STC may soon be consigned to the history books but when willliability end?

Synopsis July 2007

Tax today*

*connectedthinking

2

In this issue

STC and future liability. . . . . 2

Tax exemption regime for PBOs - a success story so far. 4

Goods liable to forfeiture underCustoms and Excise Act. . . . 5

Australian Tax Office - strategic objectives andinternational anti-avoidanceinitiatives . . . . . . . . . . . . 6

Income outside of any statutory categories . . . . . . 8

Editor: Ian Wilson

Written by R C (Bob) Williams

Sub-editor and lay out: Carol Penny

Tax Services Johannesburg

Dis tri bu tion: Elizabeth Ndlangamandla

Tel (011) 797-5835

Fax (011) 209-5835

www.pwc.com/za

It is anticipated that STC willsoon beconsigned tothe historybooks. Whilemany willheave a sigh of relief, thereremains thespectre thatliability to STCmay still beassessed bySARS at somefuture date.Companies will therefore needto understandexactly at what point they willhave finallyshed theburden of STC.

STC to be consigned tohistory books but whenwill liability end?

The SARS Comprehensive Guide to Secondary Tax on

Companies contains a detailed commentary on how

prescription operates when a return for payment of secondary

tax on companies (STC) is filed. The treatment suggested is

anomalous and the conclusions reached in the document bear

further examination.

Payment structure

The payment structure for STC is relatively simple. When a

company declares a dividend, it is required to file a return and

render payment of the tax then due not later than the last

business day of the month following that in which the dividend

is declared. The tax is calculated on the “net amount”, being

the amount by which the dividend declared exceeds dividends

that have accrued to it in the same dividend cycle. Each

payment must be accompanied by a return in such form as the

Commissioner for the SARS may require. It is further provided

that the Commissioner may “extend the applicable date of

payment”.

Prescription provisions

The prescription provisions of the Income Tax Act prohibit

SARS (in the absence of fraud, misrepresentation or material

non-disclosure) from issuing additional assessments after the

expiration of three years from the date of payment of any

amount paid in respect of STC. The relevant provision applies in

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respect of taxes payable other than by

way of an assessment, which would

include a self-assessing tax such as STC.

A liability to STC may not arise when a

dividend is declared. The reasons for

non-liability may differ. For instance, the

company may have sufficient STC

credits that result in the “net amount”

being zero, or the company may be

making payment to its wholly-owning

parent company and be eligible for an

exemption. This raises the question

whether such company, having filed the

required return for payment within the

time limits and in the form prescribed,

with no misrepresentation or non-

disclosure of material facts, can safely

say that the Commissioner cannot raise

an additional assessment after three

years from date of filing of the return?

Not so, says SARS. The guidelines state

that there is a distinction between the

situation where an amount is paid and

that where no amount is payable. A

company that makes a payment is

entitled to rely on the three-year

limitation from date of payment.

However, a company that has no liability

to make payment, and files a return

within the prescribed time limit reflecting

that position, is denied the same relief.

Here SARS states that it relies on the

general rule that applies in the case of

normal tax, namely, that the three-year

prescription period only runs from the

issue of the assessment to normal tax.

Selective reasoning

This appears to be a case of selective

reasoning. There is no difference in

principle between a taxpayer who has a

legitimate reason for not having to make

payment and one who has a payment to

make. Both are required to comply with

the formalities for reporting a potential

liability to STC. Assume, for the

moment, that two companies report

their respective potential liability on the

same day. Company A has an amount

of tax to pay, by reason that the net

amount is greater than zero, and there is

no exemption available in respect of

such amount. Company B has no tax to

pay, and the reason therefore is clearly

indicated on the prescribed form.

Company A is immune from further

assessment after three years. Company

B must wait until three years have

elapsed after SARS has assessed it to

normal tax in respect of the relevant

year of assessment – a significantly

longer period.

Date of payment

Does the use of the term “date of

payment” – the term used in the relevant

section providing for when and how

STC liabilities must be reported and

paid – have any relevance? It is

submitted that it should. The entire

purpose of the filing of a return and

claiming relief, whether by way of credit

or exemption, is to give SARS notice of

a potential liability. The date that the

return is filed is the “date of payment”.

The Income Tax Act even empowers the

Commissioner to extend this “date of

payment”.

The SARS Charter promises that

taxpayers in similar positions will not be

discriminated against. It is difficult to

justify discrimination in this instance.

The fact that company A has a liability

and company B does not is no

justification for the discrimination. If

both companies have filed a return on

the same day in prescribed form, giving

notice of their liability or non-liability,

they should enjoy equal treatment under

the law. It is not justification to say that

because company A made a payment, it

should be placed in a preferred position

to company B, which had no payment

to make.

Anomaly

The ridiculous conclusion that the

anomaly creates is that any company

that wishes to limit the prescription

period to the shortest possible time

should make a payment of at least one

rand when rendering a return, even if it

has no liability.

The ridiculous conclusion that the anomaly creates is that any company that wishes to limit theprescription period to the shortest possible time should make a payment of at least one rand whenrendering a return, even if it has no liability.

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The complexity of the Australian system

The virtues of the South African system are highlighted if one looks, for comparison,

at the recent decision of the Federal Court of Australia in Commissioner of

Taxation v Triton (2006) 226 ALR 293.

This case concerned a dispute as to whether the Triton Foundation, which was

established for “the promotion of a culture of innovation and entrepreneurship”,

qualified for tax exemption on the basis that it was a charitable institution, as defined

in Australia’s Income Tax Assessment Act of 1997. The Triton Foundation provided

advice, gratis, to entrepreneurs on marketing, intellectual property and business

planning.

In terms of the latter Act, the Australian Commissioner of Taxation must endorse an

entity as exempt from tax if it is a “charitable institution”.

The Act does not, however, define the term “charitable institution”. As a result, the

court in the Triton case, as in many other reported Australian decisions, had to search

out and apply criteria laid down in a slew of complex judgements going back a

hundred years and more, and in terms of criteria laid down in an English statute from

the reign of Elizabeth I!

The South African system of approved PBOs

By contrast, in South Africa section 30(3) of the Income Tax Act (read with the

definitions in section 30(1)) provides for the Commissioner to approve a public benefit

organisation which carries on a “public benefit activity” falling within the scope of part

I of the ninth schedule whose constitution contains certain prescribed provisions.

One of the success stories ofrecent tax reform in South Africahas been the introduction of thesystem of tax exemption for publicbenefit organisations (PBOs) interms of section 30 of the IncomeTax Act 58 of 1962 read withsection 10(1)(cN).

Although the Income Tax Actprovides in section 3(4) for a rightof objection and appeal against arefusal by the Commissioner toapprove a PBO, no decisions ofthe tax court or the superior courts in respect of such objections haveyet been reported. The absence oflitigation is itself an indicator thatthe legislation is clear andunambiguous.

It may also indicate that charitableand other organisations that aspire to tax-exempt PBO status aresucceeding in securing theCommissioner’s approval in termsof section 30(3).

Tax-exemption regime for PBOs

A success story so far

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These provisions dovetail with section

10(1)(cN), which provides that the

receipts and accruals of such public

benefit organisations are exempt from

tax to the extent they are not derived

from any business activity or trading. To

overcome the difficulty that many

genuine PBOs carry on limited trading

activities, it is now provided that trading

income above a defined threshold is

taxable in the ordinary way.

The success of the South African

tax-exemption regime for PBOs can be

gauged from the complete absence,

thus far, of any reported litigation

between taxpayers and SARS as to the

interpretation or application of the

statutory rules.

However, the clarity and certainty of the

South African tax-exempt PBO regime

comes at the cost of considerable

technicality and complexity in the

legislation.

Drawing the constitution of a PBO so as

to include all the provisions mandated

by section 30(3) is a task beyond the

skills of the ordinary lay person. This

means that any PBO, no matter how

lowly, needs to incur the cost of briefing

a professional to draft the constitution,

and advise on how the PBO should

organise its activities in order to keep

within the boundaries of part I of the

ninth schedule.

The other complexity lies in the statutory

provisions regarding the tax-deductibility

of donations to public benefit

organisations. It is often important for a

PBO to be able to assure the funders

that their donations will be

tax-deductible. The provisions of section

18A of the Income Tax Act are complex,

in particular the provisions regarding the

issuing of receipts for tax-deductible

donations.

This issue is of particular concern to

churches, since section 18A provides for

tax-deductible donations only in respect

of PBOs that carry on public benefit

activities listed in part II of the ninth

schedule.

Significantly, “the promotion or practice

of religion” appears only in part 1 of the

ninth schedule, and not in part II.

Consequently, churches that desire to

have tax-exempt PBO status, but would

also like to secure the tax-deductibility of

donations have a problem in the latter

regard. This can sometimes be partially

or completely overcome by careful

tax-planning.

The surreptitious take-over ofPBOs

An intriguing development in recent

years could yet result in litigation

involving PBOs and their members.

With the steep escalation of land values

in recent years, some PBOs (including

churches), which have never thought of

themselves as wealthy, have found

themselves owning valuable land and

buildings.

Unscrupulous land developers have

been known to set about a clandestine

take-over of PBOs, including churches,

with a view to acquiring control of their

assets, freeing up the land for

commercial development, and

channelling the profits into their own

pockets.

Such a scheme inevitably involves the

loss of tax-exempt PBO status and

taxability of the profits, but that is of little

consequence if control of the assets was

acquired for a pittance.

The success of the South African tax-exemption regime for PBOs canbe gauged from the complete absence, thus far, of any reportedlitigation between taxpayers and SARS, although an intriguingdevelopment involving the surreptitious take-over of PBOs in recentyears could change the picture.

Possession of goodsliable to forfeitureunder Customs andExcise ActGeneral principle of our criminallaw provides that a person doesnot incur criminal liability unless heor she had mens rea (a guilty stateof mind).

Section 83(b) of the Customs andExcise Act 91 of 1964 states that–

“Any person who … knowingly has in his

possession any goods liable to forfeiture

under this Act … shall be guilty of an

offence”.

In S v Lunga (judgement given on14 August 2006; not yet reported) theTransvaal Provincial Division revieweda conviction by a magistrate’s court inwhich the accused was found guiltyand sentenced to a fine of R2 000 orsix months imprisonment for acontravention of this provision.

Southwood J said that, in themagistrate’s court trial, the State had not proved that the accused “knowingly” had goods in her possession that were liableto forfeiture, nor had the accusedadmitted such knowledge.

The High Court set aside the convictionand sentence, and ordered that the finebe repaid.

The decision affirms the generalprinciple of our criminal law that (unlessthe relevant statute provides for strictliability) a person does not incur criminal liability unless he or she had mens rea(a guilty state of mind) when carryingout the act in question, and that theprosecution bears the onus of provingthis element of the offence.

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The regulatory pyramid

The Commissioner said that the

Australian Tax Office’s compliance

model was a regulatory pyramid which

seeks to encourage as many taxpayers

as possible into the base of the pyramid,

where there is self-regulation and a high

level of voluntary compliance. The apex

of the triangle was characterised by a

wilful minority who try to abuse the tax

system.

Good governance, said the

Commissioner, helps an organisation

stay at the apex of the compliance

pyramid and also helps it avoid material

tax and other risks which, in an extreme

case, can bring about failure of the

business.

He said that many large businesses have

corporate governance processes in

place which ensure that there is

appropriate oversight of systems to

provide integrity and risk assurance.

The Australian Tax Office hasexpectations of the businesssector

The ATO’s expectations, said the

Commissioner, were that a business

should have –

· a sound framework to manage tax

issues and comply with tax

obligations;

· a well-resourced, skilled and

experienced in-house capability to

support the management of tax

issues;

· appropriate reporting systems in place

so that significant tax risks are brought

to the attention of the board or

decision-makers in a timely manner;

· appropriate review and sign-off for

material transactions in which, as part

of the process, tax impacts are

considered;

· a clearly-articulated approach to

managing tax risk (including seeking

rulings in relation to complex and

novel transactions); and

· regular audits of these systems and

processes to ensure that they are

operating effectively.

Globalisation issues andInternational co-operation

The Commissioner said that, with the

growth in globalisation, compliance

issues are increasingly associated with

international markets.

He said that when 35 tax commissioners

met at the OECD’s Forum on Tax

Compliance in Seoul in September 2006,

the main focus was on how to improve

international tax compliance. The final

communiqué stated that –

“Our discussions in Seoul confirmed that

international non-compliance is a

significant and growing problem.

Cross-border non-compliance can take

many forms, up to and including outright

tax fraud. Individuals have, for example,

used offshore accounts, offshore trusts

or shell companies in offshore financial

centres or other countries to conceal

taxable assets or income, as well as

credit cards held in offshore jurisdictions

to provide access to concealed assets;

businesses of all sizes have created shell

companies offshore to shift profits

In the past, state revenue

authorities took for granted that

their function was simply that of

tax collectors.

In many countries around the

world, the fiscus is now

re-examining its role, and

expanding its vision and its

modus operandi. Australia is a

case in point, and South Africa

could soon follow suit.

In an address during July 2007

to the Financial Executives

Association, Australia’s

Commissioner of Taxation said

that the Australian Tax Office

had recently changed its

Strategic Statement from

“optimizing collections” to

“optimizing voluntary

compliance” with the tax laws.

The Australian Tax Office rethinks its strategicobjectives and reports on internationalanti-avoidance initiatives

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abroad, often taking recourse to over- or

undervaluation of traded goods and

services for related party transactions

and some multinational enterprises

(including financial institutions) have

used more sophisticated cross-border

schemes and/or investment structures

involving misuse of tax treaties and the

manipulation of transfer pricing to

artificially shift income into low tax

jurisdictions and expenses into high tax

jurisdictions which go beyond legitimate

tax minimisation arrangements.”

The Commissioner said that Australia

has developed strong global tax

information-sharing through international

tax forums and bilateral agreements.

These held advantages for international

corporations, in eradicating double

taxation.

The Joint International TaxShelter Information Centre

The Commissioner said that a Joint

International Tax Shelter Information

Centre (JITSIC) had been established in

2004 by the tax administrators of

Australia, Canada, the United Kingdom

and the United States to supplement

their continuing work in identifying and

curbing abusive tax-avoidance

arrangements.

The JITSIC members had identified

highly artificial arrangements including –

· a scheme, which had been marketed

in a cross-border fashion, involving

hundreds of taxpayers and tens of

millions of dollars in improper

deductions and unreported income

from retirement account withdrawals;

· financial institutions creating financing

structures selling the benefit of foreign

tax credits separately from the

economic benefit of the underlying

income; and

· brokers providing made-to-order

losses on futures and options

transactions for individuals in other

JITSIC jurisdictions, leading to a tax

loss of over $100 million.

There were plans for the future

development of JITSIC, along with

expansion into Asia.

Mergers, acquisitions anddivestments

The Commissioner said that many of the

corporate tax issues of concern to tax

administrations relate to the global

growth in mergers and acquisitions. The

Australian Tax Office needed on-going

assurance that the tax outcomes of

these deals were appropriate.

The ATO was increasingly working with

business to understand the structure of

these deals and the tax consequences

at the point of divestment and the point

where new tax entities are formed. As

par of the review of tax risks, the ATO

would check that capital gains tax

outcomes on divestment were

appropriate and reflected the economic

gains made.

Post-acquisition, it would be necessary

to ensure compliance with thin

capitalization rules so that interest

deduction claims complied with those

rules, and so that capital allowance

deductions, based on the increased tax

value of assets on acquisition, were not

excessive.

The ATO needed to check that the

carry-forward of tax losses complied

with the tax rules, and that the payment

of new international related-party fees

was not excessive and was

appropriately characterised for tax

purposes.

The ATO, said the Commissioner, had

established a project to identify high-risk

hybrid financing arrangements, in

particular the potential for –

· corporate financing instruments to be

misclassified as debt rather than

equity;

· circumvention of debt/equity

provisions by the use of unit trusts;

and

· tax planning involving stapled

instruments, tax deferred distributions

and CGT deferrals in relation to

unstapling of hybrid instruments.

The criteria to identify tax risks

The Commissioner said that the ATO

tried to understand a corporate group’s

cash-flow generation and management

through corporate structures in order to

see jurisdictional impacts, for example,

the correct allocation of global profit.

The role of corporate leaders

The Commissioner said that corporate

leaders in the Australian community

strongly influenced general community

confidence in Australia’s tax system.

Australia has developed strong global taxinformation-sharing through international taxforums and bilateral agreements assisting ineradicating double taxation.

Income outside of any statutory categories

One of the most strikingweaknesses in South Africa’s taxjurisprudence is the lack of anyconceptual framework for theconcept of “income” in the Income Tax Act 58 of 1962.

What the opening words of the definition

of “gross income” in section 1 of the Act

say, in essence, is that any receipt or

accrual that is not capital is income. If this

is taken at face value, then income is an

amorphous residual category with no

distinctive characteristics of its own. If

this is so, then it is only ever necessary to

ask whether an amount in dispute is

“capital”, and the answer to this question

will determine whether it is or is not

income.

In this regard the Act is simplistic and

ill-considered. The truth is that income is

not merely “non-capital”, but has its own

distinctive characteristics which are well

recognised in disciplines such as

accounting and economics, and which

have been acknowledged in a number of

seminal tax decisions of our courts.

Thus, in CIR v Lunnon 1924 AD 94 at 98,

Innes CJ endorsed the dictum in COT v

Booysens Estates Ltd that “income was

sometimes the product of capital

invested, and sometimes was earned by

the labour or the wits of the recipient”.

(This principle was approved in Millin v

CIR 1928 AD 207 at 214.) In Crowe v CIR

1930 AD 122 Stratford JA observed that,

“Broadly speaking income is derived from

capital productively employed, or is

received for services.”

Unfortunately, in more recent decisions,

our High Court has tended to adopt a

blinkered approach to the concept of

income, and to regard the Income Tax

Act (probably the worst-drafted legislation

on the statute book and in dire need of a

rewrite) as the repository of all tax

knowledge.

Australian High Court affirmsthat “income” can ariseoutside of statutory categories

By contrast, our sister tax jurisdiction,

Australia – from which South Africa

copied its first Income Tax Act – is far

more analytical in its approach to the

fundamental nature of income.

In particular, Australia has long

recognised the existence of a category of

income referred to as “income according

to ordinary concepts”, in other words a

category of income that exists

independently of the provisions of income

tax legislation, whose nature must be

determined by looking to the generally

accepted meaning of the term “income”.

The notion of “income according to

ordinary concepts” was central to the

recent decision of the High Court of

Australia in Commissioner of Taxation v

McNeil (2007) 233 ALR 1.

The case involved a complex

arrangement involving a taxpayer who

held shares in St George Bank Ltd

(“SGL”) which were listed on the

Australian Stock Exchange. A share

buy-back arrangement was put into

effect, in terms of which shareholders

could oblige SGL to buy back their shares

at a stipulated price.

The issue before the court was whether

the taxpayer had derived income as a

result of her exercise of the right to sell

shares back to SGL.

Despite the fact that Australia’s Income

Tax Assessment Act contains the usual

complex provisions regarding the taxation

of dividends and income derived from

schemes of profit-making, the taxability

or otherwise of the proceeds from the

sale of the taxpayer’s shares in terms of

the buy-back arrangement was held to

depend on whether those proceeds

constituted “income according to

ordinary concepts”, that is to say, income

that fell outside of statutory categories

and was income in the ordinary,

non-technical sense of that word.

This was the basis on which the case had

been argued and decided in the Full

Bench of the Federal Court of Australia,

and was the basis on which it was

decided on appeal to the High Court of

Australia.

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