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APRIL 2015 – ISSUE 187

CONTENTS

TAX ADMINISTRATION

2402. Interpreting statutory

provisions

2403. Preservation orders

2404. Tax compliance status

INTERNATIONAL TAX

2406. Treaty shopping

EXEMPT INCOME

2405. Pensions for foreign service

SARS NEWS

2407. Interpretation notes, media

releases, rulings and other documents

TAX ADMINISTRATION

2402. Interpreting statutory provisions

SARS has investigated, and in many cases raised assessments in respect of,

share incentive schemes where the employee had accepted an offer to purchase

shares at a fixed price prior to 26 October 2004, subject to delivery and payment

taking place at a future date. The law relating to these schemes (known as

deferred delivery schemes or DDS schemes) was amended with effect from that

date.

The Supreme Court of Appeal has now delivered its judgment in the matter of

C: SARS v Bosch [2014] ZASCA 171 (19 November 2014) and provided clear

guidance on the application of the Income Tax Act No. 58 of 1962 (the Act) in

relation to deferred delivery share incentive schemes, where the employee had

exercised the right to acquire the shares prior to 26 October 2004.

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SARS had raised assessments on 117 employees of the Foschini Group, against

which objection and appeal had been noted, and the cases of Ms Bosch and a

fellow employee, Mr McClelland, were test cases in relation to the assessments

in question. It is well known that disputes and investigations relating to a

number of similar share schemes operated by other employers have been stayed,

pending the outcome of this appeal.

The facts

The employees were employed by the Foschini Group and, in September and

December 1998, they were each granted options to acquire shares in Foschini’s

listed holding company at the middle market price quoted on the JSE on the

date of the notice of grant.

The options had to be exercised within 21 days of the notice, and were duly

exercised within that time by both employees.

The scheme provided that the shares would be delivered in three equal tranches

on the second, fourth and sixth anniversaries of the notice of grant of the option.

The purchase price for the shares was payable on delivery, but the employees

could elect that the scheme shares be sold and that the amount remaining after

deduction of the purchase consideration and costs of sale be paid to them.

The final tranches fell due on 14 August 2004 and 2 December 2004. Ms Bosch

paid for the shares which were delivered to her, and Mr McClelland elected to

sell the shares and received a cash payment as described above. In each case,

the market value of the shares was considerably higher than the purchase

consideration, and SARS sought to impose tax on the benefits derived.

Both of the tranches were the subject of the appeal, as SARS had argued that the

tranche that fell due after 26 October 2004 should be taxed on the basis

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indicated in section 8C (the amendment to the Act), which came into effect

from that date.

The law

The statutory provision that applied to the options was section 8A(1)(a) of the

Act, which stated:

“There shall be included in the taxpayer’s income for the year of

assessment the amount of any gain made by the taxpayer after the first

day of June, 1969, by the exercise, cession or release during such year

of any right to acquire any marketable security (whether such right be

exercised, ceded or released in whole or part), if such right was

obtained by the taxpayer before 26 October 2004 as a director or

former director of any company or in respect of services rendered or

to be rendered by him or her as an employee to an employer.”

The arguments

The contention by SARS was that the right to acquire the marketable security

was exercised when the employee became obliged to pay for and take delivery

of the shares. The agreements entered into in 1998 were subject to conditions

which had the effect that the sale agreement arising from exercise of the option

only became enforceable on their fulfilment. On that basis the taxable benefit

was the difference between the market value of the shares and the purchase

consideration on the date of delivery. In relation to the later delivery, in

December 2004, SARS contended that this fell within the ambit of the newly

enacted section 8C. In the alternative, SARS alleged that the deferred delivery

scheme was a simulated transaction, and the true exercise of the right occurred

when the shares were actually acquired.

The employees argued that they had exercised their right to acquire the

marketable securities in 1998, at a time when the taxable benefit was an

inconsequential amount, and that delivery and payment were deferred. This

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deferral did not affect the fact that they had an unconditional right to

performance in terms of the scheme. They denied that there had been any

simulation in the scheme or in the contracts concluded subject to its terms.

The judgment

In a lucid and eloquent judgment, Wallis JA (with whose judgment the full

Court concurred) dealt first with the interpretation to be placed on section

8A(1)(a). The Court was called upon to determine the meaning of the term ‘any

right to acquire any marketable security’.

Wallis JA affirmed the principles that should be applied to determine the

meaning of words used in a statute, at paragraph 9, where he stated:

“The words of the section provide the starting point and are

considered in the light of their context, the apparent purpose of the

provision and any relevant background material. There may be rare

cases where words used in a statute or contract are only capable of

bearing a single meaning, but outside of that situation it is pointless to

speak of a statutory provision or a clause in a contract as having a

plain meaning. One meaning may strike the reader as syntactically and

grammatically more plausible than another, but, as soon as more than

one possible meaning is available, the determination of the provision’s

proper meaning will depend as much on context, purpose and

background as on dictionary definitions or what Schreiner JA referred

to as ‘excessive peering at the language to be interpreted without

sufficient attention to the historical contextual scene’.”

In his analysis, Wallis JA dealt first with the syntax and grammar, observing at

paragraph 10 that:

“The section refers to the exercise by the taxpayer of a right to acquire

any marketable security. It does not refer to the acquisition of a

marketable security. That suggests that it is concerned with something

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prior to the actual acquisition of ownership, which is effected by

transfer of the marketable security to the taxpayer.”

After examining the difference between an option and an offer to sell and

identifying circumstances in which a right to acquire a marketable security

might otherwise arise, Wallis JA concluded at paragraph 12 that:

“The characteristic of each of those situations is that they do not

necessarily mean that the exercise of the right brings about the

immediate acquisition of the marketable security in the sense of title

to it as an asset. When that occurs will depend upon the terms of the

contract that results from the taxpayer’s exercise of the right.”

After considering SARS’s argument that the ordinary legal meaning of the word

‘acquire’ is to acquire ownership, and the authority cited in support thereof,

Wallis JA found at paragraph 13 that:

“…[All] that those cases demonstrate is that whether this is the correct

meaning is always dependent upon context and that the word may

have a broader meaning of the acquisition of the right to acquire

ownership …”

This, in turn, led him to find that:

“There is nothing to indicate that section 8A(1)(a) was directed at

performance of the contract resulting from a prior exercise of rights,

as opposed to the exercise of a right leading in due course, in

accordance with the applicable contractual provisions, to the

acquisition of ownership of a marketable security.”

Turning next to the context, Wallis JA observed that since 1969 it had been

accepted that the right to acquire a marketable security was intended to deal

with the situation in which an option is exercised, and related to the exercise of

the option.

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This principle had been extended in the matter of SIR v Kirsch [1978]

40 SATC 95 to the acceptance of an offer to allot shares, which was found to be

no different than the exercise of an option to acquire shares. It was conceded

that Kirsch’s case did not deal with the exercise of a right giving rise to a

contract of purchase and sale, subject to delayed performance. Wallis JA

nevertheless found at paragraph 15 that:

“It did, however, recognise that the allotment of shares would not

occur simultaneously with the acceptance of the offer to allot shares

and cited the example of a rights offer where the acceptance and

performance of the resulting contract occur at different times.

Nonetheless it identified the acceptance of the offer and the

conclusion of the contract as the event that attracted liability to tax

under section 8A.”

An internal memorandum in SARS, prepared in 1996 in respect of deferred

delivery schemes, had not suggested the approach that SARS had adopted in

raising the assessments, but had instead recommended amendment of the law to

deal with the taxation of benefits under deferred delivery schemes.

However, amending legislation was not enacted until 2004. In addition, the

practice of SARS, prior to the issue of the assessments that were before the

Court in this appeal, was that the acceptance of the option under a deferred

delivery scheme was the time of exercise of a right to acquire the shares.

Looking at the conduct of SARS in administering the section, Wallis JA found

at paragraph 17:

“The conduct of those who administer the legislation provides clear

evidence of how reasonable persons in their position would

understand and construe the provision in question. As such it may be a

valuable pointer to the correct interpretation. In the present case the

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clear evidence that for at least eight years the revenue authorities

accepted that in a DDS scheme the exercise of the option and not the

delivery of the shares was the taxable event, fortifies the taxpayers’

contentions.”

Finally, Wallis JA considered that the amendment of the law in 2004 also

provided context in relation to the operation and interpretation of section 8A.

After explaining the effect of the amendment, he stated:

“As explained in the Explanatory Memorandum accompanying the

amending legislation when it was placed before Parliament, the

existing provisions of section 8A(1)(a) ‘fail to fully capture all the

appreciation associated with the marketable security as ordinary

income’. That not only identifies the purpose of the amendment, but is

also a permissible guide to Parliament’s understanding of the existing

section.”

As a result, Wallis JA concluded at paragraph 19:

“Weighing all relevant contextual and background material it points

consistently in favour of the construction of the section in the manner

for which the taxpayers contend. That reinforces the linguistic

analysis. I conclude that when the section speaks of the exercise of a

right to acquire a marketable security it is concerned with the action

by the taxpayer that gives rise to a binding contract under which the

taxpayer will be entitled, subject to compliance with the terms of the

contract, to acquire the marketable security, whether the acquisition

by transfer to the taxpayer occurs immediately or is postponed to a

future date. The contrary contention by the Commissioner must

therefore be rejected.”

These paragraphs in the judgment provide a master class in how the language of

a statute should be interpreted by having regard not only to syntax and grammar

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but also to the context and history in order to identify a single universal

interpretation.

Was the contract conditional?

SARS had not risked everything on the interpretation of section 8A(1)(a),

however, and fired its second salvo. Even if the trigger event was the exercise of

the option, it said, the right was inoperative until delivery and payment fell due.

In effect, the rights and obligations under the contract were suspended and only

became operable when delivery was required to be made. It relied on conditions

in the scheme that cancelled the contract on the happening of certain events

which might occur prior to the date of delivery.

The approach adopted by Wallis JA was to examine the terms of the scheme. In

order for the SARS’ argument to succeed, it had to be shown that the scheme

incorporated a condition that suspended the operation of the contract until the

happening of a future uncertain event. After discussing the terms of the notice

of the option and its acceptance, and evaluating the scheme itself, Wallis JA

stated at paragraph 25:

“The scheme itself contained no clause that could, even remotely, be

construed as a suspensive condition. Clause 7.3 which provided for

the postponed delivery dates did not purport to suspend the operation

of the contract until those dates.”

Further, the learned Justice of Appeal found that the existence of a condition

could not be inferred by way of a tacit term. SARS argued that the suspensive

condition could be inferred because the participants in the scheme could not

take delivery unless on due date for delivery they were in the employ of the

employer. However, it was found that a condition of this nature could not be

universally applied.

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Instead, after his analysis of the terms of the scheme, Wallis JA found at

paragraph 30:

“A wide variety of circumstances would entitle the participant to

receive the shares notwithstanding the fact that they did not remain in

the employ of the company for the full period.”

In addition, it was found that the inference of a condition would deprive the

share trust of rights under the contract, and that it was unlikely that it would

have inferred the existence of the condition. It was therefore held that the

condition suggested by SARS could not be inferred. The terms of the scheme

were intended to operate in the manner set out in the scheme rules for good

practical and commercial reasons.

SARS then sought to assert that there was a fiscal conditionality that the

taxpayers should be subject to tax on the de facto gain that they had derived

from the scheme. Wallis JA was unpersuaded, and responded that this was not

the outcome provided in the Act at paragraph 34:

“Once the section was held to apply by virtue of the exercise of an

option bringing into existence a contract of purchase and sale, the tax

consequences followed from the language of the section itself. Any

gain realised by the taxpayer in the year in which the right was

exercised was to be included in the taxpayer’s income for that year.”

The gain had therefore been determined in 1998 in the manner provided in

section 8A. Authority cited by SARS in support of its contentions was held to

have no relevance to the issue.

SARS’s final argument that the contract was conditional as it required

reciprocal performance by the parties, failing which it could not be completed,

was also rejected.

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Substance and form

The final throw of the dice was a submission that the form that the contract took

was different than its substance, and that the deferred delivery mechanism was a

simulation.

Wallis JA distinguished between simulation, which may amount to tax evasion,

on the one hand, and arranging one’s affairs so as to pay the least amount of tax

(tax avoidance) on the other, confirming that there is nothing impermissible in

tax avoidance, and dealt with SARS’s argument at paragraph 41:

“Once that is appreciated the argument based on simulation must fail.

For it to succeed, it required the participants in the scheme to have

intended, when exercising their options to enter into agreements of

purchase and sale of shares, to do so on terms other than those set out

in the scheme. That is manifestly implausible and was not suggested

to either Ms Bosch or Mr McClelland in evidence. Their approach was

simply that they were being offered an opportunity to acquire shares

on the terms of the scheme and they accepted those offers. ... [In] this

case there was no advantage to the parties in entering into a

conditional contract of purchase and sale when they were free to enter

into an unconditional contract and postpone performance of the

obligation to pay the purchase price and deliver the shares. The

Commissioner’s contentions based on the notion of substance over

form must be rejected.”

Impact

The judgment will bring to finality a number of unresolved disputes between

SARS and employers and their employees in respect of the exercise prior to

26 October 2004 of a right to acquire shares in terms of deferred delivery

schemes. It is considered that SARS will be obliged to close audits, allow

objections, concede appeals and issue reduced assessments. In this regard the

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decision may be seen as the final chapter in the history of the now defunct

section 8A of the Act.

However, the practical exposition of the methodology to be applied to interpret

a statutory provision will serve as a model for many for years to come.

PwC

ITA: Sections 8A and 8C

2403. Preservation orders

The judgment of the Western Cape High Court in CSARS v eTradex (Pty) Ltd

[2014] ZAWCHC 142 which was handed down on 9 September 2014 was

published by SARS in mid-October.

In those proceedings, SARS was seeking confirmation of a provisional

preservation order granted in terms of section 163 of the Tax Administration

Act No. 28 of 2011 (the TAA) on 14 August 2013.

The first respondent, referred to as Tradex, and the third respondent, Business

Wize Accounting and Management Services CC (‘BWA’), were entities owned

by one Louise Wiggett, the second respondent.

The judgment reveals that, after the granting of the provisional order, the

respondent taxpayers had been trying to put their tax affairs in order and to pay

the outstanding taxes owed by them, but that SARS was dissatisfied with

progress and applied to the High Court for a final preservation order.

The taxpayers’ business background

After three years of research and development by Wiggett, Tradex commenced

business in 2002, supplying technology solutions for automating and

streamlining export and import processes, and it had recently expanded into

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consulting services in the field of international trade. Tradex had 38 full-time

employees but did not own any immovable property.

BWA had started business in 2006-2007 and Wiggett had caused it to purchase

a property in Montague Gardens for R2,149 million and one in Caledon for

R1,95 million. Both properties were mortgaged.

BWA had agreed to supply Tradex with furniture, equipment, office

accommodation and operational support services at market-related charges, and

BWA had appointed Tradex its agent in terms of section 54 of the Value-Added

Tax Act No. 89 of 1991 (the VAT Act). Wiggett owned a property in

Langebaan that she had bought in 2000 for R33 060 and also owned a share of a

property in Hout Bay.

The tax debts and fiscal non-compliance

When the application for a preservation order was made in August 2013, Tradex

owed at least R4,1 million in various taxes. Its liability for income tax for 2010

and 2011 was unknown because it had failed to render tax returns for those

years. Its liability for VAT was also unknown because it had failed to render

returns over the period January 2010 to March 2013. BWA had rendered no tax

returns since starting business in 2006. Wiggett had rendered no returns since

registering as a provisional taxpayer during March 2000.

Wiggett blamed the fiscal non-compliance on two successive financial

managers.

An auditor appointed by Wiggett found Tradex’s and BWA’s records to be in

serious disarray and in need of reconstruction. The tax affairs of Tradex and

BWA were not in order when the provisional preservation order, that had been

applied for ex parte (that is to say, without notice to the taxpayer), was issued

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on 12 August 2013, and at that juncture their tax liability was likely to exceed

R4,1 million.

The tax liability was not yet precisely determined

In his judgment, Rogers J said at paragraph 15 that it was impossible to say with

any precision what amount of tax Tradex and BWA would in due course be

liable for. The two entities had paid about R4,7 million in respect of their

known tax liabilities.

The email correspondence between Wiggett and SARS showed that Wiggett

was making a substantial effort to co-operate with SARS in its investigations.

Tradex and BWA alleged that their financial statements and tax returns were

now up to date, that BWA had made losses and did not owe any tax, that

Wiggett also had no outstanding tax liability, and that a preservation order was

unnecessary.

They repeated an earlier offer to provide SARS with security, allegedly worth

more than R18 million, which was substantially in excess of any tax that might

still be owing.

A preservation order may be granted even if tax is not presently due and

payable

In his judgment, Rogers J said at paragraph 30 that a preservation order may be

made in terms of section 163(3) of the TAA if such an order is ‘required to

secure the collection of tax’, but he expressed the view that the tax in question

need not be currently due and payable and it sufficed that tax in an unquantified

amount was likely to become due and payable.

A preservation order must be ‘required to secure the collection of tax’

However, he went on to say at paragraph 31 that a preservation order cannot be

granted unless it is ‘required to secure the collection of tax’.

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This raised the question of what is meant by ‘required’.

Rogers J quoted from the judgment in C:SARS v CJ van der Merwe [2014]

76 SATC 138, where Savage AJ said at paragraph 43, that the requirement of

necessity could not be read into the statute, nor need it be shown that a

preservation order was required to prevent the dissipation of assets; however,

the facts must show ‘an appropriate connection between the evidence available

and the nature and purpose of the order sought’. The court was not required to

determine whether, in fact, tax was due and payable by the person in question.

The test for a preservation order was not one of ‘necessity’, and he quoted from

judgments which suggested that ‘required’ meant ‘reasonably required’ in the

sense of connoting ‘a substantial advantage in the collection of the tax.’

Rogers J went on to say at paragraph 34 that there were indications that the

focus of a preservation order was the dissipation of assets, and that an ex parte

application in terms of section 163(1) of the TAA would generally be justified

only out of concern regarding such dissipation. He pointed out that, if more

urgent action was needed for the preservation of assets, section 163(2)(a)

authorised SARS to seize assets in order to prevent any realisable assets from

being disposed of or removed which might frustrate the collection of tax.

In determining whether a preservation order should be varied or rescinded in

terms of section 163(9) –

“the court is required to balance hardship to the taxpayer on the one

hand and ‘the risk that the assets concerned may be destroyed, lost,

damaged, concealed or transferred’ on the other.”

An intention by the taxpayer to dissipate assets to defeat a SARS claim

need not be established

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Rogers J said at paragraph 35 that he did not think that the word ‘required’ in

section 163(3) entailed proof of an intention on the part of the taxpayer to

dissipate his assets in order to defeat SARS’ claim.

However, he said –

“SARS is required to show, I think, that there is a material risk that

assets which would otherwise be available in satisfaction of tax will,

in the absence of a preservation order, no longer be available. The fact

that the taxpayer bona fide considers that it does not owe the tax

would not stand in the way of a preservation order if there is the

material risk that realisable assets will not be available when it comes

to ordinary execution. An obvious case is that of a company which,

believing it owes no tax, proposes to make a distribution to its

shareholders.”

Rogers J went on to say at paragraph 36 that –

“In every case where a taxpayer is liable or likely to become liable for

tax, there is a theoretical possibility that the value of its assets may for

some or other reason be diminished by the time SARS is able to

execute. I do not think the lawmaker intended that a preservation order

would routinely be available to SARS in every case of an actual or

anticipated tax liability. There must be something by way of

‘requirement’ which places the particular case outside the ordinary run

of cases. The existence of material risk that assets will be diminished

is, as I have said, the obvious example. It is in such circumstances that

the court could conclude that preservation would confer a ‘substantial

advantage’ (i.e. over the position that would prevail without the order)

and that there was thus ‘an element of need’ …”

Rogers J at paragraph 37 then critically scrutinised the specific terms of the

preservation order sought by SARS in this case, for he said that the question

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whether such an order was ‘required’ cannot be answered in the abstract and the

practical utility of its terms has to be assessed.

Rogers J made the important point at paragraph 41 that –

“Delinquency in the conduct of a taxpayer’s tax affairs may in

appropriate circumstances be part of the material from which one

could infer that there is an appreciable risk that assets available for

collection of tax will be diminished. There is, however, no automatic

connection between the two. A person may be disorganised and late in

regard to its tax administration without there being any appreciable

danger that its assets will be diminished by the time tax comes to be

collected.”

In the founding papers in which it applied for a preservation order, SARS had

made ‘generalised statements’ to the effect that a preservation order would

enable SARS to collect all the tax owed by the respondents, that the

appointment of a curator bonis would ensure that SARS recovered all taxes

owed and that in the absence of a preservation order SARS ‘will in all

likelihood sustain severe prejudice’ because the prospect of recovering the

outstanding tax ‘seems bleak’ – but he pointed out that no facts had been

alleged by SARS to establish a prima facie case that there was an appreciable

risk of assets being diminished.

Overall, said Rogers J, SARS’ case was that the respondents’ delinquency in

completing their financial statements and making their returns and the initial

disarray in their records were a basis for confirming the preservation order, but

at paragraph 48 he pointed out that SARS had not alleged that Wiggett was

causing Tradex to dissipate its assets by distributing dividends or paying

excessive salaries or engaging in other suspicious activities. Rogers J noted at

paragraph 47 that –

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“SARS did not seek to make the case that Tradex’s business was

being run into the ground or becoming less valuable.”

Rogers J said at paragraph 49 that –

“If there were a prima facie case that Tradex would be run better

under the care of a curator bonis, one might be able to say that a

preservation order was ‘required’, because then one could conclude

that there was a reasonable prospect that, without a preservation order,

the business would be less valuable by the time tax came to be

collected. But as I have said, no facts to support such a conclusion

were advanced in the founding papers or subsequently.”

Rogers J commented at paragraphs 54 – 55 that –

“One gains the distinct impression that SARS launched the application

not so much because a preservation of the respondents’ assets was

required but in order to bring matters to a head by placing legal

pressure on the respondents ….

While I can understand SARS’ frustration, that is not the purpose of

the preservation application. There are other statutory mechanisms

available to SARS to deal with taxpayers who fail to provide

information, to render returns or to make payment of tax . . .”

Rogers J accepted at paragraph 56 that the delinquency of Tradex and BWA in

rendering returns, whilst unacceptable, appeared to have been attributable in a

substantial measure to the fact that their financial managers had let them down.

He was critical (at paragraph 58) in the terms of the provisional preservation

order, sought by and granted to SARS, which interdicted the respondents from

alienating or dealing with their assets in a way that would cause a decrease in

their value, and he pointed out that if this meant that the company could not use

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its cash flow to meet ordinary business expenses, the order would have the

effect of forcing the company to close down.

Rogers J said at paragraph 58 that a preservation order –

“…It would also not be ‘required’ unless there were reason to believe

that a forced sale of the company’s assets or its business would

achieve a better outcome for SARS than if the business were to

continue in operation. There is no basis for such a view.”

Rogers J said at paragraph 60 that the function of a curator bonis is not to assist

SARS to investigate the taxpayer’s tax liabilities, but to focus on the discovery

and preservation of assets from which tax liabilities, whatever they might turn

out to be, could be met.

He went on to say at paragraph 62 that if SARS, without resorting to litigation,

had requested Wiggett and BWA to give an undertaking and permit caveats to

be registered against their properties, pending the final determination of their

tax liabilities, it is likely that they would have agreed.

In the result, Rogers J concluded that, in this case, a preservation order was not

‘required’ to secure the collection of tax within the meaning of section 163(3).

He dismissed SARS’ application for the provisional preservation order to be

confirmed and, instead, made an order – whose terms reflected a tender that had

already been made by the respondents – for caveats to be registered against

specified immovable properties.

A preservation order is a procedure for preserving assets, not for putting

pressure on taxpayers

Rogers J pointed out at paragraph 74 that section 163 is a procedure for

preserving assets and is not an execution mechanism – that is to say its purpose

is not to force payment of a tax debt.

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He then spelled out the ordinary mechanisms available to SARS to compel

payment of an assessed tax debt, namely, by taking a civil judgment against the

taxpayer for the tax reflected in an assessment and then executing that judgment

in the ordinary way against the taxpayer’s assets and, if necessary, instituting

sequestration or liquidation proceedings.

Rogers J made the valuable observation at paragraph 75 that –

“Section 163 finds its primary application where the amount of tax has

not yet been ascertained (i.e. where SARS cannot execute in the

ordinary way).”

Implicitly, therefore, the judgment makes clear to SARS that where an

assessment has been issued (and can therefore be enforced by the ordinary

means), a preservation order is not appropriate unless there is reason to believe

that the taxpayer’s assets are being dissipated.

Where there is a demonstrated risk of dissipation, but the taxpayer’s tax liability

has not been ascertained, Rogers J makes clear at paragraph 75 that it is not

appropriate for the preservation order to give the curator bonis the power to

realise the taxpayer’s assets to satisfy an unascertained tax liability.

Critical overview

This judgment reflects very poorly on SARS.

Particularly damning was Rogers J’s observation that he gained the impression

that the real reason why SARS had applied for a preservation order was not to

preserve the respondents’ assets, but to put pressure on them to get their tax

affairs in order.

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Also significant was Rogers J’s warning at paragraph 73 that SARS should not

‘frame preservation orders on a one-size-fits-all basis’ – as SARS has

apparently been doing, for the judge cited another matter where SARS had

sought an order in similar terms, and he said that similar orders had been

‘sought and granted to SARS in several matters in Gauteng’.

Overall, the judgment exposes SARS’ conduct in this case as heavy handed and

bullying, in unnecessarily resorting to a preservation order when there were no

grounds for suspecting that the respondent taxpayers were dissipating assets,

and in rejecting their reasonable tender to provide security for their tax

liabilities.

Instead, SARS had crafted a preservation order so draconian that it could have

brought the taxpayers’ business to an end, for in terms of the preservation order

sought by SARS, all the respondents’ assets were to vest in the curator bonis,

who was to take control of their assets and have the power to realise the assets.

Moreover, the order was capable of being interpreted as empowering the

curator bonis not to permit payment of ordinary business expenses out of the

cash flow.

More serious still is that the judgment implicitly casts doubt on SARS’ ethics in

seeking a preservation order for an improper purpose and on its commitment to

the fair use of its draconian statutory powers.

PwC

TAA: Section 163

VAT Act: Section 54

2404. Tax compliance status

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Tax clearance certificates (TCCs) are issued by the South African Revenue

Service (SARS) to, inter alia, validate the status of a taxpayer and confirm that

such taxpayer’s tax affairs are in order.

TCCs are, almost without exception, required for tender or bid applications, to

reflect good standing, foreign investment and for emigration purposes. A TCC

is only valid for one year from the date of issue in respect of a tender and/or

good standing, provided the taxpayer remains compliant with SARS

requirements.

On 15 July 2014, the National Treasury (Treasury) issued National Treasury

Instruction No 3 of 2014/2015 (Treasury Instruction) on tax compliance

measures for persons doing business with the State. It is stated that the Treasury

Instruction was issued to strengthen the measures to be implemented by

accounting officers of departments and constitutional institutions as well as

accounting authorities of the public entities listed in Schedules 2 and 3 to the

Public Finance Management Act, No 1 of 1999, to ensure that all persons

conducting business with the State are tax compliant.

In order to reduce supply chain management related fraud and to ensure that

persons conducting business with the State do not abuse the supply chain

management system, the Treasury Instruction provided that institutions would

no longer be required to obtain a hard copy of an original and valid TCC, as

they would be able to check the tax compliance status of bidders through an

electronic Tax Compliance Status System (TCS system).

According to the Treasury Instruction, SARS would no longer issue paper-

based TCCs with effect from 1 April 2015. A taxpayer, who requires his or her

tax compliance status to be disclosed to a department, constitutional institution

or public entity for purposes of submitting a bid or to confirm his or her good

standing, would have to request a unique security Personal Identification

22  

Number (PIN) from SARS. As the TCS system would allow for the online real-

time verification of a taxpayer’s tax compliance status, the accounting officer or

accounting authority of such department, constitutional institution or public

entity would be able to use the PIN in order to verify the tax compliance status

of the taxpayer. The implementation of the TCS system was set to take effect

from 1 November 2014.

However, it is interesting to note that on 31 October 2014, Treasury issued

National Treasury Instruction No. 3A of 2014/2015 (Treasury Instruction 3A)

which served as a clarification regarding the implementation of the TCS system.

According to Treasury Instruction 3A, the implementation of the TCS system

would be deferred and further instructions on its applicability and

implementation date would be issued at a later date. Accounting officers of

departments, constitutional institutions, accounting authorities of Schedule 2

and 3 public entities and heads of provincial treasuries were instructed to halt

the Treasury Instruction with immediate effect as both Treasury and SARS were

still evaluating the implications of the TCS system. It will be interesting to see

whether the TCS system will indeed be implemented at a future date and if so,

whether such implementation will ease the difficulties faced by taxpayers when

applying for TCCs.

Cliffe Dekker Hofmeyr

National Treasury Instruction No 3 of 2014/2015 and No 3A of 2014/2015

Public Finance Management Act, No 1 of 1999, Schedule 2 and 3

Tax Administration Act: Section 256

23  

EXEMPT INCOME

2405. Pensions for foreign service

Many South Africans spend significant periods of time working outside the

country. Due to the fact that South Africa taxes the world-wide income of its

residents, payments received by residents for services rendered outside the

country are included in their gross income for South African tax purposes, but

may subsequently be excluded from their taxable income in terms of any

available exemptions. Whilst this may be the case the question is often posed

whether any similar exemption may apply to their pension benefits received

upon retirement from their South African pension fund in relation to the period

of services rendered abroad.

There is a specific exemption contained in section 10(1)(gC) of the Income Tax

Act No. 58 of 1962 (the Act) which applies, inter alia, to any pension received

by or accrued to any resident from a source outside South Africa as

consideration for past employment outside the country.

The statutory source rules are set out in section 9 of the Act. If section 9 of the

Act does not apply, then the common law source principles as set out in case

law should be applied. In terms of our common law, the source of income from

services rendered is regarded as being located where those services were

rendered.

In the case of a pension or annuity, section 9(2)(i) of the Act provides that an

amount is received by or accrues to a person, from a source within South Africa

if services in respect of that amount is so received or accrued were rendered

within South Africa. This is subject to the proviso that if the services were

rendered partly within and partly outside South Africa, only so much of that

pension/annuity as relates to the period during which services were rendered in

South Africa must be regarded as South African sourced income.

24  

Section 10(1)(gC) as it currently reads does not specifically refer to the source

rule contained in section 9(2)(i) in relation to pension benefits, although this

provision previously referred to the old deemed source rule for pensions, which

is no longer applicable.

SARS’ has previously taken the view that, in order for the section 10(1)(gC)

exemption to apply, the pension fund must be situated outside South Africa and

the services in respect of which the pension is paid must have been rendered

outside South Africa. Accordingly, if the pension fund is situated in South

Africa, the exemption would not apply and the full monthly pension would be

taxable. This was on the basis that, in SARS’ view, the section 9(2)(i) source

rule only applies to non-residents who are taxable on their South African

sourced income only, thus does not apply to South African residents who are

taxable on their worldwide income in terms of the Act. The implication is that a

pension is regarded as being from a source outside South Africa if the pension

fund is situated outside the country.

However, SARS has now issued a Binding General Ruling No. 25 on

14 November 2014 to provide clarity on the interpretation and application of the

words ‘from a source outside the Republic’’ contained in section 10(1)(gC).

According to this binding general ruling, the term ‘source outside the Republic’,

for the purposes of section 10(1)(gC), refers to the originating cause which

gives rise to the pension income, namely, where the services have been

rendered. The ruling also sets out a formula for calculating the portion of the

pension that will be exempt due to services rendered outside South Africa,

which is effectively a proportionate amount based on the period of foreign

services relative to the total services rendered.

The ruling does not refer to section 9(2)(i) but refers to South African case law

regarding the source of income being the originating cause which gave rise to

25  

that income. In terms of this ruling, the common law principle regarding the

source of income from services rendered should be applied to pension benefits

and the source of the pension benefit should be regarded as being located where

the services to which the pension benefit relates were rendered. Where the

pensionable services were rendered partly in and partly outside South Africa,

the source of the pension should be apportioned between the South African

services and the foreign services, in order to determine the foreign sourced

pension that should be exempt in terms of section 10(1)(gC).

The ruling applies from the date of issue (14 November 2014) and will apply

until it is withdrawn or the relevant legislation is amended.

Accordingly, recipients of pension benefits, whether from South African or

offshore pension funds, should ensure that the correct apportionment of their

pension benefit is done on the basis of their services rendered abroad.

ENSafrica

ITA: Sections 9(2)(i) and 10(1)(gC)

Binding General Ruling No. 25

INTERNATIONAL TAX

2406. Treaty shopping

The concept of base erosion and profit shifting (BEPS) has been much

discussed at various international forums including the G20 Finance Ministers

and Central Bank Governors meeting in July 2013 in Moscow as well as the

G20 Heads of State meeting in September 2013.

26  

From a South African perspective, the Davis Tax Committee has been set up,

inter alia, in order to address the issue of BEPS in a South African context.

An issue considered by the OECD as part of its BEPS reports is that of ‘treaty

shopping’.

According to the OECD, ‘treaty shopping’ is an abuse or an improper use of a

tax treaty, being contrary to the objectives of the treaty. ‘Treaty shopping’

occurs where taxpayers who are not residents of contracting states seek to

obtain the benefits of a tax treaty by placing a company or another type of legal

entity in one of the countries to serve as a conduit for income earned in the other

country, (Indonesian Director General of Taxes quoted in Indofood

International Finance Ltd v JP Morgan Chase Bank N.A., London Branch

[2006] EWCA Civ 158 (Court of Appeal) at paragraph 18).

The UN Commentary on article 1 of the UN Model Convention states: “A

guiding principle is that the benefits of a double taxation convention should not

be available where a main purpose for entering into certain transactions or

arrangements was to secure a more favourable tax position and obtaining that

more favourable treatment in these circumstances would be contrary to the

object and purpose of the relevant provisions.” (United Nations ITC1 “Improper

Use of Tax Treaties, Tax Avoidance and Tax Evasion” May 2013, p6)

Silke on International Tax argues

“… that, subject to the potential application of specific anti-avoidance

provisions, there seems to be no warrant for claiming that the mere

presence of a tax avoidance purpose (even if it is a sole purpose) turns

a given factual matrix into unacceptable ‘treaty shopping’.”

                                                            1 ITC = International Tax Cooperation project. This one of the papers on selected topics in administration of tax treaties for developing countries, prepared under a joint UN‐ITC project, issued as a preliminary document for circulation at the technical meeting on “Tax treaty administration and negotiation” (New York, 30‐31 May 2013) to stimulate discussion and critical comments.  

27  

A typical would-be ‘treaty shopper’ then only has a single real hurdle to clear,

namely to qualify in principle for benefits in terms of a particular treaty. Once

this threshold has been negotiated, all that usually remains is for the relevant

provisions of the treaty to be invoked, (Silke on International Tax at § 46.42).

In a South African context, treaty shopping could apply in the context of, for

example, a foreign parent company with a South African subsidiary where the

parent company has advanced interest-bearing loan funding to its subsidiary.

However, due to the introduction of the new interest withholding tax, the parent

company now looks to route its loan funding to its South African subsidiary

through a company in an intermediate jurisdiction which has a more favourable

Double Tax Agreement (DTA) with South Africa. Such DTA would then not

allow South Africa to impose its interest withholding tax on interest paid by the

South African subsidiary to the company in the intermediate jurisdiction.

There are certain tax sparing clauses in various DTAs, for example, the DTA

with Brazil in respect of government bonds.

Article 11(1) of the DTA between South Africa and Brazil provides that interest

arising in a Contracting State and paid to a resident of the other Contracting

State may be taxed in that other State.

However, articles 11(4)(a) and (b) provide that notwithstanding the provisions

of paragraphs 1 and 2:

“(a) interest arising in a Contracting State and derived and beneficially owned

by the Government of the other Contracting State, a political subdivision

thereof, the Central Bank or any agency (including a financial institution)

wholly owned by that Government or a political subdivision thereof shall

be exempt from tax in the first-mentioned State;

28  

(b) subject to the provisions of subparagraph (a), interest from securities,

bonds or debentures issued by the government of a Contracting State, a

political subdivision thereof or any agency (including a financial

institution) wholly owned by that government or a political subdivision

thereof, shall be taxable only in that State.”

Article 11(4)(b) read with Article 11(4)(a) of the DTA therefore applies, inter

alia, to provide exclusive taxing rights to Brazil in respect of interest derived

from bonds issued by the Brazilian government and derived and beneficially

owned by South African residents other than the South African government,

South African Reserve Bank or other governmental agencies set out in article

11(4)(a) of the DTA.

In addition the DTA between South Africa and Zambia provides taxing rights to

Zambia in respect of interest paid on certain debt instruments advanced by

South African residents. South Africa may not tax such interest.

Issues of principle with treaty shopping?

The question arises whether and to what extent South Africa should care about

treaty shopping. As set out in the example above, if a parent company chooses

to invest into South Africa through an intermediate jurisdiction with a more

beneficial DTA, is such parent company not simply structuring its investment in

a tax efficient manner, as permitted in terms of South African case law?

This should be considered by the South African tax authorities at the time of

entering into DTAs with other jurisdictions. For example, South Africa entered

into a DTA with Mauritius in the knowledge that, for example, interest payable

by a South African entity to a Mauritian entity would be taxed at an effective

rate of approximately 3% in Mauritius.

29  

South Africa has also entered into DTAs with various European jurisdictions

which jurisdictions have provisions effectively mitigating the quantum of tax

paid in those jurisdictions. For example, an investor may set up a foreign

company and invest in equity in that foreign company in the form of, for

example, redeemable preference shares. The foreign company may then

advance a loan to the South African entity. As a matter of the foreign

jurisdiction’s tax law, a deduction will be granted for the dividends payable in

respect of the redeemable preference shares leaving the foreign company

taxable only on its spread/margin.

In this regard there is significant competition for tax revenues on a world-wide

basis. Jurisdictions are incentivised to enter into as many DTAs as possible and

then also to offer tax incentives, inter alia, to attract multi-nationals into their

jurisdictions.

South Africa is one of such jurisdictions. For example South Africa has recently

introduced a ‘headquarter company’ regime in terms of which foreign investors

may invest through South Africa into, inter alia, Africa. As part of marketing

this initiative South Africa has made mention of its many DTAs with African

jurisdictions. In particular South Africa competes directly with Mauritius in

respect of attracting foreign investment into Africa.

It is therefore not in South Africa’s interest and would also provoke justified

criticism if South Africa attacked foreign investors for investing in South Africa

via an intermediate jurisdiction with a favourable DTA when South Africa is

doing precisely the same in terms of its headquarter company regime. In

particular, in terms of this regime South Africa is encouraging foreign investors

who wish to invest in, inter alia, various African jurisdictions to invest in these

jurisdictions via South Africa and thereby take advantage of South Africa’s

DTAs with such African states. This will have the effect of reducing the amount

30  

of tax paid by such foreign investors in the African jurisdictions and will

increase the amount of tax revenue generated by the South African fisc.

This issue goes to the heart of the BEPS debate. Where profits are ‘shifted’

from one jurisdiction to another, it is typically only the jurisdiction from which

they are shifted that raises a concern. Most member states of the OECD and

other jurisdictions which are taking part in the BEPS process have tax

incentives which encourage profit shifting into their own jurisdictions. However

they are then aggrieved when the same techniques are used to ‘shift profit’ away

from such jurisdictions and thereby erode their tax base.

Put simply, with the global economic downturn, all jurisdictions are looking to

increase their tax revenues.

Turning back to South Africa, it seems that South African tax law already

provides several defences against treaty shopping. Three important defences in

this regard are the concepts of ‘beneficial ownership’ and ‘effective

management’ as well as the use of South Africa’s domestic anti-tax-avoidance

rules.

Take the above example of the foreign parent company looking to route its loan

funding to its South African subsidiary through a company in an intermediate

jurisdiction with a favourable DTA with South Africa. If the company set up in

the intermediate jurisdiction does not qualify as the ‘beneficial owner’ of the

interest received from the South African subsidiary then the terms of the

relevant DTA will simply not be applicable. South Africa can therefore attest

whether such company qualifies as the beneficial owner of the interest.

A further issue is whether the company in the intermediate jurisdiction is

‘effectively managed’ in that jurisdiction. If it is simply a ‘post box company’

with no substance then it is very likely that it will not be ‘effectively managed’

31  

in that intermediate jurisdiction and South Africa can then simply ignore the

provisions of the relevant DTA and impose its interest withholding tax on the

payments made to that company.

South Africa also has anti- tax-avoidance provisions. In terms of these rules if

the ‘sole or main purpose’ of a taxpayer was to obtain a ‘tax benefit’ and certain

abnormal features exist in respect of such arrangement, the anti-tax avoidance

rules can be applied to disregard the transaction entered into by the parties.

A ‘tax benefit’ will apply if a party side-steps an anticipated tax liability. In the

context of the definition of a ‘tax benefit’ in terms of section 1(1) of the Income

Tax Act No. 58 of 1962 (the Act), based on case law (Hicklin v SIR [1980]

41 SATC 179 and Smith v Commissioner for Inland Revenue [1964]

26 SATC 1), the liability for the payment of any tax, levy or duty that a

taxpayer must seek to avoid, postpone or reduce is not an accrued or existing

liability, but an anticipated liability. It was held that to avoid liability in this

sense is ‘to get out of the way of, escape or prevent an anticipated liability’.

If there is a ‘tax benefit’, the second requirement for the application of the

anti-tax avoidance provisions is that the ‘sole or main purpose’ is to obtain such

tax benefit. Therefore, provided the taxpayer does not comply with this

requirement, the arrangement will not constitute an impermissible tax avoidance

arrangement, i.e., the provisions of section 80A of the Act will not apply.

It is provided in section 80G that:

an avoidance arrangement is presumed to have been entered into or

carried out for the sole or main purpose of obtaining a tax benefit unless

and until that party proves that, reasonably considered in light of the

relevant facts and circumstances, obtaining a tax benefit was not the sole

or main purpose of the avoidance arrangement; and

32  

the purpose of a step in or part of an avoidance arrangement may be

different from a purpose attributable to the avoidance arrangement as a

whole.

In terms of the example set out above, if the South African subsidiary repays its

existing loan funding to the parent company and the foreign parent company

routes such loan funding through an intermediate jurisdiction this has the effect

of the parent company side-stepping an anticipated tax liability in respect of

interest withholding tax. A tax benefit will therefore arise for the parent

company. In order to avoid the application of South Africa’s anti-tax avoidance

provisions, such company then bears the onus of proving that its ‘sole or main

purpose’ was not to achieve such tax benefit.

ENSafrica

ITA: Sections 1(1), definition of ‘tax benefit’, 80A and 80G

UN Commentary on article 1 of the UN Model Convention

SARS NEWS

2407. Interpretation notes, media releases, rulings and other documents

Readers are reminded that the latest developments at SARS can be accessed on

their website http://www.sars.gov.za.

Editor: Mr P Faber

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

33  

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.