MARCH 2014 – ISSUE 174
CONTENTS
CAPITAL GAINS TAX
TAX ADMINISTRATION ACT
2285. The effects of inflation
2286. Value shifting provisions
2291. Understatement
penalty changes
COMPANIES
TRUSTS
2287. A group of companies for
corporate rules
2292. Distributions from and
donations to foreign trusts
2288. Foreign dividend exemption
DEDUCTIONS
VALUE-ADDED TAX
2289. Interest in re-organisations
2293. Tax invoices
2294. Deductions for income tax and
VAT
INTERNATIONAL TAX
SARS AND NEWS
2290. Transfer pricing - India
experience
2295. Interpretation notes, media
releases and other documents
CAPITAL GAINS TAX
2285. The effects of inflation
The South African capital gains tax (CGT) regime does not provide for
indexation: it does not take into account the effect that inflation may have on
capital profits over time.
1
Consider the following example: A company bought an asset on 1 January 2002
for R1 000. The company sold the asset on 1 January 2013. The inflation rate
during that period was, for example, 6% compounded annually. The company
realised a return of, for example, 10% compounded annually, that is, a return of
4% above inflation compounded annually. Accordingly, the company sold the
asset for an amount of R2 853. The company realised a nominal profit of
R1 853 (R2 853 – R1 000). But, taking into account the effect of inflation, the
company achieved a real profit of R539 (R1 539 – R1 000).
The company distributed the nominal profit of R1 853 to its shareholders who
are natural persons.
The total amount of tax payable effectively borne by the shareholders, the
ultimate investors, is determined as follows:
Step 1 – Determine CGT in the hands of the company:
Proceeds
R2 853
Base cost
(R1 000)
Capital gain
R1 853
Apply inclusion rate (66.6%)
R1 234
Apply corporate tax rate (28%)
R346
The CGT amounts to R346.
Step 2 – Determine dividends tax in the hands of the shareholders:
Profit before CGT
R1 853
CGT
(R346)
2
Profit after CGT
R 1 507
Apply dividends tax rate (15%)
R226
The dividends tax amounts to R226.
The total tax effectively borne by the shareholders amounts to R572 (R346 +
R226).
As mentioned above, the real net profit after taking into account the effect of
inflation is R539. In other words, in real terms, the shareholders are paying
more to the taxman (R572) than they are actually realising on their investment
(R539).
When CGT was introduced in 2001, the National Treasury considered the issue
of whether or not CGT should provide for indexation, that is, to take the effect
of inflation into account.
In a document entitled "Briefing by the National Treasury's Tax Policy Chief
Directorate to the Portfolio and Select Committees on Finance Wednesday, 24
January 2001" the National Treasury considered the issue in detail. Among
other things, it made the following statements:
•
"The combined benefits of the 'low inclusion rate' and deferring accrued
capital gains until realisation should more than compensate for the effects
of inflation in a moderate-inflation environment".
•
"…[T]he potential impact of inflation was one of a number of
considerations (though not the primary factor) that informed the decisions
to have moderate (low) 'inclusion rates' of capital gains in taxable
income, thereby partially adjusting for inflation".
3
•
"Assuming a constant pre-tax real return, constant inflation and constant
inclusion rate, the effective tax rate would fall over time. This suggests
that inflation compensation arising from a constantly low inclusion rate
would increase with time" (emphasis added).
The "low" inclusion rate was only one of the reasons why the National Treasury
did not provide for indexation. Notably, "administrative complexity" was one of
the motivations.
When CGT was introduced with effect from 1 October 2001, generally
speaking, the inclusion rate was set at 25% for natural persons and at 50% for
other persons. However, with effect from years of assessment starting on or
after 1 March 2012, the inclusion rate was increased to 33,3% and 66,6%,
respectively.
In the Budget Speech of 22 February 2012 it was stated that the increase of the
inclusion rate was necessary to "reduce the scope for tax arbitrage and broaden
the tax base further". The 2012 Budget Tax Proposals stated (at page 3) that
CGT: "was introduced in 2001 at relatively modest rates and has remained
unchanged for the past 10 years. This reform has helped to ensure the integrity
and progressive nature of the tax system. To enhance equity, effective capital
gains tax rates will be increased." It appears that no substantive reasons were
given for the change.
At the time, most commentators were surprised by the increase in the inclusion
rates but there was not much resistance against the increase at the time.
It would appear that the inclusion rate was increased simply to collect more tax.
The increase certainly had nothing to do with "equity". As noted above, in fact,
when CGT was introduced the National Treasury implied that the inclusion rate
4
was set at a 'low' rate for reasons of equity: to compensate for the effects of
inflation. Further, it said that the inflation compensation would increase over
time as a result of a constantly low inclusion rate, suggesting that the
compensation would only work over a long period of time if the inclusion rate
was kept steady. (It is noted that the corporate tax rate at the time was 30%
compared to the current rate of 28%, but this does not materially affect the
principle.)
When the inclusion rates were increased in 2012, the National Treasury seems
to have conveniently forgotten what it had said before about keeping the rates
constant. The effect of the increase of the inclusion rate is of course exacerbated
by the recent replacement of secondary tax on companies with the dividends tax
and the increase of the rate from 10% to 15%.
It is manifestly apparent that the high rate of CGT combined with the dividends
tax is eroding the real returns of investors, and is not encouraging taxpayers to
invest and save.
It is submitted that, to compensate for inflation, the National Treasury should at
a minimum either reduce the CGT inclusion rates or provide for indexation.
(Editorial comment: What is happening in other countries?)
Cliffe Dekker Hofmeyr
ITA: Eighth schedule
2286. Value shifting provisions
In terms of amendments introduced by the Taxation Laws Amendment Act of
2012, the definition of ‘value shifting arrangement’ was set to exclude changes
of interests in companies with effect from 1 January 2014. A value shifting
arrangement arises if, for example, a company issues shares for less than market
5
value to a person connected to the shareholders. In this way, value is ‘shifted’
from the estates of the existing shareholders to the new shareholder/s without a
‘disposal’ as defined in paragraph 11 of the Eighth Schedule arising (other than
by way of the deemed disposal constituted by the value shifting arrangement).
For example, say a company is worth R10 million and has an issued ordinary
share capital of 100 shares. Therefore each share is worth R100 000. If the
shares are all held by Mr A who causes the company to issue a fresh 100 shares
to his son for no consideration, the value shifting provisions would deem Mr A
to have realised a capital gain in the amount represented by the decrease in his
interests, namely R5 million. Mr A’s son is in effect receiving R5 million of
value for nothing.
Due to other amendments to the Act it was believed that the value shifting
provisions as they relate to changes of interests in companies were obsolete.
This was never our view and it appears that, correctly, these provisions are now
recognised as being necessary so as to tax the party that experiences the
decrease in the value. The Taxation Laws Amendment Act of 2013 has deleted
the amendments that would have rendered the value shifting provisions
inapplicable to changes of interests in companies.
For completeness, we reproduce the definition of ‘value shifting arrangement’
below.
“‘Value shifting arrangement’ means an arrangement by which a person retains
an interest in a company, trust or partnership, but following a change in the
rights or entitlements of the interests in that company, trust or partnership (other
than as a result of a disposal at market value as determined before the
application of paragraph 38), the market value of the interest of that person
decreases and –
6
(a)
The value of the interest of a connected person in relation to that person
held directly or indirectly in that company, trust or partnership increases; or
(b)
A connected person in relation to that person acquires a direct or indirect
interest in that company, trust or partnership.”
ITA: section 1 and Eighth Schedule “value shifting arrangement”
BDO
COMPANIES
2287. A group of companies for corporate rules
The Income Tax Act No. 58 of 1962 (the Act) contains a definition of a 'group
of companies' in section 1 of the Act. However, a narrower definition of the
term 'group of companies' is contained in section 41 of the Act, which applies to
certain corporate tax roll-over rules and other provisions contained in the Act. It
is important to identify which companies fall within the different definitions of
a 'group of companies' in order to determine whether one qualifies for the
applicable tax relief.
The South African Revenue Service (SARS) released Interpretation Note No.
75 on 24 October 2013 (IN 75) to provide guidance on the interaction of the
definitions of 'group of companies' as found in sections 1(1) and 41(1). To
obtain a better understanding of SARS's interpretation of the proviso to the
'group of companies' definition in section 41and the 'group of companies'
definition in section 1, it is helpful to consider the following basic example of a
foreign tax resident holding company (USCo) that holds directly 100% of the
equity shares in two South Africa tax resident companies (SACo 1 and SACo
2):
7
In determining whether USCo, SACo 1 and SACo 2 form part of the same
'group of companies' for purposes of section 41(1), IN 75 submits that:
•
The first requirement of section 41(1) would be satisfied in that there is a
'group of companies' as defined in section 1(1). USCo holds at least 70%
of the equity shares in SACo 1 and SACo 2. SACo 1 and SACo 2 are
therefore the 'controlled group companies' of USCo.
•
Paragraph (i)(ee) of the proviso to the 'group of companies' definition in
section 41excludes a company incorporated under the law of any other
country other than the Republic of South Africa (unless that company has
its place of effective management in South Africa). USCo, being a nonresident, should be excluded from being considered as being part of the
'group of companies'.
•
The definition contained in section 1(1) should be re-applied to assess
whether the remaining companies fall within the 'group of companies'
definition in section 1. If one applies this approach, USCo would be
excluded from the consideration of the 'group of companies' definition in
section 1 and there would be no 'controlling group company' in relation to
SACo 1 and SACo 2. As result, SACo 1 and SACo 2 would not form part
of the same 'group of companies' for purposes of section 41.
8
IN 75 concludes that it is not permissible to interpret the proviso as an
independent enacting clause and its provisions must be read as if they form part
of the opening words of the definition in section 41(1) (that is the 'group of
companies' definition in section1). The exclusion by the proviso of, for
example, a controlling company from a group of companies will accordingly
impact whether its controlled companies remain part of a group of companies
under rules.
We are aware that the South African Institute of Chartered Accountants
(SAICA) submitted comments on the draft IN 75. In particular, SAICA
submitted that "[w]hat section 41 definition requires is that a group of
companies must be determined in accordance with the section 1 definition.
Paragraph (i) of the proviso then requires that the specified companies are
excluded from that group of companies for purposes of section 41. Nowhere
does it suggest that the section 1 definition must be reapplied without having
regard to the specified companies."
If one were to adopt the above interpretation and apply it to the aforementioned
example, for purposes of section 41:
•
US Co would not form part of the same 'group of companies' as SACo 1
or SACo 2 (excluded by the provision in paragraph (i)(ee) of the 'group of
companies' definition in section 41); and
•
SACo 1 and SACo 2 would still
form part of the same 'group of
companies' on the basis that they fall within the 'group of companies' as
defined in section 1 and do not fall within any of the provisos to the
'group of companies' in section 41.
However, with the release of IN 75 it is clear that SARS does not accept the
above interpretation. It is critical that taxpayers carefully analyse whether their
transactions fall within the relevant 'group of companies' definitions, otherwise
the anticipated tax implications of the transaction may be queried by SARS.
9
Cliffe Dekker Hofmeyr
ITA: Sections1 and 41and Interpretation Note No. 75
2288. A Foreign dividend exemption
South African residents are required to include in their gross income any
amount received or accrued by way of a foreign dividend, as defined.
A “foreign dividend” is defined in section 1 of the Income Tax Act No. 58 of
1962 (the Act) as including, inter alia, any amount that is paid or payable by a
foreign company in respect of a share in that foreign company where that
amount is treated as a dividend or similar payment by that foreign company for
the purposes of the laws relating to •
tax on income on companies of the country in which that foreign
company has its place of effective management; or
•
companies of the country in which that foreign company is incorporated,
formed or established, where the country in which that foreign company has its
place of effective management does not have any applicable laws relating to tax
on income (subject to certain exclusions).
The South African income tax treatment of a foreign distribution will therefore
be a function of the income tax treatment of that distribution in the foreign
jurisdiction. It is therefore recommended that confirmation is obtained that
dividends declared by a foreign company, are treated as dividends or similar
payments in the relevant foreign jurisdiction, as set out above.
Foreign dividends, as defined, are however, exempt from tax in terms of section
10B of the Act in certain circumstances. Most notably, section 10B, provides
for the so-called “participation exemption”.
10
In this regard section 10B(2)(a) of the Act provides that foreign dividends
received by or accrued to a person are exempt from tax where that person holds
(whether alone or together with any other person forming part of the same
group of companies) at least 10% of the equity shares and voting rights in the
company declaring the dividends, subject to certain exclusions.
The participation exemption has recently been amended to exclude foreign
dividends from shares other than “equity shares”. An “equity share” is defined
in section 1 of the Act as any share in a company excluding any share that,
neither as respects dividends nor as respects returns of capital, carries any right
to participate beyond a specified amount in the distribution.
Previously, South African companies which held at least 10% of the equity
shares and voting rights in a foreign company as well as preference shares
would have qualified for the participation exemption in respect of the dividends
declared on the preference (and ordinary) shares. Therefore, the participation
exemption applied to all shares as long as the South African company held 10%
of the equity shares and voting rights.
As stated above, the participation exemption has now been amended to exclude
foreign dividends on shares other than equity shares. The legislature has
indicated that it was always intended that the participation exemption should
apply only to foreign dividends received from equity shares.
The amendment applies with effect from 1 April 2014 in respect of foreign
dividends received or accrued after that date.
ENSAfrica
ITA: Sections1 and 10B
11
DEDUCTIONS
2289. Interest in re-organisation transactions
Amongst the slew of amendments, was an amendment regulating the
deductibility of interest incurred in respect of reorganisation transactions. The
amendment will affect the structuring of reorganisation transactions, especially
those that are debt funded, with significant consequences for the taxpayer.
The history
To understand these amendments, one has to go back a few years to June 2011
when section 45 of the Income Tax Act (the Act), which deals with intra-group
transactions, was suspended for a period. The main reason why section 45 was
suspended was to allow National Treasury to put in place measures to curb the
perceived erosion of South Africa’s tax base through numerous debt funded
private equity transactions that occurred utilising the provisions of section 45 to
avoid triggering any taxation.
When the suspension of section 45 was lifted, an interim measure in the form of
Section 23K of the Act was introduced. Section 23K denies the deduction of
interest incurred in respect of debt utilised to fund reorganisation transactions
(involving intra-group transactions (in terms of section 45) and liquidation
transactions (in terms of section 47)). Section 23K does however, provide for
the Commissioner of SARS (“the Commissioner”) to approve the deductibility
of interest incurred in respect of such debt, if it is satisfied that the level of debt
and interest incurred does not pose a significant threat to the South African tax
base. The Commissioner considers various factors in such an assessment.
However, section 23K was not intended to be a long-term solution, but was
initially expected to apply only until 31 December 2013.
New provisions
12
The TLAA now contains a long-term solution to the base erosion problem,
identified by National Treasury, in the form of a new section 23N. Unlike
section 23K, which rendered the deductibility of interest subject to the
discretion of the Commissioner, section 23N now proposes a more objective
test, thereby negating the requirement for affected taxpayers to apply for a
directive from the Commissioner. If a taxpayer meets the qualifying criteria, the
interest incurred in affected reorganisation transactions will be tax deductible,
subject to the stipulated deductibility thresholds.
In essence, section 23N provides that when the acquisition of assets in terms of
a reorganisation transaction is funded through debt, the interest incurred will be
allowed as a deduction, subject to a formula, which equals:
Interest received by, or accrued to, the acquiring company
Add:
40% of the adjusted taxable income of the acquiring company
Less:
Interest incurred by the acquiring company, other than interest
incurred that is the subject of the section 23N limitation
The adjusted taxable income used in this formula is the higher of the adjusted
taxable income of the acquiring company for the year of assessment in which
the reorganisation transaction is entered into or the year of assessment in which
the interest is incurred. This establishes a base for determining the interest
deduction limitation.
Adjusted taxable income is determined as follows:
Taxable income
Less:
Interest received or accrued
Less:
Net income of a controlled foreign company
Less:
Capital asset recoupments
13
Add:
Interest incurred
Add:
Any deduction or allowance in respect of a capital asset
Add:
75% of gross income from the letting of any immovable
property
In principle, adjusted taxable income is similar to an accounting EBITDA
(earnings before interest, tax, depreciation and amortisation) number.
Section 23N provides that the interest deduction limitation described above,
must be applied for the year of assessment in which the reorganisation
transaction is entered into and the five years of assessment immediately
thereafter.
The introduction of a defined set of rules governing the deductibility of interest
incurred in respect of debt funded reorganisation transactions is welcomed as it
removes the need to obtain pre-approval from the Commissioner. However, the
application of these rules in practice, and whether or not they will result in an
equitable outcome remains to be seen.
Section 23N will apply to any reorganisation transaction (i.e. an intra-group or
liquidation transaction) entered into on or after 1 April 2014. For reorganisation
transactions entered into prior to 1 April 2014 any directive issued by the
Commissioner in terms of section 23K will continue to apply to interest
incurred on any debt utilised or assumed to fund such transactions. However,
should any new debt be issued, assumed or used after 1 April 2014 to redeem,
refinance, substitute or settle any debt utilised / applied in a reorganisation
transaction which was subject to a section 23K directive, section 23N will be
applicable to the interest incurred on such new debt.
14
Section 23N also applies to acquisition transactions in terms of section 24O of
the Act where a controlling interest in an operating company is acquired, i.e. the
acquisition of shares in specific circumstances.
Anyone involved in reorganisation transactions is advised to consider the
amendments carefully as they could have a significant (positive or negative)
effect on future transactions.
Grant Thornton
ITA: Sections 23K, 23M, 23N, 23O, 23P, 45 and 47
INTERNATIONAL TAX
2290. Transfer pricing - India experience
When it comes to transfer pricing, India is widely considered the most advanced
and experienced member of the BRICS countries (Brazil, Russia, India, China
and South Africa.) In its position as leader, India has reinforced its commitment
to assist other countries to improve and strengthen their own domestic transfer
pricing laws. India has expressly committed to providing aid in further
developing China and South Africa’s transfer pricing legislation and its
enforcement.
Considering that India is providing guidance and training to the South African
Revenue Service (SARS), it is vital that we take cognisance of the potential
influence that the Indian transfer pricing specialists will have on any further
amendments to the current transfer pricing provisions included in our domestic
law. The Indian Revenue Authorities (IRA) will likely enhance the ability of
SARS to conduct procedurally efficient and thorough transfer pricing audits in
the future.
15
It has been argued that Multinational Enterprises (MNEs) operating throughout
Africa have in the past been exploiting the profits of many developing nations,
including South Africa’s, and that this has effectively inhibited the efforts of
these countries’ leaders to improve the social standards of their citizens. With
the assistance of a country like India, South Africa may be able to mitigate the
perceived risk of MNE’s unjustly stripping the country of any further profits.
The possibility of South Africa then extending this knowledge and experience
gained from India to other African economies (with the assistance of bodies like
the African Tax Administration Forum [ATAF]) and the ensuing development
of robust transfer pricing legislation throughout the continent, is promising.
Despite the obvious need for assistance in the area of transfer pricing, many
have expressed concern that India, as a non-OECD member, may influence
South Africa in a manner contradictory to the internationally recognised and
widely accepted OECD guidelines and principles. While South Africa is also
not an OECD member (although currently viewed as an observer country), our
transfer pricing laws have thus far largely been based on OECD guidelines. An
example of this is the recent fundamental changes to section 31 of the Income
Tax Act No. 58 of 1962 (the Act) that were implemented to ensure convergence
with the OECD principles.
There are a number of notable differences between the transfer pricing
principles envisaged by the OECD Guidelines and the legislation enacted and
applied by the Indian Revenue Authorities. The significant differences are
discussed below:
Use of concurrent data
The Indian transfer pricing regulations stipulate that the analysis of the
comparability of related party transactions and similar uncontrolled transactions
should be based upon the data of the financial year in which the international
16
transaction under review was entered into. The use of data for the preceding two
years is only permitted if it is proved that such data reveals a fact that could
have an influence on the determination of arm’s length price. This is in contrast
to the OECD guidelines and practical application by most OECD member
countries, which tend to analyse data for the current and four preceding years.
Difference in risk perception
A comparison of functions performed, assets employed and risks assumed is
fundamental to any transfer pricing comparability analysis. The IRA considers
that the risk of a MNE is an inevitable by-product of performance of functions
and ownership, exploitation or use of assets employed. Accordingly, risk is not
seen as an independent element, requiring separate analysis as contained in the
OECD guidelines.
Further, the IRA disagrees with the idea that risk can be controlled remotely by
the parent company and that an Indian subsidiary or related party engaged in
core functions (e.g. carrying out research and development (R&D) activities), or
providing consulting type services, can truly be risk free entities. The IRA
believes that if a R&D function or other service is located in India, the Indian
subsidiary exercises a level of obligatory control over the operational and other
risks attached to the function. In these circumstances, the ability of the parent
company to exercise full control over the risk is very restricted.
Allocating the full risk to the parent MNE in such cases is therefore not
accepted.
Single arm’s length price
Application of the most appropriate method in terms of the OECD principles
will likely result in computation of more than one arm’s length price (i.e. a
range of prices is established.) Where there may be more than one arm’s length
17
price, the arithmetic mean of such prices is calculated and considered as the
single acceptable arm’s length price for Indian transfer pricing purposes. Indian
transfer pricing regulations do not accept a range of prices as envisaged by the
OECD Guidelines. In other words, Indian transfer pricing regulations do not
mandate the use of inter quartile range as accepted practice.
Location savings
The OECD does not recognise the notion of location savings and no explanation
is provided in this regard, not even in the OECD Guidelines drafted in respect
of developing countries. According to the IRA, “location savings” should be
one of the major aspects to be considered when carrying out a comparability
analysis during transfer pricing audit. Because operating in India provides
advantages such as reduced labour and raw material costs, the IRA considers
that these advantages warrant some level of compensation.
There is also debate about the number of location specific advantages related to
operating in India, such as highly specialised and skilled manpower and
knowledge, access and proximity to a fast growing local/ regional market as
well as a large customer base with increased spending capacity. The incremental
profit resulting from these advantages is widely referred to as “location rents”.
One of the main transfer pricing issues the IRA is dealing with is the
quantification and allocation of location savings and location rents among
associated enterprises. Under arm’s length pricing, allocation of location
savings and rents between associated enterprises should be made by reference to
the value which independent parties would have agreed in comparable
circumstances. The IRA believes it is possible to use the profit split method to
determine arm’s length allocation of location savings and rents in cases where
comparable uncontrolled transactions are not available.
Now what?
18
With increasing focus being placed on transfer pricing by the media, both
domestically, and internationally, there is pressure on SARS to act according to
their stated intention to combat the complex international schemes that have
been singled out as contributors to the erosion of the tax base. It will be
interesting to see how stringent SARS audits, and any further legislation and
guidance thereto, become the reality following the training and guidance
provided by the IRA.
(Editorial comment:
This article shows that there is a world trend to
strengthen transfer pricing monitoring it is not yet clear which path will be
adopted by tax authorities.)
Grant Thornton
ITA: Section 31
TAX ADMINISTRATION ACT
2291. Understatement penalty changes
(Refer to article 2255)
Current provisions of the Tax Administration Act
The Tax Administration Act No. 28 of 2011 (the TAA) became effective on
1 October 2012 and introduced the understatement penalty regime. In terms of
section 222 of the TAA, a taxpayer must pay an understatement penalty in
addition to the tax payable for the relevant tax period in the event of an
“understatement”.
What constitutes an “understatement”?
An “understatement” is defined as any prejudice to the South African Revenue
Service (SARS) or the fiscus in respect of a tax period as a result of:
•
a default in rendering a return;
•
an omission from a return;
•
an incorrect statement in a return; or
19
•
if no return is required, the failure to pay the correct amount of tax.
How is the understatement penalty calculated?
The understatement penalty is the amount determined by applying the highest
applicable understatement penalty percentage in the understatement penalty
percentage table (see below) to the difference between the amount of tax
properly chargeable for the tax period and the amount of tax that would have
been chargeable if the understatement was accepted.
The understatement penalty percentage table, prior to its recent amendment, set
out in section 223 of the TAA was as follows:
1
2
3
Item Behaviour
5
6
Voluntary
Voluntary
obstructive, disclosure
disclosure
or if it is a after
before
Standard If
case
(i)
4
‘repeat
notification notification
case’
of audit
of audit
25%
50%
5%
0%
Reasonable care not 50%
75%
25%
0%
100%
35%
0%
100%
125%
50%
5%
tax 150%
200%
75%
10%
‘Substantial
understatement’
(ii)
taken in completing
return
(iii)
No
reasonable 75%
grounds
for
‘tax
position’ taken
(iv)
Gross negligence
(v)
Intentional
evasion
20
When can the penalty be remitted?
A “substantial understatement” (referred to in row (i) of the table above) is a
case where the prejudice to SARS or the fiscus exceeds the greater of 5% of the
amount of tax properly chargeable or refundable under a tax Act for the relevant
tax period or R 1 000 000.
In the event of a “substantial understatement” SARS must remit the
understatement penalty imposed in certain circumstances. Firstly, SARS must
remit the penalty if SARS is satisfied that the taxpayer made full disclosure of
the arrangement that gave rise to the prejudice to SARS or the fiscus by no later
than the date that the relevant return was due. Secondly, SARS must remit the
penalty if SARS is satisfied that the taxpayer was in possession of an opinion by
a registered tax practitioner that was issued by no later than the date that the
relevant return was due and was based upon full disclosure of the specific facts
and circumstances of the arrangement and confirms that the taxpayer’s position
is more likely than not to be upheld if the matter proceeds to court.
Changes contained in the Tax Administration Laws Amendment Act 2013
The Tax Administration Laws Amendment Bill, No 40 of 2013 (“the TALAB”)
was introduced in Parliament on 24 October 2013 and enacted on 16 January
2014 as the Tax Administration Laws Amendment Act, No 39 of 2013 (the
TALAA).
The TALAA contains an amendment in terms of which an understatement
penalty will not be payable where the understatement results from a bona fide
inadvertent error. No definition is provided in the TALAA to indicate what will
constitute a “bona fide inadvertent error”. However, in the Explanatory
Memorandum to the TALAB it is stated that SARS will develop guidance in
this regard for the use of taxpayers and SARS officials. This amendment took
effect from 1 October 2012.
21
Furthermore, the TALAA proposes a reduction in the understatement penalty
rates for substantial understatements, reasonable care not taken in completing a
return or where there are no reasonable grounds for the tax position taken. The
penalty rates for gross negligence and intentional tax evasion will remain
unchanged.
The new understatement penalty table is as follows:
1
2
3
Item Behaviour
5
6
Voluntary
Voluntary
obstructive, disclosure
disclosure
or if it is a after
before
Standard If
case
(i)
4
‘repeat
notification notification
case’
of audit
of audit
10%
20%
5%
0%
Reasonable care not 25%
50%
15%
0%
75%
25%
0%
100%
125%
50%
5%
tax 150%
200%
75%
10%
‘Substantial
understatement’
(ii)
taken in completing
return
(iii)
No
reasonable 50%
grounds
for
‘tax
position’ taken
(iv)
Gross negligence
(v)
Intentional
evasion
In the Explanatory Memorandum to the TALAB it is stated that the reason for
these reductions is to align the penalty percentages with comparative tax
jurisdictions where largely similar penalty regimes apply. This amendment will
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only apply with effect from the date of promulgation of the TALAA, which
occurred on 16 January 2014, and will therefore not apply retrospectively.
The TALAA also contains an amendment to the circumstances where a
taxpayer can seek remittance of a penalty. In the instance where a return was
submitted prior to the commencement of the TAA, the taxpayer would not have
been aware of the dispensation mentioned above where the taxpayer could
obtain an opinion from a registered tax practitioner by the due date for the
return and so qualify for remission of the penalty. The amendment will now
enable taxpayers that submitted returns prior to the commencement of the TAA
to use an opinion obtained after the relevant return was submitted.
Furthermore, the TALAA attempts to clarify that if an understatement penalty
cannot be imposed (by reason of the understatement having occurred before the
commencement of the TAA) or if additional tax that would have been “capable
of being imposed” has not been imposed by the commencement date of the
TAA, additional tax may be imposed (as if the repeal of the previous legislation
had not been effected). “Capable of being imposed” is defined to mean the
verification, audit or investigation necessary to determine the additional tax,
penalty or interest had been completed before the commencement date of the
TAA.
Final remarks
Apart from a number of proposed tweaks, the understatement penalty regime is
essentially here to stay. Accordingly, taxpayers should ensure that they mitigate
their exposure to understatement penalties to the extent possible, for example by
making voluntary disclosure of understatements before receiving an audit notice
from SARS or by obtaining an opinion from a registered tax practitioner in
respect of a “substantial understatement”.
ENSAfrica
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TAA: Sections 222 and 223
TRUSTS
2292. Distributions from and donations to foreign trusts
On 18 November 2013 the South African Revenue Service (SARS) issued
Binding Private Ruling 157 (BPR).
The Applicant, a natural person and resident in South Africa, was a beneficiary
of two non-resident discretionary trusts A and B. Trusts A and B held various
foreign assets such as loan accounts, cash, and shares. Specifically, trusts A and
B held all the shares in non-resident companies A and B.
It was proposed that trusts A and B would distribute certain of their foreign
assets to the Applicant. Upon receipt, the Applicant would donate the assets to a
non-resident trust C.
SARS made the following ruling in respect of the tax consequences relating to
the above proposed transaction.
In respect of the loan accounts, cash and shares SARS ruled that sections
25B(1), (2) and (2A) of the Income Tax Act No. 58 of 1962 (the Act) would not
apply to the distribution. It is assumed that this is so because these assets are
essentially capital assets. It is further also assumed that the assets do not
constitute capitalised revenue from prior years of assessment as contemplated in
subsection (2A).
In respect of the loan accounts and shares, it was also ruled that:
•
Paragraph 80 of the Eighth Schedule to the Act would not apply to the
distribution (presumably because the disposal by the foreign trust would
not trigger a gain for the trust in South Africa, and the Applicant will
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become entitled to the assets and not any gain or any amount representing
a gain).
•
The base cost of the assets in the hands of the Applicant should be
determined by paragraph 20(1)(h)(vi) of the Eighth Schedule, in terms of
which the base cost would be equal to the market value of the assets on
the date of distribution. It is interesting to note that, by implication, SARS
ruled that the distribution is one governed by paragraph 38 of the Eighth
Schedule– that is, that the distribution would constitute either a disposal
by way of donation, that the consideration was not measurable in money,
or that the parties are connected persons and the price was not an arm’s
length price.
In respect of the donation of the assets by the Applicant to trust C, SARS ruled
that:
•
The donation would be exempt from donations tax in terms of section
56(1)(g)(ii). The implication here is that the Applicant either acquired the
assets (situated outside South Africa) by inheritance from a person who,
at the time of death, was not a resident, or by way of donation from a
person who was not a resident at the time of donation. In other words, the
distributions by trusts A and B to the Applicant will be seen as either an
inheritance or a donation.
•
The attribution rule contained in section 7(8) of the Act will apply. That
is, income received by trust C that is attributable to the donation will be
attributed to the Applicant. In this regard, and in respect of the shares, the
Applicant could claim the foreign dividend exemption contained in
section 10B(2)(a) of the Act should the 10% participation interest be met.
In respect of the loan accounts, any interest on the loans will be attributed
to the Applicant. In respect of the cash, interest earned on the cash or
amounts arising from investing the cash in an income-generating asset
will be attributed to the Applicant.
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The ruling is valid for a period of three years.
Cliffe Dekker Hofmeyr
ITA:Sections 7(8), 10B(2)(a), 25B, 56(1)(g)(ii), Eighth schedule Paragraphs
20(1)(h)(vi)and 80
VALUE-ADDED TAX
2293. Tax invoices
Cash-strapped companies that are staring liquidation in the face sometimes
resort to desperate measures to convince the court hearing an application for
winding-up that they are not, in fact, insolvent and should not be wound up.
A novel and imaginative method was adopted by the company, a VAT vendor,
in ITC 1865 [2013] 75 SATC 250, though it is unlikely to become popular or to
find its way into tax-planning manuals.
The taxpayer issued fictitious VAT invoices to create the illusion of a
revenue stream
In an effort to show the court hearing the liquidation application that it was not
insolvent, the taxpayer company generated VAT invoices (ostensibly genuine,
but in reality bogus, and never actually given to the addressee) reflecting
fictitious income as due and payable, and attested on oath that its assets
included the right to the invoiced amounts.
The background was that the taxpayer, a property-owning company trading as a
landlord, had rented out commercial premises to three companies in a corporate
group, but only one of the companies actually took occupation of the leased
premises. The arrangement with the other two companies was, according to the
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taxpayer, a mere “pre-emptive measure”, anticipating “a future arrangement”.
However, in respect of all three companies, the taxpayer issued some 54 tax
invoices for monthly rental.
As was noted above, this was done for the purpose of using the invoices to
oppose an application in the High Court for the winding up of the taxpayer
company.
The taxpayer sinks deeper into the mire
The taxpayer seems not to have realised that this ploy would merely drive it
deeper into the mire, for SARS now joined the queue of creditors and demanded
the output tax reflected on the invoices.
The taxpayer, with its back firmly against the wall and with no more income
than before, and yet another creditor in the form of SARS, hammering on its
door, resorted to arguing that since it had not in reality rendered the supplies
reflected in the invoices, it had not under- declared output VAT.
The taxpayer claimed that the invoices in question were “pro forma invoices”
that “were merely intended to demonstrate a potential revenue stream” in order
to oppose the liquidation application, and argued that, since the ostensible lessee
companies had not utilised the invoices to claim input tax, no output tax was
due to SARS.
The taxpayer also averred that the Commissioner’s assessment letter - issued by
SARS after a VAT audit into the taxpayer’s output tax liabilities – did not
constitute an “assessment” as envisaged in section 31(1) - (4) of the ValueAdded Tax Act (the VAT Act).
27
The court ruled that VAT became payable immediately once the invoices
were issued
In the result, the Tax Court ruled that there had indeed been a determination, as
defined in the VAT Act, by way of an assessment and, moreover, that the
taxpayer, in lodging an objection, had implicitly acknowledged that there had
been such an assessment.
The invoices in question, said the Tax Court, complied in all respects with the
statutory requirements for VAT invoices and, in terms of the VAT Act, the
taxpayer became liable for VAT as soon as the invoices were issued.
The court pointed out that the VAT Act specifically states in section 9(1) that
the supply of goods or services by a vendor is deemed to take place, at earliest,
at the time a VAT invoice is issued. The court commented (see paragraphs [51]
– [52]) in this regard that –
“As such, whether or not the appellant received payment for renting its
property, and whether or not the appellant actually enforced payment of rentals
by C (Pty) Ltd and D (Pty) Ltd, are of no consequence in relation to the
appellant’s liability for declaring output VAT ... Furthermore, declaration of
output tax ... to SARS is not dependent upon a correlating claim for input tax by
a vendor .... Similarly, declaration of output tax by a vendor ... who rents out
property, is not dependent upon whether such vendor elects to enforce
performance by a lessee in terms of a lease agreement during the term of the
lease.”
The Tax Court said (at paragraph [53]) that, in the final analysis, VAT became
payable as soon as the taxpayer issued the tax invoices in question and that it
did not avail the taxpayer to contend that the invoices were fictitious.
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The court also said that the taxpayer had not provided a credible explanation of
the tax invoices it had generated (in short, that the taxpayer could not be
believed when it said that it had lied on oath to the court hearing the winding-up
application) and that, irrespective of the explanation, the taxpayer was liable, in
terms of the VAT Act, for the payment of output VAT as indicated on the
invoices.
The court refused to overrule the Commissioner’s decision to exercise his
discretion by not remitting penalties and interest, but said that it would not be
appropriate, in the circumstances of this case, to impose additional tax, given
the imposition of the penalty and interest.
But, said the court, the grounds of appeal relied on by the taxpayer were
frivolous and an adverse costs order was warranted.
A possible sequel
Although it is not foreshadowed in the judgment, there may be a sequel to the
taxpayer’s failure in the Tax Court in the form of a criminal charge of statutory
perjury against its directors in relation to the affidavits filed in the liquidation
proceedings, falsely attesting to rental income being due and payable to the
company.
In that event, the directors may well find themselves declared delinquent in
terms of section 162(5)(c), read with section 77 of the Companies Act No. 71 of
2008, and housed in genuinely rent-free accommodation for an extended period.
(Editorial comment: It is interesting that no consideration was given as to
whether output VAT can be payable if no goods or services are supplied.)
PwC
VAT Act: Sections 9 and 31
29
Companies Act: Sections 77 and 162(5)(c)
2294. Deductions for income tax and VAT
Broadly speaking, in their ordinary business operations, certain entities are
entitled to claim certain deductions for income tax and value-added tax (VAT)
purposes. In this article we discuss the tests used by South African courts and in
practice, for income tax and VAT purposes, in order to determine whether a
taxpayer will be entitled to such deductions. Consideration will be given
specifically to the deduction of legal expenses incurred by a taxpayer in terms
of section 11(c) of the Income Tax Act No. 58 of 1962 (the Act) and the
deduction of input tax in respect thereof in terms of section 1 read with section
7 of the Value-Added Tax Act No. 89 of 1991 (the VAT Act).
An income tax perspective
Section 11(c) of the Act provides, most relevantly, for a deduction from income
of “any legal expenses … actually incurred by the taxpayer during the year of
assessment in respect of any claim, dispute or action at law arising in the
course of or by reason of the ordinary operations undertaken by him in the
carrying on of his trade…”
The phrase “arising in the course of or by reason of the ordinary operations
undertaken by him in the carrying on of his trade” has been considered by our
courts and has been interpreted to mean that the deductibility of expenditure in
terms of section 11(c) of the Act does not depend on the purpose of the
expenditure, but rather the causal connection of the relevant events with the
taxpayer’s trade. Accordingly, it would be sufficient if the causal connection
between the ordinary trading operations of the taxpayer and a claim, action or
dispute is sufficiently close that it can be regarded as having arisen in the course
of or by reason of the trading operations. For example, in the case of ITC 1710
[1999] 63 SATC 403, an employee of the taxpayer who was the owner of a farm
30
producing grapes, had while working in the vineyards, negligently set a
neighbour’s farm alight causing severe damage thereto. The High Court, in an
action for damages brought against the taxpayer, had found that the employee in
question had acted within the course and scope of his employment and the
taxpayer was accordingly liable for the damages caused by the employee as a
result of the fire. The taxpayer, in order to defend the legal action, had incurred
legal costs and the issue to be decided by the court was whether such costs were
deductible in terms of section 11(c). It was found that the costs in issue were
connected by chance with work performed by the employee on the farm, as part
of the taxpayer’s business and that there was a sufficient causal connection with
the taxpayer’s farming operations. Accordingly, it was held that the legal costs
incurred by the taxpayer were deductible in terms of section 11(c).)
In light of the above, it appears that the test for determining whether
expenditure will be deductible in terms of section 11(c) would be to consider
the causal connection with the taxpayer’s trade. The purpose for which the
expenditure is incurred or the purpose of the events giving rise to the costs is
not the deciding factor.
A VAT perspective
Section 7(1)(a) of the VAT Act provides, inter alia, that:
“there shall be levied and paid for the benefit of the National Revenue Fund
a tax, to be known as value-added tax(a) on the supply by any vendor of goods or services supplied by him on or
after the commencement date in the course or furtherance of any enterprise
carried on by him
Essentially a VAT vendor is entitled to an input tax deduction on the acquisition
of goods or services to the extent utilised for making taxable supplies in the
course or furtherance of his enterprise. In order for a taxpayer to claim an input
31
tax deduction in terms of section 16 the VAT Act, the taxpayer must be a
registered VAT vendor, be carrying on an enterprise and must have paid VAT
on goods or services which the vendor acquired wholly for the purpose of
consumption, use or supply in the course or furtherance of any enterprise
carried on by him, as envisaged in section 7(1)(a) of the VAT Act.
In the fairly recent case of the Commissioner for the South African Revenue
Service v De Beers Consolidated Mines Limited [2012] 74 SATC 127, an aspect
that the Supreme Court of Appeal (SCA) had to consider was whether the VAT
charged to the vendor on fees for certain local advisory services qualified for
deduction as input tax. De Beers Consolidated Mines Limited (DBCM) engaged
the services of a range of South African advisors and service providers,
including attorneys (local suppliers), to assist in finalizing a proposed
transaction. DBCM treated the amounts expended to obtain such services as
deductible input tax in its VAT returns. The Commissioner disallowed the input
tax claim, against which DBCM lodged an objection. The objection was
disallowed by the Commissioner and DBCM lodged an appeal to the Tax Court
held in Cape Town which also found, inter alia, that the VAT paid by DBCM in
respect of certain local services was not deductible as input tax. The test was
whether the services acquired by DBCM were acquired for the purpose of
consumption, use or supply of goods or services in the course or furtherance of
the enterprise. The SCA had to, inter alia, clarify the meaning of and nature of
the word “enterprise” since the purpose of acquiring the services and whether
they were consumed or utilized in making taxable supplies could only be
determined in relation to a particular enterprise. This involved a factual enquiry
as to what constituted DBCM’s enterprise. The SCA, in adopting a restrictive
approach, found that DBCM’s enterprise, for the purposes of the VAT Act,
consisted of mining, marketing and selling diamonds. It was found that the
services provided by such local suppliers were provided for multiple purposes,
32
but ultimately not for the purpose of making taxable supplies by an enterprise
which mines, markets and sells diamonds.
Conclusion
In light of the above, it would seem that there are two distinct tests, from an
income tax and VAT point of view, in determining whether a taxpayer can
claim a deduction. From an income tax perspective, the test is whether there is
a causal connection between the relevant events (giving rise to legal
expenditure) and the taxpayer’s trade whereas from a VAT point of view, the
test is whether the expenditure incurred in procuring legal services was acquired
for the purpose of consumption, use or supply of goods or services in the course
or furtherance of the taxpayer’s enterprise. Another (perhaps over simplified
way) summary of the position is that for income tax purposes, deductions in
respect of overhead and general business expenditure not aimed directly at the
taxpayer’s income earning activity will be allowed whilst for VAT purposes,
our courts tend to require VAT expenditure to be incurred by the taxpayer,
significantly more directly in connection with the earning of (vat-able) income.
ENSAfrica
ITA: Section 11(c)
VAT Act: Sections 7 and 16
SARS AND NEWS
2295. 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
33
Editor:
Mr P Nel
Editorial Panel:
Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan,
Prof KI Mitchell, Prof L Olivier, 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.
All rights reserved. No part of this Newsletter covered by copyright may be
reproduced or copied in any form or by any means (including graphic,
electronic or mechanical, photocopying, recording, recorded, taping or retrieval
information systems) without written permission of the copyright holders.
Ref# 453718
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