South Africa: Base Erosion And Profit Shifting – A South African Perspective

Last Updated: 25 November 2014
Article by Peter Dachs

Most Read Contributor in South Africa, September 2018

The concept of base erosion and profit shifting (BEPS) has been debated at various international forums following discussions at the G20 Finance Ministers and Central Bank Governors meeting and the G20 Heads of State summit in Russia last year.

The Organisation for Economic Co-operation and Development's (OECD) BEPS Action Plan provides for 15 actions to be completed in three phases by December 2015.

One of the first of these is an in-depth report identifying tax challenges raised by the digital economy and the necessary actions to address them. The report includes recommendations on the design of domestic and tax treaty measures to neutralise the effects of hybrid mismatch arrangements both from a domestic and treaty law perspective. It also makes recommendations on the design of domestic and tax treaty measures to prevent abusive tax treaties as well as changes to transfer pricing rules in relation to intangible assets.

The Davis Tax Committee has been tasked with addressing BEPS in a South African context, which includes hybrid mismatch arrangements.

According to the OECD, hybrid mismatch arrangements exploit the differences in the tax treatment of instruments, entities or transfers between countries. These arrangements generally use one or more of the following elements:

  • Hybrid entities that are treated as transparent for tax purposes in one country and non-transparent in another;
  • Dual-resident entities, which are resident in two different countries for tax purposes;
  • Hybrid instruments that are treated differently for tax purposes in the countries involved, for example as debt in one country and equity in another; and
  • Hybrid transfers, which are arrangements treated as transfer of ownership of an asset in one country, but as a collateralised loan in another.

Hybrid mismatch arrangements include double-deduction schemes, where a deduction related to the same contractual obligation is claimed in two different countries; schemes that create a deduction in one country, but avoid the corresponding income inclusion in another country; and arrangements that generate foreign tax credits that would otherwise not be available .

Among concerns noted by the OECD are:

  • While it can be difficult to determine which of the countries has lost tax revenue, it is clear that the countries concerned collectively lose tax revenue.
  • Businesses that use mismatch opportunities have competitive advantages over those that cannot.
  • Where a hybrid mismatch is available, a cross-border investment will often be more attractive than an equivalent domestic investment.
  • The adoption of tax-driven structures leads to a lack of transparency, with most people generally unaware that the tax regime is quite different for those using mismatch opportunities.
  • Mismatch opportunities are more readily available for taxpayers with income from capital, rather than labour.

From a South African tax perspective, transactions that involve hybrid entities or instruments may result in the claiming of foreign tax credits in circumstances where the foreign tax suffered is effectively neutralised in the foreign jurisdiction.

Alternatively, such arrangements result in exemption from tax in respect of foreign-sourced income by virtue of an appropriate double-tax agreement.

Repurchase transactions are common hybrid entity arrangements. There are several variations of these transactions, but the key mechanics are essentially the same:

  • A partnership is set up in Jurisdiction A;
  • An investor in Jurisdiction B acquires an interest in the partnership in terms of a repurchase agreement. The investor may borrow money to acquire this "partnership interest";
  • The partnership uses its capital to invest in a loan and earns interest;
  • The investor is, in terms of Jurisdiction B's tax laws, entitled to its share of the partnership income derived in accordance with the partnership agreement.

From Jurisdiction A's tax perspective, the partnership is viewed as a separate entity and is liable to tax. The partnership therefore pays tax and the investor claims a credit for the tax suffered in respect of its partnership distributions. The partnership then distributes a post-tax return to the investor.

The investor is entitled to a credit for the tax paid by the partnership. The investor may also claim a deduction for its funding costs to acquire the partnership interest.

However, Jurisdiction A provides a tax credit to the seller of the partnership interest in respect of the amount of tax paid by the partnership. The tax paid by the partnership is therefore neutralised since, on a consolidated basis, no tax is suffered in Jurisdiction A.

By way of an example of dual-resident entities and hybrid instruments, a company is incorporated and tax resident in Jurisdiction B. The company issues redeemable preference shares to investors in Jurisdiction A and invests in debt instruments issued by companies in Jurisdiction A.

From Jurisdiction A's tax perspective, the company earns interest income that is not taxed in Jurisdiction A due to the provisions of the double-tax agreement between Jurisdiction A and Jurisdiction B.

The company pays out dividends that are tax exempt in the hands of the investors in Jurisdiction A.

From Jurisdiction B's tax perspective, the interest received by the company is taxable. However, the redeemable preference shares are re-characterised as debt for tax purposes and therefore a deduction is granted for the dividends paid on these shares. The company is therefore only taxed on a spread/margin in Jurisdiction B.

The issue arises whether transactions such as these erode the South African tax base and, if so, how they have been dealt with in terms of South African law.

We do not have any case law in respect of foreign tax credit transactions. However, various New Zealand cases have dealt with foreign tax credits and disallowed such credits in the hands of the New Zealand entities. Although only of persuasive influence in South Africa, the New Zealand courts held that the foreign tax credits could not be claimed and set out detailed reasoning in this regard.

It also needs asking whether there is any policy or principle issue with a tax credit being granted in circumstances where foreign tax is suffered by a foreign entity, but where such tax is then effectively neutralised in the foreign jurisdiction.

It may be argued that to place an onus on a South African taxpayer to prove that the foreign tax was not "economically neutralised" in some manner is to place too high a burden on such taxpayers.

In respect of current law, section 6quat of the Income Tax Act and the provisions relating to the elimination of double taxation in double-tax agreements require that tax is paid in the foreign jurisdiction and that this represents a final tax by the relevant entity. It may be argued that this should be sufficient for a South African taxpayer to claim a credit in respect of foreign taxes.

South Africa has a general anti-tax-avoidance provision which is contained in sections 80A-L of the Act and may be used in appropriate circumstances. The first issue is whether a tax benefit exists as a consequence of the transaction.

In the context of the definition of a "tax benefit" in terms of section 1 of the Act, based on case law (Hicklin v SIR 41 SATC 179 and Smith v Commissioner for Inland Revenue 26 SATC 1), the liability for the payment of any tax, levy or duty that a taxpayer must seek to avoid, postpone or reduce is not an accrued or existing liability, but an anticipated liability. It was held that to avoid liability in this sense is "to get out of the way of, escape or prevent an anticipated liability".

In ITC 1625, 59 SATC 383, it was held that the test to be applied in determining whether a transaction had the effect of avoiding tax was to ask whether "the taxpayer would have suffered tax but for the transaction". The court stated that "if the transaction in issue had not been entered into the taxpayer would not have acquired the property, it would not have earned the income and it would not have incurred the interest expenditure" and thus the court could find "no basis on which it can successfully be argued that by incurring expenditure on interest in order to earn the income on which it has to pay tax the taxpayer avoided tax or reduced tax".

If there is a tax benefit, the second requirement for the application of the anti-tax-avoidance provisions is that the "sole or main purpose" is to obtain such benefit. Therefore, provided the taxpayer does not comply with this requirement, the arrangement will not constitute an impermissible tax avoidance arrangement.

If a South African resident invests in a transaction such as those described above instead of, for example, advancing a loan to an entity, then this will have the effect of sidestepping an anticipated tax liability in respect of the interest that the South African resident would have received. A "tax benefit" will therefore arise for the South African resident who will then bear the onus of proving that its sole or main purpose was not to achieve such benefit.

Without satisfying this requirement, the issue of base erosion can be seen not to apply since, in terms of the provisions of section 80B of the Act, the transaction may be re-characterised in a manner such that the South African resident is deemed to have advanced a loan to the ultimate borrower and received interest from this.

These are the main issues involved in hybrid mismatch arrangements, and other aspects of BEPS in a South African context will be discussed in future articles.

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Werksmans Incorporated
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Werksmans Incorporated
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions