and Parmalat events that took place internationally. These amendments entail the following –
- a non-excusive set of factors will be introduced in determining abnormality for schemes. In addition, the burden of proof will be on a taxpayer to disprove abnormality where certain of these factors are present;
- GAAR may be applied to steps within a larger scheme and not only to the overall transaction;
- GAAR may be applied in the alternative. In other words, SARS can rely on specific provisions of the Act and, in the alternative, argue that GAAR is applicable;
- new penalties will be introduced for scheme promoters and for taxpayers that substantially underreport their income;
- the purpose of the taxpayer is to be determined objectively by reference to the relevant facts and circumstances and no longer subjectively.
With reference to the relevant indicia of abnormality, some of them may have far reaching consequences. For instance, some of them are –
- the time at which the arrangement or any step or part thereof was entered into and the length of period during which the arrangement or step was carried out;
- the form and economic substance of the arrangement;
- a circular flow of assets;
- the participation of a tax indifferent party or a special purpose vehicle;
- inconsistent treatment of any items or amounts for tax purposes by the parties to the arrangement (such as the payment of a deductible interest expense and the receipt of an exempt dividend);
- the lack of any change in the financial position of any person resulting from the arrangement;
- the absence of a reasonable expectation of a pre-tax profit.
It is to be welcomed that the abnormality requirement will be retained. However, it seems that, in most cases, even a financial lease will potentially be seen to be abnormal and it will be up to a taxpayer to discharge the burden of proof that the transaction is not abnormal given the circumstances in question. The problem is that, once abnormality is proven, the burden of proof is also on the taxpayer to discharge the onus what the sole or one of the main purposes to the transaction may have been. This requirement will now be tested objectively, which may be relatively difficult as a main purpose would more often than not be present, even though it may not be the predominant purpose in the circumstances.
The date of promulgation of the amendments is still to be finalised.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.