Every day, taxpayers structure their transactions to make use of the deductions, exemptions and allowances contained in the tax statutes so as to minimise the tax liabilities imposed by the detailed, complicated and lengthy sets of taxing provisions. The question is: when does this activity cease being legitimate tax planning and become tax avoidance which the law should prohibit? Courts and lawmakers have long grappled to discover abusive transactions so that taxpayers cannot benefit from the related tax savings.
As a result of experience, South Africa has determined it is necessary to go beyond the approach of detailed anti-avoidance rules and to fashion a doctrine, the concept of the impermissible tax avoidance arrangement or the general anti-avoidance rule described in sections 80A to 80L of the Income Tax Act, Act 58 of 1962 (the Act) that prohibits tax avoidance with a broader sweep. As a conceptual matter, it is difficult to draw a distinction between legitimate tax planning and impermissible tax avoidance arrangements. Discussions concerning this topic often begin by citing the tax planning adage from the United States case of Gregory v Helvering 293 U.S. 465 , that the legal right of a taxpayer to decrease the amount of what otherwise would be its taxes, or to altogether avoid them, by means which the law permits, cannot be doubted.
That narration is often only the start of an examination of the possible application to the particular factual situation of numerous tax avoidance concepts including the “sham transaction doctrine”, “tax avoidance” versus “tax evasion”, the “pre-ordained series of steps concept”, the “business purpose ” test or the ” substance over form” doctrine. Many studies on tax avoidance are written as if we all know precisely what these terms mean. This article has been particularly motivated by the introduction of the revised general anti-avoidance rule in sections 80A to 80L of the Act.
One could say that if a transaction is undertaken solely for tax reasons it should be disregarded for tax purposes. This criterion still leaves many types of transactions that have both tax effects and other economic effects. As the body of knowledge around corporate tax avoidance develops it will normally be possible to make reasonably certain judgments about whether a particular avoidance arrangement will be considered to be consistent with the law. But there will be uncertainty in marginal cases.
Historically, the determination of what can be defined as acceptable tax planning has referred back to the concepts of tax avoidance and tax evasion. Tax evasion, in contradistinction to tax avoidance, has been described by various commentators as the deliberate, dishonest act of suppressing income or inflating expenditure in order to reduce a tax burden. Professional bodies prohibit members from assisting clients to evade tax, and no reputable tax adviser would risk reputation and livelihood by doing so. No special provision is necessary in a taxing statute for the nullification of these schemes, which are illegal and are subject to heavy and severe penalties. As regards disguised transactions entered into for the purpose of tax evasion, the fiscus is sufficiently protected by common law, in that a court will not hesitate to strip the transaction of its disguise and expose the true nature or substance of the contract.
Tax avoidance, on the other hand, is described by commentators usually to denote a situation in which the taxpayer has arranged its affairs in a perfectly legal manner that it has either reduced its income or that it has no income on which tax is payable. No obligation rests upon a taxpayer to pay a greater amount of tax than is legally due under the taxing Act, and a taxpayer is not barred from entering into a bona fide transaction which when carried out has the effect of avoiding or reducing liability to tax, provided that there is no provision in the law designed to prevent the avoidance or reduction of tax.
The starting point in the analysis of acceptable tax planning is that South Africas tax statutes generally operate, both in their interpretation and in their application, so as to tax by reference to the legal substance of the transactions which taxpayers enter into and the legal substance of transactions will usually, though not always, flow from the legal form used to document them. A court, in considering whether the taxpayer has properly achieved a reduction of tax, will give effect to the true nature and substance of the transaction and will not be deceived by its form. The legal substance of a transaction will prevail over the form of the transaction (that is, the label or the nomenclature) where the form does not reflect, or is inconsistent with, the legal substance. However, where the form properly reflects the legal substance of a taxpayers transaction, the form will be respected. This means that tax law is applied to the legal effect of transactions ascertained under ordinary legal principles.
A future article will address how the various principles fit together in the overall scheme of tax statute interpretation and application with specific emphasis on the circumstances under which courts may re-characterise a transaction in accordance with its substance if the essence of the transaction is demonstrably contrary to the form.
Edward Nathan Sonnenbergs