South Africa: Residency, Permanent Establishment And Liability For Tax Of A Mauritian Trust (Recent Developments in Taxation, July 2011)

Originally published in Recent Developments in Taxation, July 2011

This brief provides a synopsis of a recent tax judgement on residency, information on proposed amendments to the Income Tax Act; the Customs Control and Customs Duty Bills; and the Permanent Voluntary Disclosure Programme

On 13 June 2011, the Western Cape High Court handed down judgement on a case in which the court was approached by the trustees of a trust established in Mauritius (the Trust) for a declaratory order that:

• the Trust is neither a resident nor does it have a permanent establishment in South Africa and is therefore not liable or chargeable to tax in South Africa; and
• the Commissioner for the South African Revenue Service (Commissioner) is liable to repay an amount of R20 million unilaterally removed from the Trust's South African bank account. This was done based on a purported tax assessment issued by the Commissioner and after appointing the bank as agent of the Trust in terms of section 99 of the Income Tax Act, No. 58 of 1962 (the Act). The amount of R20 million was removed from the Trust's bank account by the Commissioner before the "due date" indicated on the "assessment letter".

The applicant, being the sole trustee of the Trust, was incorporated and situated in Mauritius, whilst the Trust had assets and business relations in South Africa.

The Commissioner issued the tax assessment in question, seeking to hold the Trust liable to tax in South Africa, on the basis that:

• the Trust was a resident as defined in the Act by virtue of having its place of effective management (POEM) in South Africa; and
• the Trust derived income sourced in South Africa and carried on business through a permanent establishment in South Africa.

The crux of the matter before the court was whether the High Court could exercise its discretion to issue the declaratory relief sought by the applicant. In order to do so, it had to be established that the issues on which relief were sought were purely of a legal nature. It is settled law that the High Court has jurisdiction to hear and decide on income tax cases turning on legal issues, as opposed to findings of fact, only.

The application for a declaratory order was brought on the basis that the Commissioner requested certain information from the Trust in terms of section 74A of the Act, which applies to "taxpayers". Consequently, the applicant averred that it was entitled to know whether it is obliged to respond to the Commissioner's request and this depends on whether it is liable to tax in South Africa.

The applicant submitted that the High Court was not requested to adjudicate on the tax assessment made by the Commissioner (the applicant had already instituted appeal proceedings in terms of the normal alternative dispute resolution rules for the matter to be heard by the Tax Court). Instead, the applicant requested the High Court to pronounce on a purely legal question regarding residency as opposed to carrying on business through a permanent establishment. The applicant was agreeable that the decision be taken based on facts which are common cause and indicated that no factual disputes existed.

The Commissioner contended that the declaratory order sought was not purely a legal question, but mixed questions of fact and law. It therefore contended that the High Court was required to adjudicate on the integral aspects of the tax assessment.

In pronouncing judgement, the court referred to case law and stated that when all material facts are "fully found" and "sufficiently clear", the question of whether the facts are such as to bring the case within the provisions of some statutory enactment, is one of law. Only in such instance will the High Court have the necessary power to adjudicate on the particular matter, i.e.: it will be a legal question.

It was further held that for the High Court to declare that the Trust is not a resident of the Republic, it would need to make factual findings (e.g.: where is the Trust's key management situated? where were the commercial decisions necessary to conduct the Trust's business made during the years in question?). It was stated that all the material facts relating to the management of the Trust have not been "fully found" and are not "sufficiently clear" in order to simply pose the question whether the facts are such as to bring this case within the definition of "resident" properly construed.

The court concluded that whether or not the Trust is a resident of South Africa is not, at this stage, simply a question of law. Furthermore, the issues in question will have to be decided before the Tax Court. It was therefore not appropriate for the High Court to make the declaratory orders requested.

Although the court found that the removal of the R20 million before the "due date" was impermissible and unlawful, it found that the declaratory order requested for the repayment of the amount of R20 million could not be issued for two reasons:

• While the "due date" for the payment of the tax component of the "assessment" had not yet come when the money was deducted, the interest component was already payable at that stage. The R20 million recovered through the section 99 agency appointment was therefore in respect of the interest already due and payable.
• Even if the above is not the case, at the time the application for the declaratory order was made, the "due date" indicated on the "assessment letter" had passed and the full assessed amount had fallen due for payment. Consequently, it would serve no purpose to issue the declaratory order sought by the applicant as the Commissioner would immediately (after the order for repayment by the court) in any event appoint the bank as agent again to return the R20 million back to the Commissioner.

This judgement indicates that the question of "residency" based on POEM and permanent establishment issues is not purely legal. As such, the answer will have to be determined based on an evaluation of all the relevant facts and circumstances.

The judgment unfortunately did not clarify whether or not the applicant is obliged to respond to the Commissioner's questions in terms of section 74A before the matter proceeds to the Tax Court, which could take a substantial amount of time.

While the facts were not "fully found" or "sufficiently clear" to make the issues under consideration issues of law and enable the court to exercise its discretion to grant the declaratory relief, the court made some comments indicating that it had taken a view on the facts. These include that, "it would appear that at least some key management decisions and at the very least key commercial decisions necessary for the conduct of [the Trust's] business were in substance made in South Africa" and further that the business of the Trust, "was carried on at the very least partly through a fixed place of business in South Africa".

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.