FEBRUARY 2016 – ISSUE 197
CONTENTS
TAX ADMINISTRATION
CAPITAL GAINS TAX
2489. Definition
of
immovable 2494. Legal privilege procedure
2495. Treatment of PAYE for VDP
property
purposes
2490. Valuation of shares in private
companies
DAVIS TAX COMMITTEE
VALUE-ADDED TAX
2491. First report on mining
2496. Recovery of costs
DEDUCTIONS
SARS NEWS
2492. Definition of interest
2497. Interpretation notes, media
releases and other documents
INTERNATIONAL TAX
2493. The OECD BEPS project
1 CAPITAL GAINS TAX
2489. Definition of immovable property
In order to provide the necessary legislative amendments required to implement
the tax proposals that were announced in the 2015 National Budget on
25 February 2015, the National Treasury published the Draft Taxation Laws
Amendment Bill (TLAB), 2015, on 22 July 2015 for public comment.
One of the proposed amendments (which was enacted into the legislation on
8 January 2016) relates to the definition of ‘immovable property’ as provided
in paragraph 2 of the Eighth Schedule to the Income Tax Act, 1962 (the Act).
By way of background, paragraph 2 of the Eighth Schedule distinguishes
between residents and non-residents for purposes of determining a capital gains
tax (CGT) liability.
Insofar as residents are concerned, CGT applies to any capital gain derived from
the disposal of any capital asset irrespective of where the asset is situated. As
far as non-residents are concerned, the CGT liability will only be triggered if the
assets are capital in nature and constitute:

Fixed (immovable) property in South Africa;

Any interest or right of whatever nature of that non-resident to or in
immovable property situated in South Africa; or

Any asset which is attributable to a permanent establishment of that nonresident in South Africa.
Paragraph 2(2) of the Eighth Schedule defines an ‘interest in immovable
property’ situated in South Africa as:

Equity shares held by a person in a company or a vested interest in the
assets of a trust if more than 80% of the market value of those equity
shares is attributable to immovable property situated in South Africa; and
2 
In the case of a company or other entity, that person directly or indirectly
holds at least 20% of the equity shares in that company or ownership or
right to ownership of that other entity.
According to paragraph 2 of Article 6 of the Organisation for Economic
Co-operation and Development (OECD) Model Tax Treaty, the term
immovable property is defined to include the “rights to which the provisions of
general law respecting landed property apply, usufruct of immovable property
and rights to variable or fixed payments as consideration for the working of, or
the right to work, mineral deposits, sources and other natural resources;…”
Having regard to the above, it is clear that the current definition of ‘immovable
property’ in paragraph 2(2) of the Eighth Schedule is not aligned with the
definition of ‘immovable property’ in the OECD Model Tax Treaty in that the
current definition does not include the right to mine, prospecting rights, and the
right to work mineral deposits and other natural resources. Given South Africa's
vast treaty network, the Explanatory Memorandum to the Draft TLAB proposes
that the definition of the term ‘immovable property’ in paragraph 2(2) of the
Eighth Schedule be closely aligned to that provided in paragraph 2 of Article 6
of the OECD Model Tax Treaty, to include the right to variable payments or
fixed payment as consideration for the working of or right to work mineral
deposits, sources and other natural resources.
It is intended that the amendment will avoid any possible anomalies and thereby
create legal certainty with regard to what constitutes immovable property for
non-residents. The amendment will come into operation on 1 January 2016 and
will apply in respect of years of assessment commencing on or after that date.
Cliffe Dekker Hofmeyr
ITA: Paragraph 2 of the Eighth Schedule
3 Explanatory Memorandum to the Taxation Laws Amendment Bill, 2015
OECD Model Tax Treaty: Paragraph 2 of Article 6
2490. Valuation of shares in private companies
In CSARS v Stepney Investments (Pty) Ltd [2015] ZASCA 138, where judgment
was given by the Supreme Court of Appeal on 30 September 2015, the central
issue (at paragraph [1] of the judgment) was whether the taxpayer, Stepney
Investments, had discharged the onus of proving the base cost of certain shares
held by it (namely, the 4.37% shareholding in Emanzini Leisure Resorts (Pty)
Ltd (ELR)) which it had disposed of during the 2002 and 2003 tax years.
In other words, Stepney Investments bore the onus of proving the value of those
shares on 1 October 2001 when capital gains tax came into force so as to
establish the taxable gain (if any) made on their disposal some two years later.
Determining the market value of shares in a private company
Stepney had elected, in terms of paragraph 26(1) of the Eighth Schedule to the
Income Tax Act, 1962 (the Act), to use market value as the method of valuing
the shares as at 1 October 2001. In terms of paragraph 31(1)(g), ‘market value’
in this context means –
‘the price which could have been obtained upon a sale of the asset between a
willing buyer and a willing seller dealing at arm’s length in an open market’.
The interest of the judgment is the guidance that the Supreme Court of Appeal
gives (or fails to give) in relation to the broad question of the appropriate
method for determining the market value of shares in private companies.
Establishing the market value of shares (or any other property) at a given point
in time is, inherently, a hypothetical and somewhat speculative inquiry into
4 what a notional purchaser would have paid in an open market on a particular
date.
Shares have aptly been described as a ‘bundle of rights’, which is to say, they
are a conglomeration of personal rights (rights in personam) that the taxpayer
has vis-à-vis the company, and they are not rights vis-à-vis the company’s
property.
It is thus fundamental that a shareholder has no real right (right in rem) in assets
owned by the company (Macaura v Northern Assurance Co Ltd [1925] AC 619
(H)).
Nonetheless, the value of property owned by a company impacts on what a
notional purchaser would be prepared to pay for its shares. Thus, an obvious
yardstick for valuing shares is the net asset value (NAV) method. This method
has regard to the value of the company’s assets less the value of its liabilities at
the relevant time. The net asset value so derived can then be divided by the
number of the company’s shares to arrive at the value per share.
This method of valuation could be appropriate where the value of the company,
as a going concern, is largely determined by the assets that it owns, such as
where the company is a property-holding enterprise, or if the company is in
liquidation.
The limitation of the net asset method of valuation is that it yields a mere static
snapshot at a given moment in time.
A second method of valuation is the income approach, which seeks to estimate
the flow of revenue that the company will generate in the future.
5 Thus, if the company is in a line of business in which consumer demand is on
the increase, this will impact on the valuation of its shares beyond their static
net asset value at a moment in time. A variant of the income approach is the
discounted cash-flow (DCF) method, which entails valuing the business in
question on the basis of its forecast future cash flow, discounted back to present
day values through the application of a discount factor.
At issue was the base cost for CGT purposes of the ELR shares
In the Stepney Investments case it was necessary to arrive at the market value,
as at 1 October 2001, of particular shares that the company had disposed of
during the 2002 and 2003 tax years, namely a 4.37% shareholding in ELR.
That company, which at the time was engaged in developing, owning and
operating casinos, hotels and related leisure activities, held a 15-year casino
licence for the Richards Bay area, granted by the KwaZulu-Natal Gambling
Board, and it intended to establish a casino, but litigation by a religious group
opposed to the casino had resulted in a delay. During the dispute, in order to
make use of its licence, the taxpayer established temporary premises in
Empangeni.
Bridge Capital Services Ltd (the Bridge valuation) utilised the discounted cashflow method to conduct the valuation commissioned by Stepney Investments
and determined the market value of the ELR shares as at 1 October 2001, that is
to say, their base cost for capital gains tax purposes.
By contrast, SARS (at paragraph [3] of the judgment) utilised the NAV method
of valuation in ‘adjusting’ down to nil (in terms of paragraph 29(7)(b) of the
Eighth Schedule) the Bridge valuation, and this adjusted valuation was the basis
of the additional, disputed assessments.
6 This ‘adjustment’ (as appears from the unreported judgment of the Tax Court)
was based on a view taken by an in-house ‘chartered accountant and principal
auditor’ at SARS which was so lightweight that SARS’s legal team in the Tax
Court did not even try to argue that it was credible.
As the Supreme Court of Appeal noted at paragraph [7]) –
“No separate independent valuation was done by [anyone] on behalf of the
Commissioner [and] ultimately the Tax Court had before it only the Bridge
valuation . . .”
The Supreme Court of Appeal judgment notes (at paragraph [6]) that SARS –
“implicitly conceded in the court below that [the NAV method] was
inappropriate and that the DCF method should have been used. The concession
was properly made”.
The judgment is silent as to why the NAV method was not appropriate
It is regrettable that the Supreme Court of Appeal did not provide guidance for
the future by expanding on why the net asset method of valuation was
‘inappropriate’ and why the DCF method was the most suitable method in
relation to this particular taxpayer.
It may be inferred, however, that the court accepted that ELR’s line of business
was dynamic and changeable, and that the value of the business was dependent
on such factors as fluctuations in the disposable income of its client base as the
national and regional economy waxed and waned, and the vagaries of public
opinion in regard to the attractiveness of casino-based gambling as a leisure
activity, as well as the possibility of future legislation that might impact on
organised gambling.
7 As was noted above (and see the judgment at paragraph [7]), SARS had not
commissioned its own independent valuation of the value of the ELR shares.
Instead, in its revised assessment, SARS (purportedly applying the net asset
value method, but in reality almost arbitrarily) valued the shares in question at
nil. In this regard, the Supreme Court of Appeal observed at paragraph [28] that
–
“There was clearly considerable value attached to ELR’s sole asset, the casino
licence. It was not seriously disputed that a casino licence which grants the
holder exclusive rights in respect of the specified area for a period of 15 years
has considerable value”.
In essence, SARS confined itself (at paragraph [9]) to attacking the reliability of
the Bridge valuation commissioned by Stepney Investments without putting
forward any substantive valuation of its own.
The conduct on the part of SARS in assigning a nil value to the shares in
question raises important questions, and it is regrettable that this did not come
under closer critical scrutiny by the Supreme Court of Appeal. Since the
judgment in SARS v Pretoria East Motors (Pty) Ltd [2014] 76 SATC 293, it has
been clear that SARS must have a basis for issuing an assessment and cannot
issue assessments to tax that are plucked from thin air. In that case, the Supreme
Court of Appeal said (at paragraph [11]) that the approach taken by the SARS
auditor in the matter then before the court was –
“that if she did not understand something she was free to raise an additional
assessment and leave it to the taxpayer to prove in due course at the hearing
before the Tax Court that she was wrong. Her approach was fallacious. The
raising of an additional assessment must be based on proper grounds for
believing that, in the case of VAT, there has been an underdeclaration of
supplies and hence of output tax, or an unjustified deduction of input tax.
8 In the case of income tax, it must be based on proper grounds for believing that
there is undeclared income or a claim for a deduction or allowance that is
unjustified. It is only in this way that SARS can engage the taxpayer in an
administratively fair manner, as it is obliged to do. It is also the only basis upon
which it can, as it must, provide grounds for raising the assessment to which the
taxpayer must then respond by demonstrating that the assessment is wrong.”
A cynical reader might infer that, in the present matter, SARS’ strategy in
valuing the shares in question at nil in its additional assessment was to try to
engineer a situation where, if Stepney Investments was unable, in the ensuing
litigation, to discharge the onus of proving that the Bridge valuation was
accurate, the court would have no choice but to disallow the taxpayer’s
objection to the assessment, thereby leaving intact the assessment with the nil
value.
If such indeed was the stratagem, it did not succeed.
In the event, in the litigation in the Tax Court and the Supreme Court of Appeal,
the only valuation of the shares that was on the table (at paragraph [7]) was the
Bridge valuation and no other.
In giving judgment, the Supreme Court of Appeal concluded (at paragraph [28])
that the Bridge valuation, put forward by Stepney Investments, was ‘fatally
flawed’ and that the Tax Court had erred in upholding it.
Such a finding would usually be catastrophic for the taxpayer in that, if he fails
to discharge the onus of proving the correctness of his objection in the Tax
Court, the assessment will usually then prevail and the taxpayer will be obliged
to pay the assessed amount of tax.
9 In this case, however, SARS had (as was noted above) taken the approach in its
revised assessments (see the judgment at paragraph [3]) of determining the base
value of the ELR shares in issue – that is to say, their market value as at 1
October 2001 – as being nil.
Fortunately for the taxpayer, SARS conceded in the Supreme Court of Appeal
(though not, apparently, in the Tax Court – at paragraph [28]) that a nil value
was insupportable. As was noted above, in its judgment (at paragraph [28]), the
Supreme Court of Appeal said in this regard that–
“counsel for the Commissioner very properly conceded that the value of the
shares cannot be nil. There was clearly considerable value attached to ELR’s
sole asset, the casino licence. It was not seriously disputed that a casino licence
which grants the holder exclusive rights in respect of the specified area for a
period of 15 years has considerable value”.
The court went on to say that–
‘it is in the interests of justice that a proper valuation be calculated. The Tax
Court should have remitted the matter to the Commissioner for further
investigation and assessment in terms of section 83(13)(a)(iii) of the Act.’
These two findings by the Supreme Court of Appeal had four important
consequences.
First, although the taxpayer had not succeeded in affirmatively proving the
market value of the shares in question as at 1 October 2001, it was common
cause that the nil valuation accorded to the shares by SARS in the disputed
assessments was insupportable.
Second, the disputed additional assessments were set aside by the court.
10 Third, the taxpayer was awarded its costs in the Tax Court and also in the
Supreme Court of Appeal – a not inconsiderable monetary solace for this
lengthy saga.
The fourth consequence was that the Supreme Court of Appeal ordered that the
matter be remitted, not to the Tax Court, but to the Commissioner ‘for further
investigation and assessment’. In the circumstances, it would have been
pointless to refer the matter back to the Tax Court, given that the only valuation
on the table – the Bridge valuation – had been held to be fatally flawed.
Conclusion
The future of this dispute will be that (unless the parties can negotiate a
settlement) the Commissioner, having considered the matter afresh, will issue
yet a further additional assessment and the taxpayer will have another bite at the
cherry in objecting to the new assessment if its determination of the base cost of
the shares is unacceptable. In the meantime, Stepney Investments will
presumably revise the Bridge valuation and submit an amended version to
SARS.
In addition, after analysing the evidence and considering SARS’ further
criticisms, the SCA found that:
 there were problems in the projected tax calculations in that the incorrect
statutory rates were used, and that the calculations differed from what
was previously submitted to the Gambling Board;
 the capital expenditure forecasts were inaccurate because they did not
take into account any construction to be undertaken at the temporary site,
and this impacted materially on the valuation;
11  the valuation was based on the assumption that the licence would be
renewed after the 15 year period and it did not take into account the risk
that the licence could potentially not be extended;
 the Company had a licence which it could not put to economic use given
the unresolved litigation, and this risk factor was disregarded; and
 applying the discounted cash flow method, a discount factor was applied
across the board for all companies in the group of the Company, and that
such “one size fits all” approach was inappropriate in the circumstances.
PwC and Cliffe Dekker Hofmeyr
ITA: Section 83(13)(a)(iii) and paragraphs 26(1); 29(7)(b) and 31(1)(g) of
the Eighth Schedule
DAVIS TAX COMMITTEE
2491. First report on mining
The Davis Tax Committee (the Committee) was established by the Minister of
Finance (the Minister) to give effect to government’s tax review and assessment
of the tax policy framework and its role in supporting the objectives of inclusive
growth, employment, development and fiscal sustainability, as proposed in the
2013/14 National Budget.
The Committee submitted the First Interim Report on Mining (the Report) to the
Minister on 1 July 2015, and it was released for public comment on 13 August
2015. This Report is a provisional interim report and a useful point of departure
for engaging with stakeholders before final and conclusive recommendations
are made to the Minister, who will then determine any further steps to be taken
with regard to the Report.
12 The Report concentrates on traditional mining and does not deal with oil and
gas extraction, for which separate reports will be tendered at a later stage. It is
mainly concerned with income tax and the mineral royalty charge imposed in
terms of the Mineral and Petroleum Resources Royalty Act, No 28 of 2008
(MPRRA).
The Committee was tasked with reviewing the existing mining taxes and has
made, inter alia, the following recommendations:
 The Committee is broadly in favour of retaining the status quo of taxing
mining taxpayers on taxable income at the same rate as non-mining
taxpayers.
 The Committee is working toward aligning the mining corporate income tax
regime to correlate with tax systems applicable to other taxpaying sectors
generally, leaving the royalty system to respond to the non-renewable nature
of mineral resources.
 It is recommended that the upfront capex write-off regime be discontinued
and replaced with an accelerated capex depreciation regime, which is in
parity with the write-off periods provided for in respect of the manufacturing
(40/20/20/20) basis. This capital expenditure should be written off from the
date of incurral of such expenditure. The cost base applicable to this writeoff covers expenditure contained in sections 36(11)(a) and 36(11)(b) of the
Income Tax Act,1962 (the Income Tax Act), in so far as it relates to capex
expenditure allowable in terms of the current tax regime. Effectively, this
means that the partial allowances will retain their current write-off periods
and will not be depreciated on a 40/20/20/20 basis (with a view toward
seeking alignment of write-off periods between non-mining long term
infrastructure expenditure).
 The removal of the upfront capex tax allowance regime allows for the
removal of ring-fences aimed at preventing the set-off of capex against a
13 non-mining tax base. The removal of these ring-fences should adequately
compensate taxpayers for the removal of the upfront capex allowance. An
immediate removal of ring-fences could trigger a rush of trapped losses and
unredeemed capex set-offs against non-mining income and other previously
ring-fenced mining income, resulting in tax collections being compromised.
As a result, the Committee will defer the timing for removal of the ringfences to the National Treasury which is best able to determine what the
country can afford.
 The Committee would prefer to bring the taxation of the gold mining
industry in line with the tax regime applicable to non-gold mining taxpayers
(in so far as possible). The Committee recommends that the gold formula be
retained for existing gold mines. The retention of the gold formula should
apply to existing gold mines only, as new gold mines are unlikely to be
established in circumstances where profits are marginal or where gold mines
are conducting mining of the type intended to be encouraged by provision of
the gold formula. Accordingly, the Committee recommends that the gold
formula should not apply to newly established gold mines. Given the
retention of the gold formula for existing gold mines, it will be necessary to
retain ring-fences in mines where the gold formula subsists. In light of the
fact that these recommendations raise neutrality issues when comparing new
gold mines with existing gold mines, an alternative recommendation is to
phase out the gold formula for all mines over a reasonable period of time.
 With regard to the additional capital allowances available to gold mines, the
Committee holds that such allowances should be phased out so as to bring
the gold mining corporate income tax regime into parity with the tax system
applicable to taxpayers as a whole. In doing so, restrictions on the deduction
of interest expenditure (where applicable) should be lifted to accord with
normal tax principles so that taxpayers are compensated for their finance
costs.
14  The Committee takes the view that new tax instruments are not necessary,
particularly since the mineral royalty has been carefully designed to achieve
a strong balance of ensuring that the royalty is responsive to different
economic circumstances, capturing rents when profits are high and ensuring
a measure of cover in the form of a minimum revenue stream during weak
economic cycles and low commodity prices.
 The Committee recommends that the Department of Mineral Resources
conduct an in-depth examination of the current regulatory framework
applicable to Greenfield investors (as prescribed by the Mineral and
Petroleum Resources Development Act, No 28 of 2002 (MPRDA),
following which, further tax incentives should be considered.
 The Committee would like to explore an amortisation write-off in respect of
the various mineral rights accorded in terms of the MPRDA, in greater depth
and will offer a last view on the matter in the final report.
 The Committee recommends that all infrastructure costs incurred in terms of
a Social and Labour Plan (SLP) be allowed for tax purposes, even if such
expenditure benefits the community at large and not just the direct
employees. The Committee tentatively recommends that community
expenditure incurred outside the SLP should be channelled through the
Public Benefit Organisation system.
 The Committee has articulated a recommended methodology for National
Treasury to solve technical problems and disparities relating to pieces of
legislation such as the MPRDA, MPRRA, the Income Tax Act and National
Environment Management Act, No 107 of 1998. The Committee has assisted
in identifying aspects of legislation which require remedy.
The Committee recommends the removal of section 37 of the Income Tax Act,
which deals with recoupments relating to mining assets, with a view to bringing
mining asset recoupments in line with the law applicable to non-mining
taxpayers.
15 Regarding the above, it is likely that the current tax regime applicable to mining
companies will be amended. As a result, it is important for mining companies to
take cognisance of the recommendations made by the Committee so as to fully
understand the impact of the proposals on their mining businesses.
Comments on the Report were due on 31 October 2015.
Cliffe Dekker Hofmeyr
DTC: First Interim Report on Mining (DTC Report)
ITA: Sections 36(11) and 37
Mineral and Petroleum Resources Royalty Act, No 28 of 2008
Mineral and Petroleum Resources Development Act, No 28 of 2002
National Environment Management Act, No 107 of 1998
Editorial Comment: Under the chairmanship of Judge Dennis Davis, the
committee has been tasked with an enquiry into the role of the tax system in
the promotion of inclusive economic growth, employment creation,
development and fiscal sustainability.
A number of reports have already been issued by the committee and more will
follow. While we will be publishing articles on the work and reports of the
committee, it must be recognised that not all of its recommendations will be
accepted by our Minister of Finance and find their way into our tax
legislation.
DEDUCTIONS
16 2492. Definition of interest
Introduction
Sections 11(a) and 23(g) of the Income Tax Act, 1962 (the Act) are commonly
referred to as the ‘general deduction formula’. As the name suggests, it is in
terms of these sections of the Act that tax deductions in general are sought to be
claimed by taxpayers. The Act does, however, contain provisions which are
specially tailored for the deduction of specific expenditure. Section 24J of the
Act is one such provision and allows taxpayers to claim a deduction specifically
for interest expenditure.
A taxpayer who acquires credit will normally incur various costs in relation to
such credit. However, before it can be considered whether such costs, or any
portion thereof, may be claimed as a deduction in terms of section 24J, such
costs must, as a prerequisite, be shown to constitute ‘interest’ as defined in
section 24J. The purpose of this article is to consider which of the said costs
meet this prerequisite requirement, so that it stands to be considered whether
they are deductible in terms of section 24J, as opposed to the general deduction
formula. In this regard, the details of the rest of the requirements of section 24J
are not discussed in this article.
Section 24J’s definition of ‘interest’
In everyday language, one can correctly state that interest is not the only cost of
credit, and that instead, the cost of credit further includes other types of finance
charges, such as commitment fees and arrangement fees. However, in the
context of section 24J, the accuracy of such a statement, which assumes that
there is a clear distinction between ‘interest’ and such other finance charges as
commitment fees and arrangement fees, depends on how wide the parameters of
the notion of ‘interest’ are. If wide enough, commitment fees and similar
charges may be seen to constitute ‘interest’, so that they may be claimed as a
17 specific deduction in terms of section 24J, provided that all other requirements
of this section are met. On the other hand, if ‘interest’ is narrowly defined, such
amounts will be seen as being different to ‘interest’ and thus not deductible in
terms of section 24J. In such a case, the question would be whether such
amounts nevertheless qualify for a deduction in terms of the general deduction
formula.
Section 24J defines ‘interest’ to include, inter alia, the following:
“(a) gross amount of any interest or related finance charges, discount or
premium payable or receivable in terms of or in respect of a financial
arrangement;
(b) …
(c) …
irrespective of whether such amount is—
(i) calculated with reference to a fixed rate of interest or a variable rate of
interest; or
(ii) payable or receivable as a lump sum or in unequal instalments during the
term of the financial arrangement.”
From the above, it can be deduced that for an amount to constitute ‘interest’ in
the context of section 24J, it must constitute, inter alia, one of the following:

interest;

related finance charges; or

a discount or premium payable or receivable in terms of a financial
arrangement.
For purposes of this article, only the words ‘interest’ and ‘related finance
charges’ as used in section 24J’s definition of ‘interest’ will be discussed in
more detail.
18 The word ‘interest’ as used in section 24J’s definition of ‘interest’
It can be noted that the definition of ‘interest’ in section 24J circularly includes
the word ‘interest’, and therefore does not ascribe a meaning to this word. As if
this doesn’t make the definition appear elusive enough, the position turns out to
be that the word ‘interest’ is not defined in any other part of the Act. Such a
scenario calls for the general principle of statutory interpretation commonly
referred to as the ‘literal approach’. Accordingly, where no specific meaning is
given to a term contained in a piece of legislation, that term must be given its
ordinary meaning, provided that such ordinary meaning does not lead to an
absurdity so glaring that it could not have been intended by the Legislature.
In determining the ordinary meaning of a word, a court will normally have
recourse to dictionaries. In this regard, the Shorter Oxford English Dictionary
(Sixth Edition) defines the word ‘interest’ as ‘money paid for the use of money
or for the forbearance of a debt’. This definition is consistent with the meaning
that our courts have generally given to the notion of interest in terms of
common law, that is, ‘compensation for the use of money lent’. (See
Commissioner for Inland Revenue v Cactus Investments (Pty) Ltd [1996] 59
SATC 1).
For an amount to be seen as compensation for the use of money lent, it follows
that the amount must be paid for the benefit of the lender. That is to say, if the
amount is not paid for the lender’s benefit, one cannot say that such an amount
serves to compensate the lender for allowing the borrower to use the lender’s
money. As such, the element of compensation requires that the payment of the
relevant amount establishes a link (whether direct or indirect) between the
borrower and the lender.
19 A direct link which clearly establishes the element of compensation can be said
to exist where:

the borrower pays the amount directly into the lender’s hands; and

the lender can put the amount to any lawful use as he pleases.
On the other hand, it can be said that an indirect link which nevertheless
establishes the element of compensation exists where:

the borrower pays the amount directly into the hands of a third party;

who receives the amount on behalf of the lender;

so that it is the lender, and not the third party, who acquires the right to
put the amount to any lawful use as he pleases.
It is not unusual to find cases where a borrower’s payment of certain fees
relating to its acquisition of credit is not for the lender’s benefit, but for the
benefit of, for instance, an independent third party who is an arranger or agent
in relation to the lender. Normally, whether or not one is dealing with such a
case can be determined with reference to the terms of the relevant credit
agreement and related documentation. What is important to note, however, is
that whereas such fees do not constitute ‘interest’ within its ordinary meaning
(i.e. because the element of compensation for the use of money lent is absent),
there is still the possibility that they fall within section 24J’s definition of
‘interest’ by virtue of being ‘related finance charges’. As such, due
consideration must be given to what is meant by the words ‘related finance
charges’.
‘Related finance charges’
The term ‘related finance charges’ is not defined in the Act, nor is there any
case law bearing particularly on this term in the context of section 24J.
20 Therefore, as per the ‘literal approach’ to statutory interpretation explained
above, the term must be given its ordinary dictionary meaning.
The Dictionary of Banking Terms (Sixth Edition) defines the term ‘related
finance charge’ as:
“the borrower’s total cost of credit, including loan interest, commitment fees,
and prepaid interest, in a consumer loan”
The description of a ‘related finance charge’ as a cost of credit entails that at the
very least, there must be a factual causal link between the borrower’s obligation
to pay the amount in question and the lender’s extension of credit to the
borrower. This means that one must be able to say that as a matter of fact, the
borrower would not have incurred the obligation to pay the relevant amount but
for the lender’s extension of credit to the borrower. However, arguably, such a
causal link is only a minimum requirement. In this regard typical charges
include arrangement fees and commitment fees. An arrangement fee is
generally payable upfront, i.e. on entering into the loan agreement. Such fee is
generally not paid unless the loan is advanced. A commitment fee is generally
charged on the undrawn portion of a facility and is charged for the relevant
financial institution committing its funds to the borrower even if they are
undrawn. In both these cases the causa for the fees relates to the commitment of
funds/the provision of credit to the borrower. These amounts are generally not
paid for, for example, services provided by the lender to the borrower.
Conclusion
From the discussions above, it is evident that the question of whether the costs
incurred by a taxpayer in relation to its acquisition of credit can be seen as
21 ‘interest’ for purposes of section 24J is, for the most part, one which must be
determined through a rigorous factual analysis. Although this means that
taxpayers (or their legal advisors) do not have the luxury of simply applying a
set of hard and fast rules to determine this question, it is noted that because the
deductibility requirements of section 24J(2) are fewer and easier to meet than
those of the general deduction formula, undertaking such a factual analysis is
worth the taxpayer’s while. Taxpayers are therefore advised not to simply
conclude that certain costs they incur in relation to their acquisition of credit,
such as arrangement fees or agency fees which are paid to and for the benefit of
an independent third party, are not ‘interest’ and are therefore not deductible in
terms of section 24J. Instead, it is prudent for taxpayers to consult their tax
advisors on the position in this regard.
ENSafrica
ITA: Sections 11(a), 23(g) and 24J
INTERNATIONAL TAX
2493. The OECD BEPS project
The BEPS Project involves input from the 34 member countries of the OECD,
all G20 members, and more than 40 developing countries. The objective of the
BEPS Project is to close gaps in international tax rules – effectively eliminating
or substantially reducing BEPS – and to secure government revenues by
ensuring that profits are taxed in the jurisdiction where the economic activities
generating such profits are performed and where value is created.
On 5 October 2015, the OECD BEPS Project delivered its 15 final outputs, two
years after its launch in 2013. Pascal Saint-Amans, Director of the Centre of
22 Tax Policy and Administration at the OECD, stated that “the international tax
system is outdated (and) we are bringing it up to date”. Indeed the denouement
of the BEPS Project represents the most fundamental changes to international
tax rules in a century. That stated, the Project does not advocate global tax
symmetry, nor does it promise a tax utopia. What it does is propose a workable
framework for inter-jurisdictional cooperation at the international tax level.
Co-operation at this level, particularly as between the tax authorities of different
countries, was inconceivable before the global financial crisis.
The BEPS Project will precipitate changes to the OECD Model Tax Convention
and the OECD Transfer Pricing Guidelines, and include recommendations for
improvements to domestic legislation to better align it with the revised
international tax system. These are soft law instruments which have been
developed and agreed to by the governments of all participating countries. They
will address double non-taxation and improve mechanisms to counter instances
of double taxation.
One of the criticisms levelled at the ambitious BEPS Project to date has been
how to quantify the effect of BEPS in the absence of a monitoring body to
consolidate global data on point; the exercise has facilitated the approximate
quantification, albeit conservative, of revenue losses from BEPS. Extensive
research done during the course of the BEPS Project indicates that between
US$100 billion and US$240 billion is lost annually due to BEPS. This equates
to between 4% and 10% of global revenues from corporate income tax and far
exceeds the speculative estimate referenced in the Tax Justice Network report,
“The Missing Billions”, or Oxfam’s attribution of US$50 billion to lost revenue
for developing countries due to multi-national enterprises (MNEs) engaging in
tax avoidance. Given that developing countries are heavily dependent on such
tax revenues, estimates of the impact on these countries, as a percentage of
GDP, is even greater.
23 The result of the BEPS Project thus far is a comprehensive package of measures
designed for coordinated domestic and treaty implementation, fortified by
targeted monitoring and enhanced transparency. The measures include:

Agreed minimum standards to level the playing field in the areas of treaty
shopping, country-by-country reporting, dispute resolution and harmful
tax practices. These are areas where all OECD and G20 countries have
committed to consistent implementation to address situations where no
action by some countries would have negative consequences for other
countries. Examples of such minimum standards are:

the model provisions to prevent treaty abuse that will be included
in the multilateral instrument that countries may adopt to
implement the results of the work on tax treaty issues into their
existing double taxation agreements (DTAs) without having to
renegotiate each one bilaterally;

standardised
country-by-country
reporting
and
other
documentation requirements to grant tax administrations global
oversight of where MNEs’ profits, tax and economic activities are
reported, thereby enabling the tax authorities to assess transfer
pricing and other BEPS risks;

a peer review process to tackle harmful tax practices, including a
review of patent boxes that contain harmful features;

adoption of the mandatory spontaneous exchange of relevant
information on taxpayer-specific rulings; and

a commitment to improve dispute resolution.
 Evaluation of the existing international tax standards to eliminate double
taxation with the objective of curtailing abuses and closing BEPS
opportunities. In particular, it provides guidance on the agreed
interpretation of the provisions of Article 9 (Associated Enterprises) of
both the OECD and UN model tax conventions; modernisation (in
24 relation to intangibles) of and changes to the Transfer Pricing Guidelines.
This will ensure that the transfer pricing of MNEs better aligns taxation
of profits with economic activity, and reduces the shifting of income to
‘cash boxes’, and the provision of methodology to appropriately price
hard-to-value intangibles.

Amendments to the permanent establishment (PE) definition to bring the
definition into alignment with the technological era and to tackle
techniques employed to inappropriately circumvent the tax nexus e.g.
through commissionaire arrangements and/or the artificial fragmentation
of business activities. Follow-up work will be done to provide guidance
on profit attribution to PEs and additional clarification will be
forthcoming on the unintended consequences of the proposed new treaty
wording, particularly with regard to the global trading of financial
products.

A common approach to align the national practices of interested countries
to limit base erosion through interest expenses; and to neutralise hybrid
mismatches. Recommendations for the design of both domestic and
model treaty provisions have been agreed. Guidance based on best
practices has also been provided for countries wishing to galvanise their
domestic law pertaining to mandatory disclosure by taxpayers of
aggressive transactions. In addition, the fundamentals of a sound
controlled foreign company (CFC) regime form part of the proposed
measures.

Regarding the digital economy, the BEPS Project acknowledges that it is
in fact the economy itself, and as such, while it may exacerbate BEPS
risks, it cannot be ring-fenced for tax resolution purposes. For this reason,
it is anticipated that the measures developed through the work of the
BEPS Project will mitigate such risks.

One of the most exciting measures, from a jurisprudential perspective, is
the negotiation of a multilateral instrument – an innovative mechanism to
25 update the global network of more than 3 500 DTAs. More than ninety
countries are collaborating to formulate a multilateral instrument to
implement the treaty-related BEPS measures, the objective being to
modify the DTAs in a synchronised and efficient manner, obviating the
need to expend resources on bilaterally renegotiating each DTA. The
deadline for conclusion of the multilateral instrument is the end of 2016.
So, where to from here?
The BEPS Action Plan notes that:
“The emergence of competing sets of international standards, and the
replacement of the current consensus based framework by unilateral measures,
could lead to global tax chaos marked by the massive re-emergence of double
taxation.”
Given this potential risk, it is submitted that consistent, coordinated
implementation and application are critical. There has been a shift in the
international tax paradigm for governments, tax administrations and taxpayers
(particularly MNEs) since the global financial crisis, the best of which is
evidenced
by
the
overwhelming
cross-jurisdictional
participation
and
collaboration in the BEPS Project; and embodied in the Project’s measures. It
has been observed that South Africa has developed certain sophisticated and
robust measures to protect its tax base from erosion over time, so why should
we concern ourselves with what happens beyond our borders? Well, simply
because we operate within the global community and as SAICA commented,
with reference to another international tax issue, South Africa is “too small an
economy in the world to be out of step with the general consensus view”.
It is submitted that SAICA’s observation is relevant here too. The objectives of
the BEPS Project may be lofty, but how can that be viewed as a shortcoming?
They make practical sense in both the domestic and international tax arenas.
26 And who knows? Perhaps South Africa’s active involvement in the BEPS
Project, and its commitment to consider the proposed measures, provided they
align with the NDP, will operate as a notional extra-jurisdictional sanction on
the perceived willingness of South African corporate taxpayers and MNEs
conducting business in South Africa, to invest substantial amounts of time,
money and resources on domestic tax avoidance. This could be to the South
African Revenue Service’s (SARS’) advantage, particularly given that domestic
tax morality is under threat due to inefficient government spending and
corruption; inchoate e-tolling pronouncements; and SARS’ rapacious collection
methods, all of which have caused the ‘trust deficit between taxpayers and
government’ to increase.
Cliffe Dekker Hofmeyer
TAX ADMINISTRATION
2494. Legal privilege procedure
The draft Tax Administration Laws Amendment Bill of 2015 (TALAB),
published for public comment on 22 July 2015, proposed the introduction of a
new section 42A into the Tax Administration Act of 2011 (the TAA), dealing
with the procedures to be followed where legal professional privilege
(Privilege) is asserted by a taxpayer. These procedures are particularly onerous
on the taxpayer and may result in undue delays in the tax dispute resolution
process, particularly in relation to discovery proceedings.
National Treasury released an amended TALAB (introduced to the National
Assembly on 27 October 2015), in which the information required is now listed
as follows:
27  a description and purpose of each item of the material in respect of which
Privilege is alleged;
 the author of the material and the capacity in which they were acting;
 the name of the person for whom the author of the material was acting in
providing the material;
 confirmation in writing that the aforementioned person is claiming Privilege
in respect of the material;
 if the material is not in possession of the aforementioned person, from whom
did the person asserting privilege obtain the material; and
 if the taxpayer is not the same person who has confirmed in writing that they
are claiming Privilege, a description of the circumstances and instructions
regarding the privilege under which that person obtained the material from
the taxpayer.
It follows that, despite the required information having been reduced slightly,
taxpayers may still face a number of challenges in meeting these disclosure
requirements without inadvertently waiving Privilege.
The procedure to be followed once SARS has received this information – it may
dispute the allegation of Privilege by arranging with a member of the panel of
advocates and attorneys constituted in terms of section 111 of the TAA to take
receipt of the relevant document/s. The person alleging Privilege will then be
obliged to hand over sealed copies of the relevant document/s. Thereafter, the
panel member will make a determination (which is subject to challenge on
application to a High Court) as to whether or not Privilege applies.
Given the potential timing implications which the revised proposed section 42A
may have on ongoing and future tax dispute resolution proceedings, it may
become necessary (where possible) for taxpayers and their legal practitioners to
pre-emptively compile the required information in relation to Privileged
28 material, prior to an anticipated request for information being received from
SARS. Alternatively, taxpayers will have to ensure that these onerous processes
are taken into account when contemplating the various time frames within
which required relevant material must be delivered to SARS, and the potential
duration of tax dispute resolution proceedings. It is also notable that, inter alia,
disputes regarding Privilege and consequential delays have motivated the
extension of prescription rules applicable to tax disputes.
ENSafrica
TAA: Section 111
Taxation Laws Amendment Bill, 2015
Tax Administration Laws Amendment Bill, 2015
2495. Treatment of PAYE for VDP purposes
The disclosure to the South African Revenue Service (SARS) of potential tax
defaults can be addressed in various ways. However, the formal voluntary
disclosures programme (VDP), as contemplated in the Tax Administration Act,
2011 (the TAA), is the preferred and recommended option.
The VDP is a formal statutory process, regulated under Part B of Chapter 16 of
the TAA, in terms of which a taxpayer can approach SARS voluntarily to
regularise its tax affairs with the prospect of obtaining various forms of relief. It
is important to note that upon a successful VDP application, the VDP process
does provide relief in respect of understatement penalties (which could be up to
200% in severe cases), 100% relief from administrative non-compliance
penalties and in addition thereto, SARS will not pursue criminal prosecution.
Recently there has been an increase in the number of employers defaulting on
their pay-as-you-earn (PAYE) obligations to SARS. This is especially true
29 where one is dealing with non-resident employees and the obligation on the
employer to withhold PAYE.
In general, a ‘resident’, as defined in section 1 of the Income Tax Act, 1962 (the
Act), is taxed on their worldwide income, irrespective of where the income is
earned. Non-residents are only taxed on income from a South African source,
subject to the application of a relevant double tax agreement (DTA).
Accordingly, where a DTA finds application, South Africa’s taxing rights may
be limited, notwithstanding the fact that the expatriate employee’s income is
from a local source.
Where, however, South Africa’s taxing rights are not limited by the application
of a relevant DTA, the next step is to determine whether the employer
concerned has an obligation to withhold PAYE. Paragraph 2(1) of the Fourth
Schedule provides that an employer who is a resident or representative
employer in the case of a non-resident and who pays or becomes liable to pay
any amount by way of remuneration to any employee, will be required to deduct
employees’ tax in respect of the normal tax liability of that employee.
The SARS External Reference Guide - Treatment of PAYE for VDP Purposes
(the SARS Guide), specifically provides that where employers wish to
regularise their employees’ tax affairs in terms of the VDP process, the
employers must apply in the prescribed manner and in accordance with either
one of the following options:
1. The employer recovers the employees’ tax directly from the employees
concerned.
2. The employer does not recover employees’ tax directly from the employees
concerned but applies the ‘gross–up’ method.
30 In relation to the first option, it is important to note that one of the key
requirements that must be present before an employer can rely on the first
option in regularising its PAYE affairs is that the employer must have issued a
valid IRP5 certificate to the relevant employee. By implication, this would
mean that the employee, to whom the IRP5 certificate has been issued, must
have a valid South African income tax reference number.
In circumstances where the employee does not have a valid income tax
reference number and an IRP5 certificate has not been issued to the employee,
the employer should automatically default to the second option in regularising
its PAYE affairs. In other words, the employer would not be able to recover the
employees’ tax from the employee concerned, but would by default elect to pay
the PAYE on behalf of the employee.
The consequence of the employer paying the PAYE on behalf of the employee
is that such payment would constitute a ‘payment of the employee’s debt’ which
triggers a taxable fringe benefit in the hands of the employee under the
provisions of paragraph 2(h) of the Seventh Schedule to the Act.
The SARS Guide (at page 4) specifically states that the “…benefit due to the
payment of the employees’ debt will result in another benefit on which tax
again becomes payable….” It is important to note that this ‘tax-on-tax’ benefit
is calculated in accordance with the following prescribed formula:
‘Taxable amount’ x 100
100 – employee’s marginal tax rate
= ‘Taxable amount plus tax on tax benefit’
The ‘taxable amount’ represents the value of the remuneration in respect of
which the employer wishes to regularise the PAYE. The full ‘taxable amount
plus tax on tax benefit’ represents remuneration. The difference between the full
31 ‘taxable amount plus tax on tax benefit’ and the ‘taxable amount’ represents the
tax attributable to the tax-on-tax benefit (payment of employee’s debt).
It is further important to note that where the gross-up of the taxable
remuneration results in an increase in the tax rate from one tax bracket to the
next, the marginal tax rate in the above formula must be increased by 1%. For
example, where the marginal tax rate of the employees equals 40%, the increase
by 1% will result in a marginal rate of 41%.
The SARS Guide concludes by stating that once the employer has determined
the total PAYE amount payable to SARS, the employer must issue one global
IRP5 certificate for the total employees’ tax not recovered from the employees
(including the value of the tax attributable to the tax-on-tax calculation above).
Accordingly, once the aforementioned is completed, the relevant EMP501 must
be amended and reconciled and submitted together with the new VDP tax
certificate to SARS.
Cliffe Dekker Hofmeyr
ITA: Paragraphs 2(1) of the Fourth Schedule and 2(h) of the Seventh
Schedule
TAA: Part B of Chapter 16
SARS External Reference Guide - Treatment of PAYE for VDP Purposes
VALUE-ADDED TAX
2496. Recovery of costs
32 The question of whether VAT must be levied on costs that are on-charged often
arises, particularly when no VAT was incurred on the cost in the first instance.
The issue is most prevalent in the services industry where a consultant, for
example, seeks to recover from his client certain costs that the consultant has
incurred in rendering services to the client.
Where the consultant incurs costs on behalf of the client, such as the payment of
an application fee or a license fee, then such fees are paid in the capacity as
agent for and on behalf of the client. The recovery of the costs in these
circumstances will not be subject to VAT in the hands of the consultant. The
consultant will simply recover the actual cost incurred from the client without
claiming any input tax and will not account for any output tax on the recovery
either. This is because section 54(2) of the Value-Added Tax Act, 1991 (the
VAT Act) deems the supply to be made to the client directly.
The position is less clear where the consultant incurs the costs for his own
account, for example VAT exempt costs for using the Gautrain to attend a
meeting at the client’s premises, or zero-rated petrol costs (based on a rate per
kilometre) for travelling to the client, which he seeks to recover from the client.
Section 7(1)(a) of the VAT Act levies VAT on the supply by a vendor of goods
or services in the course or furtherance of an enterprise carried on by the
vendor. The VAT is then, in terms of section 10(2) and 10(3) of the VAT Act,
calculated at the applicable rate on the consideration received for the supply.
The term ‘consideration’ is defined in section 1(1) of the VAT Act to include
any payment made or to be made in respect of, in response to, or for the
inducement of, the supply of any goods or services. The consulting services will
be a taxable supply if the consultant is a registered VAT vendor, and
consequently any consideration paid in respect of or in response to the supply of
the consulting services will be subject to VAT. One therefore needs to consider
33 whether the recovery of the costs incurred constitutes consideration for the
consulting services rendered, or for the on-supply of the goods or services
acquired.
In the case of Commissioner, South African Revenue Service v British Airways
plc [2005] 67 SATC 167, the Supreme Court of Appeal (‘SCA’) considered
whether passenger service charges levied on an airline by an airport operator
and on-charged by the airline to passengers on an international flight, comprised
consideration for separate services rendered by the airline to the passengers
which is subject to VAT at the standard rate of 14 per cent. The SCA held that:
“The charge that the [airports] company makes to British Airways is no more
than a cost that British Airways has to bear in order to operate its carrier service,
similar to those that it pays to land and park its aircraft, which it recovers from
its passengers directly, rather than indirectly.”
The SCA concluded that:
“...The moneys that are recovered by British Airways are not a consideration for
the supply by it of airport services simply because it does not supply them at
all”.
The SCA therefore confirmed that the cost incurred by the airline and recovered
from the passengers formed part of the consideration for the zero-rated
international transport service supplied as opposed to being consideration for
separate passenger services rendered by the airline to the passengers.
In a similar vein, SARS has previously ruled in general written ruling 20 that
where a landlord recovers a proportion of property rates incurred by him from
his tenants in respect of commercial rental, the recovery of these costs by the
landlord from the tenant forms part of the total rental consideration, irrespective
of whether it is specified as a separate component of the rental consideration;
34 VAT must accordingly be levied on the total rental consideration in terms of
section 7(1)(a). At the time that the ruling was in effect, property rates fell
outside the scope of VAT, but this did not affect the recovery of such costs to be
subject to VAT. SARS also previously ruled in general written ruling 76 that
where a company recovers travelling expenses based on a rate per kilometre
from another company (and these expenses include petrol costs), the recovery of
the travelling expenses constitutes consideration in respect of a taxable supply
and will therefore be subject to VAT in terms of section 7(1)(a).
Although rulings 20 and 76 were withdrawn by SARS, the principles on which
they were based are in line with the SCA judgment in the British Airways case.
In the case of ruling 20, the landlord does not supply municipal services to the
tenant for which he receives the recovery of the property rates as consideration,
but the recovery of the costs forms part of the rental consideration for the
property. In the case of ruling 76 the recovery of the petrol costs forms part of
the consideration of the services rendered by the company and is not
consideration for the supply of petrol.
Revisiting the scenario of the consultant, the cost of commuting via the
Gautrain forms part of the consultant’s consideration for rendering the services
to the client and as such is subject to VAT at the standard rate. Similarly, the
recovery of the petrol costs for travelling to the client is subject to VAT at the
standard rate, being part of the consideration for the consulting services
rendered. The fact that the Gautrain fares or the petrol costs did not attract VAT
in the hands of the consultant, is a moot point.
Service providers should therefore closely scrutinise as to whether they are
properly accounting for VAT on costs recovered as part of their services
rendered to clients.
35 ENSafrica
VAT Act: Sections 1(1), 7(1)(a), 10(2), 10(3) and 54(2)
SARS NEWS
2497. Interpretation notes, media releases and other documents
Readers are reminded that the latest developments at SARS can be accessed on
their website http://www.sars.gov.za.
Editor:
Ms S Khaki
Editorial Panel:
Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan,
Prof KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC
Foster
The Integritax Newsletter is published as a service to members and associates of
The South African Institute of Chartered Accountants (SAICA) and includes
items selected from the newsletters of firms in public practice and commerce
and industry, as well as other contributors. The information contained herein is
for general guidance only and should not be used as a basis for action without
further research or specialist advice. The views of the authors are not
necessarily the views of SAICA.
36