Author: Amanda Visser (BDlive)
The challenges developing countries face from tax avoidance and tax evasion are not new, yet developed countries have suddenly woken up to these challenges, mainly due to the global financial crisis. They call it base erosion and profit shifting, or Beps.
The Organisation for Economic Co-operation and Development has over the past two years looked at ways to strengthen international tax standards, and ways to identify and address loopholes in tax laws.
The danger is that the developing world will have to adopt new rules, made by the developed world for problems they have been struggling with for many years.
The African Tax Administration Forum (Ataf) has published a discussion paper in preparation for a consultative conference on the new rules of the global tax agenda held recently in Johannesburg.
In the paper it recognises the key risks facing African tax bases as the granting of inappropriate and wasteful tax incentives, ineffective natural resource taxation regimes, and profit shifting through cross-border, related-party transactions.
It states that the risks arising from large multinational companies with global operations are likely to be in the nature of tax avoidance involving complex but well-documented transfer pricing designs. “The risk of illegal or fraudulent activity is relatively low,” Ataf says in its document.
Andrew Wellsted, a tax director at Norton Rose Fulbright, says that in this argument about profit shifting, very few people ask whether the tax structures created by multinational corporations comply with revenue laws. “I think what you will find is that a number of these structures are in compliance with the law as it stands. What is happening is that you are reverting to the dodgy area of tax morality,” he says.
The most common response to Beps has been a slew of anti-avoidance legislation aimed primarily at cross-border transactions.
Tax laws introduced to address these concerns become overly complex, difficult to implement and ultimately a disincentive to foreign investment.
Mr Wellsted says a recent example of this phenomenon is South Africa’s rules pertaining to inward-bound loans. When a global group of companies wishes to set up a South African subsidiary, it has to be funded and it can be done in two ways, through equity funding or debt funding.
The catch is that South Africa now has three measures in place to combat perceived abuse in this area.
The first line of defence is transfer pricing rules.
A key goal of any transfer-pricing rule is to ensure that foreign debt is introduced at reasonable interest rates, and that the capitalisation of the local company does not rely too heavily on debt, as opposed to equity funding.
“Where a company’s equity-to-debt ratio is deemed to be excessive, we say the company is thinly capitalised. In recent times, South Africa’s transfer pricing has been heavily revised but the revisions made to the thin capitalisation rules are unclear and have caused much uncertainty for taxpayers,” Mr Wellsted says.
As a further measure against base erosion, an interest withholding tax was introduced which will be effective from January 1 next year. The introduction of this tax means that nonresidents earning from a South African source will be subject to South African tax at a rate of 15%.
Another rule that has been introduced recently, section 23M of the Income Tax Act, applies to interest earned by nonresidents where the debtor in the arrangement is a connected person to the creditor, and where the nonresident creditor is not subject to South African tax on the interest earned. The nonresident may have a specific exemption, or may not be taxed in terms of a double tax agreement between his country and South Africa.
The effect of this section is to limit the deduction the local debtor may claim on the interest paid.
“If you fall within the section, then the interest expenditure incurred in respect of that loan is limited to an amount determined by adding all interest accrued to the debtor in the year in question, and 40% of that debtor’s adjusted taxable income.”
Mr Wellsted says the “adjusted taxable income” is determined in terms of a very complex calculation. A company may comply with the first two rules, but will have to do the calculations to determine what is 40% of the adjusted taxable income.
Ataf says that for developing countries the tax system has a more substantive role: it is an important tool for good governance and the basis for the social-fiscal contract between a government and its citizens and corporations.
Mr Wellsted says the amount of regulation and the compliance burden attached to the regulations must be considered when South Africa wants to extract the right amount of tax, but remain attractive as an investment destination.
“Having three different rules to address a transaction as ordinary and prevalent as shareholder loans, which are necessary for local operations to grow, appears not to achieve the balance that is desired,” Mr Wellsted says.