International tax: proposed amendments
As part of the South African tax calendar, the month of July entails the introduction of the new Draft Tax Laws Amendment Bill (“DTLAB”) which always proves to be a time of uncertainty, discussion and may require the restructuring of your tax affairs. The latest proposed amendments will see, inter alia, some relief for taxpayers in relation to the Controlled Foreign Company (“CFC”) rules and the scope of an “Affected Transaction” as defined in section 31 of the Income Tax Act 58 of 1962 (“the Act”) to be extended. We intend dealing with these amendments briefly below.
The CFC rules contains and exemption known as a comparable or high tax exemption. This exemption removes the burden on South African investors of having to apply the CFC rules if there is little South African tax at stake. The high-tax exemption is applicable if the total tax payable by the CFC to the foreign government is equal to or exceeds 75% or more of the normal tax that would have been payable had the CFC been a South African tax resident. The DTLAB seeks to lower comparable tax exemption to 67.5%.
This is a welcome amendment to the Act given the high domestic corporate tax rate and will hopefully lead to the international expansion of more South African companies.
The so called ant-diversionary rules dealing with income generated by a CFC in relation to Foreign Business Establishment has now been extended to include services (sale of goods) directly or indirectly to the benefit of a connected person in relation to the CFC.
The purpose behind the proposed change is to address multi-layered structures that fragment the current anti-diversionary rules. The issue with the proposed amendment is the lack of certainty as to what constitutes an indirect benefit. One would hope that SARS will provide guidance on the interpretation should they proceed with the enactment of the proposal.
It has been proposed that the definition of “Permanent Establishment” contained in the Act be updated to align with the definition of a Permanent Establishment contained within article 5(5) of the Organisation for Economic Cooperation and Development (“OECD”) Multi Tax Convention.
The proposed amendment will extend the definition of a Permanent Establishment to include within the definition of an enterprise “where a person is acting in a Contracting State on behalf of an enterprise and, in doing so, habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.”
The effect being that a person`s actions on behalf of an enterprise may be sufficient to conclude that the enterprise participates in a business activity in the state concerned. This will mean that a director, being based in South Africa, of a non-resident entity may by virtue of his actions establish a Permanent Establishment for a non-resident entity and attract tax in South Africa despite the entity being managed and controlled offshore.
The DTLAB proposes that the definition of an “Affected Transaction” be extended to include the definition of an “Associated Enterprise”. With the result being that transactions will be caught by the transfer pricing provisions where the parties are not connected to each other.
The wording of article 9(1) of both the OECD and UN MTC is as follows:
“Where an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or
Where the same persons, participates directly or indirectly in the management, control or capital of an enterprise of a Contracting State and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises…”
The definition of a “Connected Person” includes any other company, if the company is managed and controlled by connected persons.
The proposed amendment will widen the scope of the transfer pricing rules significantly and may create unwanted consequences. To illustrate an example of such unwanted consequences a non-executive director may be seen to participate indirectly in the management and control of an enterprise and bring two companies within the scope of the transfer pricing provisions, despite the parties not being connected. The proposed amendment, although aligned with international standards, is in our view to wide.
Please do not hesitate to contact the Tabacks Tax Team if you have any questions or require any advice in relation to the proposed changes.