SOUTH AFRICA’S RECENT DEVELOPMENTS IN THE INTERNATIONAL TAXATION
This Report deals with various international tax issues of recent development in South Africa. The tax amnesty section covers amnesty in respect of, the contravention of Exchange Control Regulations, violation of income tax laws and estate duty. 5% is payable for contravention of Exchange Control Regulations, 2% for contravention of income tax laws, and 10% for retaining funds offshore. Applications for tax amnesty closes on 30 November 2003.
In our recent court decision of interest the highest court held that where, in international financial transactions, the important factors that caused interest income to arise occurred in South Africa, the interest was deemed to have been received in South Africa and therefore taxable in South Africa.
Our income tax law incorporates tax free corporate restructuring rules that cater for capital gains tax in mergers and acquisitions. South Africa has concluded double tax Agreements with various countries and is still negotiating more of such agreements.
Most of our rules in transfer pricing are based on the OECD Guidelines. There are no special provisions in the income tax law that deal with documentation and penalties in respect of transfer pricing. We do not have advance rulings or advance pricing agreements.
In line with the Report format forwarded to National Reporters, the South African International tax position follows below:
Recent Legislative Developments of InterestOn 29 May 2003, South Africa joined the international trend by enacting the Exchange Control Amnesty And Amendment of Taxation Laws Act, 12 of 2003, ("the Amnesty Act"). In terms of the Amnesty Act, the tax amnesty window runs from 1 June 2003 to 30 November 2003 and is in respect of foreign assets held on 28 February 2003. An Amnesty Unit has been established to administer amnesty applications and this unit will cease to exist after processing all successful applications and after all appeals on unsuccessful applications have been determined.
The aims and objectives of the amnesty are to facilitate maximum disclosure and repatriation of foreign assets, to extend the South African tax base and to reduce money laundering and other illegal activities. The amnesty also provides individuals who have violated the Exchange Control Regulations, the Income Tax Act and the Estate Duty Act with an opportunity to regulate their affairs. The amnesty is limited to natural persons, close corporations (corporate entities with a maximum of ten members), trusts and related party facilitator, but excludes companies. Evidence given at the parliamentary special committee debate on the legislation suggested that the reason that companies had been excluded was that an extension to companies would erode the very essence of the Exchange Control Regulations. The amnesty is divided into an exchange control amnesty and an income tax amnesty, which are related.
Income Tax Amnesty
In 2001, South Africa changed its income tax system from one of source to a system which taxes residents on worldwide income, and non-residents on amounts sourced in South Africa. In consequence of this, South African residents have been required to pay tax on income from foreign sources, which they previously did not have to pay. South Africans with foreign assets have been reluctant to disclose these assets for income tax purposes, as the assets have accumulated in contravention of exchange control and disclosure would alert the authorities to this.
In order to qualify for the income tax amnesty, residents are required to hold foreign assets at 28 February 2003. These assets must be disclosed in the applicant’s tax return for the year ending 28 February 2003, thereby including such investments in the tax base in the future. In addition to this, in the event that these amounts were accumulated without income tax having been paid thereon, a levy of 2% of the total amount so accumulated is payable in order to receive amnesty. An applicant for exchange control amnesty is also required to disclose his income in the income tax return for the year ending 28 February 2003.
In order to apply for the income tax amnesty, a person is required to be a resident of South Africa as contemplated by the Income Tax Act. The Income Tax Act provides that people who are ordinarily resident qualify as residents of South Africa. There is no definition of ordinarily resident, and there is a long of case law which insists on determining whether a person is ordinarily resident. If the person is not ordinarily resident, there is a physical presence test in terms of which a person will be deemed to be a resident for income tax purposes.Exchange Control Amnesty
Applicants for exchange control amnesty are required to be resident in terms of the Exchange control Regulations. These provide that a resident is "a person of whether of South African or other nationality, who has taken up residence or is domiciled in the Republic …". Accordingly, it is possible to be a resident for exchange control purposes, but not for income tax purposes as a result of the introduction of domicile into the definition.
Applicants for the exchange control amnesty are also required to hold foreign unauthorised assets on 28 February 2003. South Africa previously had a strict exchange control regime in which residents were not entitled to accumulate funds offshore. These have been relaxed in the past few years, and residents are now entitled to hold R750 000.00 (approximately US$100 000.00) offshore with approval, and resident are not required to repatriate foreign earned income and foreign inheritances. The amnesty applies to all amounts which were accumulated by the resident in breach of the Exchange Control Regulations. A levy of 5% is payable on any amounts held offshore in contravention of Exchange Control Regulations which are repatriated or which are retained offshore within the allowance applicable to the individual, while a levy of 10% of the full amount is payable if the resident wishes to retain the funds offshore.
An applicant for the exchange control or income tax amnesty is required to declare that the funds which are the subject of the application are not the proceeds of unlawful activities (excluding exchange control and income tax contraventions). Applicants who are currently being investigated in terms of the Exchange Control Regulations and the Income Tax Act are also precluded from apply for amnesty.
A related party facilitator who assisted the applicant in contravening the legislation is entitled to apply jointly with the applicant for amnesty. Related party facilitators are limited to natural persons, companies held by natural persons, close corporations, trusts of deceased estate. The related party facilitator need not be a South African resident, and can only apply if he assisted the applicant by accumulating foreign assets for the benefit of the applicant or by transferring funds or assets from South Africa for the benefit of the applicant. Accordingly, an individual who has used a foreign trust or company structure in order to assist him in contravening the legislation is entitled to apply for amnesty for both himself and the trust and company.
There is no requirement on applicants to disclose the identity of professional advisors or others who assisted them in contravening the regulations, and professional advisors are further exempt from their duty under the Financial Intelligence Centre Act from reporting unlawful transactions to the Financial Intelligence Centre in respect of those clients seeking advice and assistance on amnesty.
There have been no other fundamental legislative developments which would be of interest to foreign practitioners. There have been minor amendments to the capital gains tax and residence tax provisions of our Income Tax Act, and there has been some development in corporation restructuring legislation.
Recent Court Decisions of Interest and Tax TreatiesAccording to South African tax law, South African residents are taxed on a worldwide basis and non South African residents are taxed on source or deemed source basis.
In this regard, a recent court decision of interest in international financial transactions is that of First National Bank of Southern Africa Ltd v Commissioner for Inland Revenue (FNB case). The First National Bank of Southern Africa Ltd ("FNB") lent funds from foreign banks, which were then electronically transmitted to its foreign bank account. The funds in its foreign bank account were thereafter on-lent to its clients through a direct electronic transmission from the foreign bank account to clients’ accounts in South Africa. The clients had an option to make repayments in South Africa or directly into FNB’s foreign bank account. In essence, the clients borrowed funds that we kept in FNB’s foreign bank account, but the loan application was made in South Africa.
In an attempt to exclude the loan interest from its gross income in South Africa, the FNB contended that the source of interest was located in its foreign bank and therefore not subject to tax in South Africa. The highest court held the view that apart from the fact that contractually the foreign currency was made available to the borrowing client in New York and had to be repaid there, all the other important factors which caused the interest income to arise and which constituted the dominant cause of the receipt of the interest, had their origin in South Africa and flowed from the taxpayer’s business activities and operations in South Africa. On these basis, the court held that interest income accruing to the taxpayer and derived from international financing transactions had been received ’from a source within the Republic’ as contemplated in the definition of ’gross income’ in s 1 of the Income Tax Act 58 of 1962 and hence subject to tax.
In respect of tax treaties, section 108 of the Income Tax Act empowers the National Executive to enter into Double Tax Agreements ("DTA’s"). There has not been a court decision on whether or not the DTA overrides domestic tax law in case of a conflict between the two. In this regard, reference has been made to section 233 of our Constitution, which provides that every Court must prefer any reasonable interpretation of the legislation that is consistent with international law to any alternative interpretation of the legislation that is inconsistent with international law.
On the interpretation of section 233, a view exists that a DTA may override domestic law, in so far as domestic law is inconsistent with international law.
Recent Transactions of InterestAs capital gains tax was only introduced from 1 October 2001, the incidence of capital gains tax in mergers and acquisitions and the application of complicated new rules relating to tax free corporate restructuring has only taken effect in recent times. Capital gains tax has a fundamental affect on the secondary tax on companies (a tax on dividends paid by the company declaring the dividend), particularly in instances where the company is to be wound up, and also has a fundamental affect on the transfer of assets and liabilities between related companies. While no decisions in this area have been reported, these elements have played a roll in most major transactions within our jurisdiction during the past twelve months.
Another aspect which is in the process of development is the application of double tax agreements between South Africa and foreign countries. As a result of South Africa’s exclusion from the world economy before 1994, there was little application of our double tax agreements and little case law on these. However, as South Africa has substantially increased the amount of countries which it has entered into double tax agreements with, the application of these agreements has been the subject of a great deal of advice during the last year. Some tax practitioners and authors are of the view that double dip planning may successfully be done in cases of international sale and leaseback transactions. The application must be considered where a South African company sells to and leases from a US company a movable asset located in South Africa, the rental income received by the US company will not be taxed in South Africa, but the appropriate deductions may well be claimed in South Africa.
There are no particular transactions within our jurisdiction which stand out from a tax perspective.
RECENT DEVELOPMENTS IN TRANSFER PRICING
Domestic LawSection 31 of the Income Tax Act, 58 of 1962 ("Income Tax Act") , regulates transfer pricing in South Africa. As transfer pricing involves international agreements, Section 108 of the Income Tax Act empowers the South African National Executive to enter into double tax agreements ("DTA’s), if none is in existence with that particular country, in order to regulate transfer pricing and any other international agreements or transactions. In this regard, South Africa has entered into a number of DTA’s with various countries. The concept of transfer pricing has been widened to include thin capitalisation.In line with the Income Tax Act, the Commissioner for the South African Revenue Service also administers transfer pricing. In dealing with transfer pricing, the Commissioner has prepared guidelines or an explanatory document, which is referred to as Practice Note 7. Although the Practice Note is not law, it may have a persuasive effect in Court. The Commissioner further considers or takes into account the OECD Guidelines, despite the fact that South Africa is not an OECD member, and further considers exchange control regulations. In addition, as South Africa has a supreme constitution, Section 232 of the South African Constitution, which provides "customary international law is law in the Republic unless it is inconsistent with the constitution of an act of Parliament", is considered in international transactions.
Attribution of Profits to a Permanent Establishment:The issue of attribution of profits to a permanent establishment in respect of e-commerce or operation of computer server has not been judicially determined in South Africa nor addressed in the Income Tax Act.In South Africa, as stated already, we follow the OECD Guidelines. In accordance with the OECD model commentary we distinguish between computer equipment, which may be set up at a location so as to constitute a permanent establishment, and the data and software, which is used by, or stored on, that equipment. Accordingly, Internet website, which is a combination of software and electronic data, does not constitute a place of business and on those basis profits cannot be attributed by the mere existence of an Internet website.However, the server on which the website is stored and through which it is accessible may, not necessarily will, constitute a fixed place of business and therefore a permanent establishment in terms of which profits may be attributed. If the activities associated with such a permanent establishment constitute preparatory or auxiliary nature, then they may not constitute permanent establishment and therefore no attribution of profits.
In the context of the position above, it should be noted that non-residents in South Africa are subject to tax on an actual source or deemed source. They are not subject to transfer pricing provisions, controlled foreign companies rules, foreign dividends tax, or pay secondary tax on companies (STC) or donations tax. A non-resident company doing business in South Africa through a branch would be taxed on a source or deemed source basis. As a result, the attribution of profits arising from a server whose fixed place of business is South Africa would depend on whether such profits were sourced in South Africa.
Transfer Pricing Methodologies, Including Profits - Based Methodologies and Cost Contribution ArrangementsSouth Africa has not legislated any transfer pricing methodologies. We therefore rely on the South African Revenue Service’ ("SARS") Practice Note 7, which incorporates the OECD Guidelines.
The section 31(2) of the Income Tax Act, which deals with adjustments of a consideration in transfer pricing, is arguably in respect of revenue. The adjustments on capital account are usually dealt with in paragraph 38 of the Eighth Schedule of the Income Tax Act, which deals with capital gains tax.
South Africa follows the arm’s length or separate accounting method, and not the formulary apportionment method, in allocating profits among group companies. By utilising the separate accounting method South Africa is effectively conforming to Article 9 of the OECD model tax treaty, despite the fact that it is not a member of the OECD.
The separate accounting method or arm’s length method operates on the basis of taxing each company within a multi-national group separately as if transactions between them were independent transactions at arm’s length. On the other hand, the formulary apportionment method operates on the basis of the allocation of a portion of worldwide profits in accordance with a source in a particular country.
By adopting an internationally accepted method of determining the allocation of profits among group companies, South Africa can more appropriately deal with other countries, which are overly aggressive in their enforcement of their transfer pricing rules. In this regard, Practice Note 7 was issued by the South African Revenue Service ("SARS") and sets out the circumstances where the Commissioner will regard a price as an arm’s length price, based on internationally accepted principles. This Practice Note would carry more weight in a court of law, despite the fact that it is not law (ITC 1675 62 SATC 219).
SARS has therefore formulated a transfer pricing policy document, which determines the process or procedure in formulating or determining an arm’s length price. The process involves:
The conducting of a review of the relevant global and local industry, and a review of the business of tested parties (relevant group companies).
In these reviews, the global group structure is analysed and recorded. Thereafter conducted is a functional analyses and, separately, a risk analysis.
The functional analysis identifies the functions performed by each member of the multi-national group and assesses the relative importance of each function to the overall operations of the multi-national.
The risk analysis reviews market risks, financial risks, credit and collection risks, product or manufacturing liability risks, risk related to the success or failure of research and development activities, business risk related to ownership of assets or facilities and other risks which may be relevant.
SARS’s transfer pricing policy document advises clients to seek the highest practical degree of comparability, while still recognising the unique situation. It further advises and allows the taxpayer to use any one of the principal methods referred to in the OECD Guidelines. In this respect, it prefers the comparable uncontrolled price method ("CUP method"), thereafter the resale price method ("RP method"), then the cost plus method ("CP method"), and the transactional net margin method ("TNM method") or the profit split method ("PS method").
Documentation and PenaltiesSARS has indicated in Practice Note 7 that it will not be expected of taxpayers to go such lengths of preparing documents that the compliance cost related thereto are disproportionate to the nature, scope and complexity of the international agreements entered into by taxpayers with connected persons. However, in line with the global approach, there is an implication that some form of documentation is always required.
The transfer pricing provisions do not however specifically or by implication require the production of any documents. The issue of documentation is dealt with in SARS Practice Note 7, which refers to the general provisions of the Income Tax Act that place a duty on a taxpayer to furnish information and/or returns.
As a result, a request by the Commissioner to furnish documentation in terms of the general provisions of the Income Tax Act is a statutory requirement, which is applicable to transfer pricing transactions. It would therefore be wise for taxpayers to prepare and maintain transfer pricing documentation, in case the Commissioner statutorily requires documentation.
South Africa has no transfer pricing penalties specifically applicable to transfer pricing transactions. The general penalties, such as those applied in failing to furnish any documents as required in terms of the Income Tax Act or as requested by the Commissioners, are applied to transfer pricing transactions. An indirect penalty may exist where secondary tax on companies ("STC") is payable on an adjusted amount that is deemed dividend and in circumstances where withholding tax is paid on adjusted amounts.
Advance Rulings and Agreements on Transfer Pricing
There are no advance rulings nor are there advance pricing agreements ("APA’s") available in South Africa. Presumably, because of a lack of administrative capacity within SARS, SARS Practice Note 7 specifically states that APA process will not in the foreseeable future be made available to South African taxpayers and no reasons are given thereto. Accordingly, an APA is an agreement between one or more domestic tax authorities and a multi-national group engaged in cross border activities.
1. The authorities used include, The Exchange Control Amnesty And Amendment of Taxation Laws Act, 12 of 2003; Brincker, E, et al, International Tax: A South African Perspective, Siber Ink, 2003; Income Tax Act, 58 of 1962; Exchange Control Regulations; OECD Guidelines; South African Revenue Service Practice Note 7.2. Foreign assets are funds held in foreign currency and any asset transferred from or accumulated outside South Africa, but does not include any foreign bearer instrument.3. In terms of the physical presence test a person must be physically present in South Africa for more than 91 days in the current year of assessment and the three preceding years of assessment; and for a period of more than 549 days during the three preceding years of assessment. In effect, a person who is not ordinarily resident in South Africa may become a South African resident in the fourth year of assessment after first being present in South Africa. Such a person may again become a non resident if he is absent from South Africa for a period or periods exceeding 330 days in aggregate during the 12 month period after which he ceased to be physically present in South Africa.4. 64 SATC 245 / 2002 (3) SA 375.5. Section 31(2) "Where any goods or services are supplied or acquired in terms of an international agreement and -
(a) the acquiror is a connected person in relation to the supplier; and(b) the goods or services are supplied or acquired at a price which is either -
(i) less than the price which such goods or services might have been expected to fetch if the parties to the transaction had been independent persons dealing at arm’s length (such price being the arm’s length price); or(ii) greater than the arm’s length price
then, for the purposes of this Act in relation to either the acquiror or supplier, the Commissioner may, in the determination of the taxable income of either the acquiror or supplier, adjust the consideration in respect of the transaction to reflect an arm’s length price for the goods or services."