Recently, the Tax Court handed down judgment in the unreported case of AB LLC and BD Holdings LLC v the Commissioner of SARS (heard in February 2015) in which it had to determine whether or not an American company acting as an advisory group for the South African airline industry, had created a permanent establishment in South Africa. In making it’s decision, the court reviewed the Double Taxation Agreement (“DTA”) concluded between South Africa and the USA.
A permanent establishment is created in terms of a double taxation agreement and outlines the activities that an enterprise of a resident state must conduct in a source state before the profits generated from those activities can be taxed in the source state. According to Section 5(1) of the Double Tax Agreement (and the Organisation for Economic Co-operation and Development Model Tax Convention), the term “permanent establishment” means:
“A fixed place of business through which the business of an enterprise is wholly or partly carried on. The term “permanent establishment” includes especially:
- A place of management;
- A branch;
- An office;
- A factory;
- A workshop, and
- A mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
Section 5(2)(k) further provides that a permanent establishment:
“Includes especially the furnishing of services including consultancy services within a contracting state by an enterprise through employees or other personnel engaged by the enterprise for such purposes, but only if activities of that nature continue (for the same or connected project) within that state for a period or periods aggregating more than 183 days in any 12 month period commencing or ending in the taxable year concerned.”
The court held that if the provisions of 5(2)(k) apply, then because of the inclusion of the words “includes especially”, the provisions of article 5(1) would not have to apply to create a permanent establishment. The court held that the American company had created a permanent establishment because its employees had been in South Africa furnishing the consultancy services for more than 183 days and because it had a fixed base in the boardroom of its South African client (it had exclusive use of the boardroom for the entire duration of it’s contract).
Based on this reasoning by the court, the American company was found to be liable for tax on the profits attributable to the services it rendered to its South African client. SARS had also added penalties and interest on the assessed tax liability of the American company. The court held that the penalties of 100% were not disproportionately punitive and that the American company should have familiarised itself with the South African tax laws. The court found that the company had been negligent in not determining the tax consequences of the agreement it had entered into with the South African company.
There are several lessons to be learned from this case, including that:
- A foreign company with exclusive use of a room within a client’s premises can, depending on the terms of the relevant DTA, create a permanent establishment;
- It is possible for a permanent establishment to be created even if the foreign company has not created a fixed place of business, but has merely rendered services for more than 183 days in any 12 month period; and
- Foreign companies setting up businesses in South Africa or rendering services to South African clients, must make sure they seek professional tax advice to avoid any adverse tax consequences