Application of OECD Model Double Tax Treaty to given situations

Introduction

South Africa is one of the many non-member economies with which the OECD has working relationships in addition to its 30 member countries. Reflecting strong interest from member countries to involve this country in OECD work, South Africa was invited to participate in the OECD’s “Emerging Market Economy Forum” since its inception in 1996 through to its closure in 2000. Since then, it has participated actively in a variety of other OECD events open to non-members in a regional context and in OECD Global Forums. The OECD Council at Ministerial level adopted a resolution on 16 May 2007 to strengthen the co-operation with South Africa, as well as with Brazil, China, India and Indonesia, through a programme of enhanced engagement.

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The OECD’s Centre for Co-operation with Non-Members develops and oversees the strategic orientation of this relationship and ensures that the dialogue remains focused, forward-looking and mutually beneficial. Usually, meetings are held between South African officials and experts from OECD countries and the OECD Secretariat, on topics mutually agreed on and jointly prepared with analytical studies.

South Africa participates in OECD meetings at Ministerial level. It has adhered to OECD legal instruments, notably the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, and the OECD Council Acts related to the Mutual Acceptance of Data in the Assessment of Chemicals. It participates in OECD committees, and is a member of the OECD’s Development Centre. Finally, South Africa supports OECD’s regionally-focused activities in Africa.


Situations where OECD Model Double Tax Treaty are applied:

(a)Meaning of the term “source” in section 6quat

There is no universal definition or understanding of the meaning of source. Yet, even in residence-based systems, source remains a crucial concept when –
• taxes are levied on non-residents, and
• rules exist for the granting of foreign tax credit relief in respect of foreign-sourced amounts included in the taxable income of residents.

Thus the question whether an amount arises either from a South African or a foreign source remains important despite the introduction of the worldwide basis of taxation. Although South African residents may be subject to tax on a worldwide basis, only foreign-sourced amounts are eligible for a section 6quat rebate.

The comments in paragraph 19 of the Introduction to the Commentaries on the OECD Model Tax Convention on Income and on Capital July 2008 (Condensed Version) are relevant in this regard and are quoted here for ease of reference:
“For the purposes of eliminating double taxation, the Convention establishes two categories of rules. First, Articles 6 to 21 determine, with regard to different classes of income, the respective rights to tax of the State of source or situs and of the State of residence […] In the case of a number of items of income and capital, an exclusive right to tax is conferred on one of the Contracting States. The other Contracting State is thereby prevented from taxing those items and double taxation is avoided. As a rule, the exclusive right to tax is conferred on the State of residence. In the case of other items of income and capital, the right to tax is not an exclusive one.
[…] Second, insofar as these provisions confer on the State of source or situs a full or limited right to tax, the State of residence must allow relief so as to avoid double taxation; this is the purpose of Articles 23A and 23B. The Convention leaves it to the Contracting States to choose between two methods of relief, i.e., the exemption and the credit method.”

The Act contains no specific rules as to whether gross income is from sources within or outside South Africa; nor is there a definition of the term “source” in the Act. The rules developed in South Africa for determining whether gross income has a South African or foreign source are essentially those formulated by the courts, not by statute, regulation or administrative practice.

The source of income has been defined, first, to be the originating cause of the income and, secondly, the locations of the originating cause (Overseas Trust Corporation v CIR 1926 AD 444, 2 SATC 71). This jurisprudence remains valid for the interpretation of the meaning of the word “source” in section 6quat and the determination must be made upon a case-by-case basis in light of the facts and circumstances.
In many instances the actual source of an amount is located in South Africa despite the fact that the money flows from a foreign country to South Africa for the ultimate benefit of a South African resident. In these instances the foreign country will not have any taxing right in respect of the amount. The source of income is not to be confused with the source from which income is paid. This does not, however, apply when a DTA between South Africa and a foreign country has a “deemed source” provision allowing the foreign country to tax an amount derived from a true source outside that country. The “deeming source” rule overrides the South African tax rules for determining the source of certain income items and capital gains.

Example 1 – DTA providing for deemed-source rule which overrides the actual source
Facts:
A resident company provides technical services to a company resident in Swaziland. The services are rendered from South Africa and the agreement to render these services was negotiated and concluded in South Africa. Under the domestic tax law of Swaziland a withholding tax of 15% is imposable on technical fees remitted to South Africa. Under the DTA the rate of the tax is reduced to 10%.

Result:
The true source of the fees is where the services are rendered, that is, South Africa (COT v Shein 1958 (3) SA 14 (FC) at 16 and 18, 22 SATC 12). However, Article 13 of the DTA between South Africa and Swaziland, which deals with technical fees, overrides the true-source rule. Article 13(5) of the DTA deems the fees to be from a source in Swaziland, and provides as follows:
“Technical fees shall be deemed to arise in a Contracting State when the payer is a resident of that State.”
The DTA therefore creates a “source” for technical services fees and a consequent taxing right for the country in which the income is so “sourced”. In addition, Article 22 of the DTA imposes an obligation on South Africa, the country of residence, to relieve the tax suffered at this “source” through a tax credit.

A South African resident will not qualify for a tax credit when –
• tax has been levied by the tax authorities of a foreign country on a payment to that resident;
• the source of the payment is South Africa; and
• although there is a DTA with the foreign country, it does not contain a deemed-source rule.

In these circumstances the resident must seek a refund of the withholding tax from the foreign country under the DTA.
When no DTA exists between South Africa and the foreign country where the foreign tax liability was incurred, the resident may qualify under section 6quat(1C) for a deduction for the foreign taxes not qualifying for the foreign tax credit.

Example 2 – Foreign withholding tax on South African-source income when no DTA exists
Facts:
A resident mining company establishes a subsidiary company in Country A in order to conduct exploration activities in that country. The resident company provides management services from South Africa to its foreign subsidiary, with all such services being performed in South Africa. The tax authorities of Country A levy a withholding tax in respect of the management fees paid. No DTA exists between South Africa and Country A.

Result:
The actual source of the income is located in South Africa and the resident company
must include the management fees in its income for South African tax purposes. The withholding tax does not qualify for a foreign tax credit because the management fees do not constitute a foreign-sourced amount. However, the resident taxpayer may deduct the amount under section 6quat(1C) in determining the taxable income derived in respect of the management services provided to its subsidiary based in Country A.

Some commentators have suggested that the word “source” should be interpreted differently for the purposes of section 6quat from the way in which it is interpreted in relation to the definition of the term “gross income”. They argue that the word “source” should be given the less-restrictive meaning of “the quarter from which it comes” rather than the traditionally accepted meaning of the “originating cause”. Such an interpretation cannot, however, be accepted. Apart from the fact that it runs counter to a long line of case law in South Africa, it would result in unacceptable tax avoidance.

South Africa’s primary right to tax amounts actually sourced in South Africa should not be eroded by a system of unilateral relief that is not met with a reciprocal obligation by other countries (unlike a bilateral system).


(b)  OECD MODEL  ARTICLE 11 – INTEREST

This Article 11 favours the resident State. South Africa has conformed to this in that it gives an exemption from tax to non-residents who do not have a presence in South Africa.

Article 11 states that:
“1. Interest arising in a Contracting State and paid to a resident of the other Contracting State
may be taxed in that other State.
2. However, such interest may also be taxed in the Contracting State in which it arises and
according to the laws of that State, but if the beneficial owner of the interest is a resident of the
other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of
the interest. The competent authorities of the Contracting States shall by mutual agreement settle
the mode of application of this limitation.
3. The term “interest” as used in this Article means income from debt-claims of every kind,
whether or not secured by mortgage and whether or not carrying a right to participate in the
debtor’s profits, and in particular, income from government securities and income from bonds or
debentures, including premiums and prizes attaching to such securities, bonds or debentures.
Penalty charges for late payment shall not be regarded as interest for the purpose of this
Article.”

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