Originally published 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.
Residency, permanent establishment and liability for tax of a Mauritian trust
By Chemus Taljaard and Henry Isaacs, Directors
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".
Suspension of section 45 of the Act
By Leon Rood, Director
The hiatus of section of 45 of the Income Tax Act, No. 58 of 1962 (the Act) with effect from 3 June 2011 has been highlighted quite significantly in the press. This section of the Act deals with the tax-free transfer of assets within a group of companies. In an attempt to address the uproar, the National Treasury and the South African Revenue Service (the SARS) issued a joint media statement on 29 June 2011 (the media statement) in terms of which an accelerated process to provide certainty in respect of section 45 was announced.
Interested parties were invited to meet with National Treasury and the SARS with the aim of determining, "the characteristics of transactions that do not represent a potential threat to the tax base so that underlying principles or rules can be refined for a more targeted approach to be effective as soon as possible".
It is unclear at this stage how successful this consultation process proved to be as the information and feedback provided by those who came forward will be used to formulate the "rules" which will form part of the amended section 45.
The media statement advises that further opportunities for consultation will be provided before the final response document is published in mid-August.
Despite the media statement and the stated timeframes, there is still no clear indication on whether tax relief for intra-group transfers will be available within the near future. Unfortunately as a result of the "shotgun" approach by the National Treasury and the SARS, all taxpayers are affected, even if a taxpayer's intended transaction does not include any of the tainted elements sought to be prevented by the suspension.
Members of Werksmans Tax Practice have provided the National Treasury with comments on this issue, and remain of the view that any new policy should be adopted in phases so as to avoid prejudicing parties who have bona fide structured their affairs in accordance with the section as it stands.
The fact that there might be perceived abuse in an intra-group transaction under section 45, is merely a symptom of an underlying gap in the Act itself. Our tax system is becoming increasingly sophisticated, and the current year's amendments add to that sophistication.
There are two basic areas in which our tax system woefully lags behind other sophisticated tax systems. They are, in no small measure, the reason for all the complex restructurings undertaken and include:
- The need to allow a deduction for interest on debt raised to acquire a business by buying its shares (i.e.: where a business is acquired, not by acquiring the business itself but rather by acquiring the shares in the company as a whole).
- The delay in implementing group taxation - a more holistic approach, of treating a group as an economic unit with intra-group transactions effectively being disregarded for tax purposes, is now urgently needed.
A reasonable and rational implementation of amendments to address these two areas would greatly reduce the need for complex, and in some cases artificial, structuring to achieve results which should be granted automatically in the law, and are to be found in most sophisticated tax systems.
Customs Control and Customs Duty Bills
By Alison Wood, Director
The SARS Customs authorities recently published the second drafts of the Customs Control Bill and Customs Duty Bill, allowing the public a short period for comments by May and June 2011, respectively.
The Bills are two out of three which are to collectively replace the existing Customs and Excise Act, No. 91 of 1964, as amended annually. The third Bill to make up the balance of the new legislation, and which the SARS has not yet published even a first draft of, is the Excise Duty Bill.
The existing Act, read together with its extensive set of supporting Rules, sets out the basis for customs officials' control of goods being imported and exported; the principles for levying of customs duties; and the detail of how excise duties are levied on certain categories of goods being imported or locally manufactured. These three aspects of the legislation have been separated out and allocated to the relevant new Bill.
The Customs Control Bill is explained by the SARS to be the "platform" for implementing all other tax laws that are concerned with goods being imported into or exported from South Africa. This means that other specified tax acts will ultimately rely on the Customs Control Act for their implementation (and must therefore be read with the Customs Control Act).
One of those "specified" tax acts which will depend on the Customs Control Act for implementation, is the Customs Duty Bill when it becomes an act. Another is the planned Excise Duty Act. In addition, the Value-Added Tax (VAT) and Diamond Export Levy Acts will also have to be read with the Customs Control Act once it is effective.
The draft Bills contain similar provisions to those contained in the existing legislation, but many of the details contained in the rules are now sought to be included in the body of the Bills, making the Acts themselves significantly more voluminous and detailed.
While the updated legislation aims at modernising the customs administration in the country and bringing it in line with international trends and best practices, it also broadens and tightens customs authorities' powers of enforcement against traders.
Clients who deal with customs authorities in the course of business are urged to keep abreast of the status of the proposed changes to the legislation and to investigate the effect the amendments will have on their day-to-day operations.
Tax dispensation extended to holiday homes
By Daleen Malan, Associate
In recent years, a popular way of saving tax was for a private residence to be held by a company or trust. However, as tax legislation changed and became more complex, the benefits of such structures became redundant, so much so that the disposal of a residence by a company or a trust now has many adverse tax consequences. In attempting to remedy this, the SARS is currently offering a tax dispensation to companies and trusts to transfer property from the holding entity into the hands of a person, free of tax.
However, this tax dispensation is restricted to ordinary residences that are mainly used for domestic purposes by individuals who are connected persons to the holding entity. Hence holiday homes were excluded.
This restriction was not necessarily intended by the legislature. Therefore, in terms of the Draft Taxation Laws Amendment Bill, 2011, (TLAB) and much to the relief of taxpayers, it is proposed that the scope of the tax dispensation be broadened to include holiday homes and/or second homes, provided that these are mainly used for domestic purposes.
In the SARS' Guide to the Disposal of a Residence from a Company or a Trust issued on 11 May 2011, it is stated that the word "mainly" is interpreted to mean more than 50%, which percentage is generally measured on a floor-space basis. Examples of non-domestic use, which could jeopardise the trust or company's eligibility for relief, include the letting of a portion of the residence (i.e. a bed and breakfast) or using part of the residence as an office.
It should be noted that the proposal under the TLAB will, if promulgated, apply with retroactive effect on the same conditions as the current tax dispensation, which are that:
- the disposal of the property takes place on or after 1 October 2010, but no later than 31 December 2012;
- the property is mainly used for domestic purposes by natural persons who are connected persons in relation to the company or trust; and
- steps are taken to terminate the transferor company or trust within a period of six months after the disposal of the property.
Where the relief applies, the transfer of the property will not give rise to any capital gains tax (CGT), transfer duty or secondary tax on companies (STC).
Individuals acquiring a property from a company will establish a base cost for the property at an amount equal to the aggregate of their base cost for their shares and the cost of all improvements to the property subsequent to their acquisition of the shares, if:
- the individual that acquired the property (together with the other persons holding shares in the company) acquired all the shares in the company after it acquired the property; and
- 90% or more of the market value of the assets held by the company, during the period commencing on 11 February 2009 until the date the property is disposed of, is attributable to the company's interest in the residence.
In short, this means that the individual's base cost for his or her shares (plus the capital improvement costs), will be rolled-over to the property acquired.
In the event of individuals acquiring the property from a company and the above provisions not applying, or if the property is acquired from a trust, the acquiring individuals will "inherit" the CGT base cost position of the transferor company or trust, (i.e.: the transferor's base cost is rolled-over to the acquirer).
Under the current tax dispensation there appears to be no restriction on the person to whom the property can be transferred. In effect, this means that the property can be directly transferred, tax free, to any third party. The provisions under TLAB clarify this, as potential transferees are limited to those persons who are connected to the company or trust and who mainly used the residence for domestic purposes.
Taxpayers are urged to simplify their structures and to make use of the extended relief offered by the SARS.
Permanent Voluntary Disclosure Programme
By Daleen Malan, Associate
The Tax Administration Bill, 2011, (TAB) which is expected to be enacted later this year contains a permanent Voluntary Disclosure Programme (TAB VDP) which provides relief to non-compliant taxpayers, albeit on less favourable terms than the current VDP under the Voluntary Disclosure Programme and Taxation Laws Second Amendment Act No. 8 of 2010.
In terms of the latter, a window period is offered from 1 November 2010 to 31 October 2011, during which non-compliant taxpayers may disclose possible defaults, and regularise their tax affairs, while being absolved from penalties, additional tax and possibly also interest resulting from the non-payment of the tax when due.
In terms of the relief provided for in the TAB VDP, successful applicants will firstly be pardoned from any criminal sanctions under a tax act or related common law offence. Non-compliant taxpayers can furthermore expect a monetarily benefit for "coming clean" with the SARS, as they will, if successful, be relieved from additional tax to the extent provided for in the TAB.
Relief in this regard depends on the degree and level of default of the taxpayer and whether or not the SARS has embarked on an audit into the tax affairs of the applicant. Successful applicants that have remedied their defaults will, in addition, be absolved from 100% of administrative penalties that will in future be levied under TAB, save for penalties imposed for the late submission of a return.
Interest and the actual tax arising from the default (in respect of which the voluntary disclosure is made) nevertheless remain due and payable to the SARS.
The procedural aspects of the permanent VDP are similar to that of the current VDP. In order to qualify for the relief, a non-compliant taxpayer should make a disclosure to the SARS, which must:
- be voluntary and complete in all material respects;
- made in the prescribed form and manner;
- relate to a default, which could have resulted in a penalty or additional tax being levied; and
- not result in a refund becoming due by the Commissioner: SARS.
If the above minimum requirements are met, the SARS has no discretion and is obliged to grant the applicant relief. The SARS however retains the right to withdraw relief, and pursue prosecution, if it establishes that a taxpayer failed to disclose a matter that was material for purposes of making a valid voluntary disclosure. Any such decision by the SARS in this regard is, however, subject to objection and appeal.
The term "default" is defined to mean the submission of incorrect or incomplete information to the SARS; or the failure to submit information; or the adoption of a tax position, which resulted in an incorrect:
- assessment for tax; or
- payment of tax by the taxpayer; or
- refund of tax made by the SARS.
Although TAB is prescriptive as to the procedure for making a voluntary disclosure, the SARS has to date not yet released any prescribed forms or regulations. Presumably the prescribed from will take on a similar format to the prescribed form applicable to the current VDP.
Once an applicant qualifies, relief is evidenced by the conclusion of an agreement between the SARS and the taxpayer (Agreement) on the proper treatment of the taxpayer's tax affairs. Such an Agreement should contain the prescribed minimum information such as the:
- the material facts relating to the default;
- the tax, interest and where applicable the additional tax that remains due and payable;
- the proposed dates and manner for payment of the amount due to the SARS;
- future treatment of the issue (if relevant); and
- undertakings (if any) by the SARS or the taxpayer.
Lastly, in addition to the above, the SARS may issue an assessment that gives effect to the Agreement, which will not be subject to objection and appeal.
A non-compliant taxpayer may apply anonymously to the SARS for a non-binding private opinion relating to his or her eligibility for relief under the TAB VDP. The opportunity to apply for a non-binding private opinion is the only safeguard available to non-complaint taxpayers wishing to regularise their tax affairs under the VDP.
It is therefore recommended that taxpayers, who are in doubt about whether they will qualify for the VDP relief, test the chance of success of their application by making use of the non-binding private opinion option.
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.