Reportable arrangements – a bad moon rising

tax adminstrationAuthors: Ruaan van Eeden and Danielle Botha (DLA Cliffe Dekker Hofmeyr)

Draft Public Notice

The South African Revenue Service (SARS) recently issued a Draft Public Notice (Draft Notice) listing  transactions that constitute reportable arrangements (RA’s) for purposes of s35(2) of the Tax administration Act, No 28 of 2011 (TAA). The Draft Notice, once finalised, is intended to be supplementary to any previous notices issued with regard to RA’s and serves as an extension of the existing listed RA’s. Existing reportable arrangements include certain arrangements qualifying as hybrid equity instruments in terms of s8E and 8F of the Income Tax Act, No 58 of 1962 (ITA).

The Draft Notice lists various RA’s including:

  • share buy-backs for an aggregate amount of at least R10 million, if the company issued any shares within 12 months of entering into the buy-back agreement;
  • any arrangement that is expected to or has given rise to a foreign tax credit exceeding an aggregate amount of R10 million;
  • an arrangement in which a resident contributes to or acquires a beneficial interest in a non-resident trust, where the value of contributions or payments to the trust exceed R10 million, with certain exclusions;
  • an arrangement where one or more persons acquire a controlling interest in a company that has or expects to carry forward an assessed loss exceeding R20 million from the preceding year of assessment or expects an assessed loss exceeding R20 million in the year of assessment in which the relevant shares are bought; and
  • an arrangement involving payments by a resident to an insurer exceeding R1 million, if any amounts payable to any beneficiary, are determined with reference to the value of particular assets or categories of assets held by or on behalf of the insurer or another person.

VAT and permanent establishment detection

Of particular interest, however, is the RA listed in paragraph 2(a) of the Draft Notice, related to possible permanent establishment (PE) and Value added Tax (VAT) enterprise detection. Paragraph 2(a) provides that any arrangement where fees relating to technical, managerial and consultancy services in excess of R5 million are or become payable, by a resident to a non-resident, will be a RA where the non-resident:

(i)   has an office in South Africa; or

(ii)  has a physical address in South Africa; or

(iii) has established or maintains a bank account in South Africa; or

(iv) is registered as an external company in terms of the Companies Act, No 71 of 2008.

Commentary on paragraph 2(a)

Paragraph 2(a) of the Draft Notice will likely place the onus on the resident paying the fees (as the ‘participant’), to establish whether one or more of the above factors may be present to determine whether a reporting obligation arises. The relatively low threshold of R5 million will likely result in a number of transactions becoming reportable, provided that at least one of the other requirements referred to above is also satisfied.

In general, non-residents are taxed on South African source income, subject to the application of any relevant Double Tax Agreement (DTA) that South Africa has entered into. On the assumption that the fees relating to technical, managerial and consultancy services are from a South African source, the more difficult aspect to consider is whether a PE has been created. The determination of the existence of a PE requires the application of complex international tax principles and one could expect this type of early detection mechanism, through a RA, would result in an increase in SARS audit activity.

However, one suspects that VAT may be the first target under this early detection mechanism as it is widely accepted that it is easier to trigger a VAT presence in South Africa than, say, an income tax presence. Save for the the new rules on e-services, South Africa’s VAT legislation is woefully inadequate in terms of ‘place of supply’ rules, which ultimately results in a number of interpretive issues and disputes with SARS on the concept of an ‘enterprise’.

In determining whether a person is liable to register as a VAT vendor in South Africa, the basic test, apart from the compulsory R1 million per annum turnover criteria, is to determine whether such person conducts an ‘enterprise’ as defined in section 1 of the Value-Added Tax Act, No 89 of 1991. The most problematic aspect of the ‘enterprise’ definition, as it relates to the potential RA, is for SARS to determine whether the person is carrying on a continuous or regular activity in, or partly in, the Republic, which will always be a question of fact.

What needs to be borne in mind is that the reporting of a transaction will not automatically result in an income tax or VAT liability. For example, with regard to the registration of an external company, SARS issued Binding Private Ruling 102 on 4 May 2011, in which it examined whether registration as an external company by a non-resident company that did not have its place of effective management in South Africa would constitute a PE in South Africa. SARS ruled that registration of an external company in itself would not create a PE in South Africa.

Essentially, SARS is attempting to utilise the above factors, as indicative of the potential presence of a PE or a VAT enterprise in South Africa, however, no single factor can be considered as being decisive.

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