| Earlier this year Minister Pravin Gordhan (“the Minister”) announced the members of the Tax Review Committee (“the committee”) as well as the committee’s terms of reference.
The terms of reference for the committee include inquiring into the role of the South African tax system in the promotion of inclusive economic growth, employment creation, development and fiscal sustainability. The committee is required to take into account recent domestic and global developments and, in particular, the long-term objectives of the National Development Plan (NDP) and thereafter make recommendations to the Minister. Any tax proposals arising from these recommendations will be announced as part of the normal budget and legislative processes.
In addition, the committee’s mandate includes the evaluation of the South African tax system against international tax trends, principles and practices, as well as recent international initiatives to improve tax compliance and deal with tax base erosion. Aspects that will receive specific attention have also been set out and include reviewing the corporate tax system with reference to, inter alia, tax avoidance (e.g. base erosion, income splitting and profit shifting, including the tax bias in favour of debt financing) and further consider issues such as whether the current South African mining tax regime is appropriate, taking account of the agreement between Government, Labour and Business to ensure that the mining sector contributes to growth and job creation, remains a competitive investment proposition, and all role players contribute to better working and living conditions. The challenges facing the mining sector, including low commodity prices, rising costs, falling outputs and declining margins as well as the mining sector’s current contribution to tax revenues should also be taken into account.
In carrying out the review the committee should take into account the objectives of the South African tax system, bearing in mind that the South African tax system has changed since the recommendations of the last tax commission and these changes have contributed to the development of a relatively robust and competitive tax system. However, given the pace of globalisation, relative modest economic growth after the 2008/09 economic recession and the significant social challenges such as persistent unemployment, poverty and inequality, there is a need to review what role the tax system can play as part of a coherent and effective fiscal policy framework in addressing these challenges. There is also a need to address concerns about base erosion and profit shifting (“BEPS”), especially in the context of corporate income tax, as identified by the Organisation for Economic Co-operation and Development (“OECD”) and the G20-countries.
In order to address BEPS, the OECD has published an Action Plan on BEPS (“the Action Plan”). The Action Plan sets out 15 actions, which can briefly be summarized as follows:
- Address the tax challenges of the digital economy – Identify the main difficulties that the digital economy poses for the application of existing international tax rules and develop detailed options to address these difficulties, taking a holistic approach and considering both direct and indirect taxation. Issues to be examined include, but are not limited to, the ability of a company to have a significant digital presence in the economy of another country without being liable to taxation due to the lack of nexus under current international rules, the attribution of value created from the generation of marketable location relevant data through the use of digital products and services, the characterisation of income derived from new business models, the application of related source rules, and how to ensure the effective collection of VAT/GST with respect to the cross-border supply of digital goods and services.
- Neutralise the effects of hybrid mismatch arrangements – Develop model treaty provisions and recommendations regarding the design of domestic rules to neutralise the effect (e.g. double non-taxation, double deduction, long-term deferral) of hybrid instruments and entities. This may include: (i) changes to the OECD Model Tax Convention to ensure that hybrid instruments and entities (as well as dual resident entities) are not used to obtain the benefits of treaties unduly; (ii) domestic law provisions that prevent exemption or non-recognition for payments that are deductible by the payor; (iii) domestic law provisions that deny a deduction for a payment that is not includible in income by the recipient (and is not subject to taxation under controlled foreign company (“CFC”) or similar rules); (iv) domestic law provisions that deny a deduction for a payment that is also deductible in another jurisdiction; and (v) where necessary, guidance on co?ordination or tie-breaker rules if more than one country seeks to apply such rules to a transaction or structure. Special attention should be given to the interaction between possible changes to domestic law and the provisions of the OECD Model Tax Convention.
- Strengthen CFC rules – Develop recommendations regarding the design of CFC rules.
- Limit base erosion via interest deductions and other financial payments – Develop recommendations regarding best practices in the design of rules to prevent base erosion through the use of interest expense, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income, and other financial payments that are economically equivalent to interest payments.
- Counter harmful tax practices more effectively, taking into account transparency and substance – Revamp the work on harmful tax practices with a priority on improving transparency, including compulsory spontaneous exchange on rulings related to preferential regimes, and on requiring substantial activity for any preferential regime. It will take a holistic approach to evaluate preferential tax regimes in the BEPS context.
- Prevent treaty abuse – Develop model treaty provisions and recommendations regarding the design of domestic rules to prevent the granting of treaty benefits in inappropriate circumstances. Work will also be done to clarify that tax treaties are not intended to be used to generate double non-taxation and to identify the tax policy considerations that, in general, countries should consider before deciding to enter into a tax treaty with another country.
- Prevent artificial avoidance of permanent establishment (“PE”) status – Develop changes to the definition of a PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions.
- Assure that transfer pricing outcomes are in line with value creation: intangibles – Develop rules to prevent BEPS by moving intangibles among group members. This will involve: (i) adopting a broad and clearly delineated definition of intangibles; (ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced from) value creation; (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and (iv) updating the guidance on cost contribution arrangements.
- Assure that transfer pricing outcomes are in line with value creation: risks and capital – Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation.
- Assure that transfer pricing outcomes are in line with value creation: other high – risk transactions – Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to: (i) clarify the circumstances in which transactions can be recharacterised; (ii) clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and (iii) provide protection against common types of base eroding payments, such as management fees and head office expenses.
- Establish methodologies to collect and analyse data on BEPS and the actions to address it – Develop recommendations regarding indicators of the scale and economic impact of BEPS and ensure that tools are available to monitor and evaluate the effectiveness and economic impact of the actions taken to address BEPS on an on-going basis. This will involve developing an economic analysis of the scale and impact of BEPS (including spill over effects across countries) and actions to address it.
- Require taxpayers to disclose their aggressive tax planning arrangements – Develop recommendations regarding the design of mandatory disclosure rules for aggressive or abusive transactions, arrangements, or structures, taking into consideration the administrative costs for tax administrations and businesses and drawing on experiences of the increasing number of countries that have such rules. The work will use a modular design allowing for maximum consistency but allowing for country specific needs and risks. One focus will be international tax schemes, where the work will explore using a wide definition of “tax benefit” in order to capture such transactions.
- Re-examine transfer pricing documentation – Develop rules regarding transfer pricing documentation to enhance transparency for tax administration, taking into consideration the compliance costs for business. The rules to be developed will include a requirement that multinationals provide all relevant governments with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template.
- Make dispute resolution mechanisms more effective – Develop solutions to address obstacles that prevent countries from solving treaty related disputes under Mutual Agreement Procedures (“MAP”), including the absence of arbitration provisions in most treaties and the fact that access to MAP and arbitration may be denied in certain cases.
- Develop a multilateral instrument – Analyse the tax and public international law issues related to the development of a multilateral instrument to enable jurisdictions that wish to do so to implement measures developed in the course of the work on BEPS and amend bilateral tax treaties. On the basis of this analysis, interested parties will develop a multilateral instrument designed to provide an innovative approach to international tax matters, reflecting the rapidly evolving nature of the global economy and the need to adapt quickly to this evolution.
Tax authorities and governments worldwide (especially G20-countries) will be hoping that the actions suggested by the OECD will lead to a tax system in which profits are taxed “where economic activities deriving the profits are performed and where value is created”, as opposed to being taxed in the lowest tax jurisdiction.
Ehrhard Furstenburg – Associate at ENS