A new General Anti-Avoidance Rule (GAAR) has been introduced and is applicable in respect of any transaction or any step therein or part thereof entered into on or after 2 November 2006 (the effective date). This means that if an arrangement was entered into before the effective date and a step therein or part thereof is entered into after the effective date, the new GAAR will not apply.
The motivation cited by SARS for the introduction of the new GAAR is the fact that, as a result of the increasingly sophisticated forms of tax avoidance implemented by taxpayers and their advisors; international developments; and the conflicting interpretation by the courts of the scope and meaning of s 103(1) the current GAAR has become a largely ineffective deterrent.
The new rules pertaining to the new GAAR is contained in a new Part IIA of Chapter III of the Income Tax Act, 58 of 1962 (the Act), comprising section 80A to 80L.
Impermissible avoidance arrangement
In order for the Commissioner to invoke the current GAAR contained in s 103(1) all of the following four requirements must be present:
• There must be a transaction, operation or scheme;
• Which has the effect of avoiding, reducing or postponing the liability for the payment of tax;
• It must have been entered into or carried out in a manner not normally employed for bona fide business purposes, other than obtaining a tax benefit or have created rights and obligations that would not normally be created between persons dealing at arm’s length (the abnormality requirements); and
• It must have been entered into solely or mainly for the purpose of obtaining a tax benefit.
Once all these requirements have been met the Commissioner is empowered to determine the tax liability of a taxpayer as if the transaction had not been entered into.
Although, in the new GAAR, these four essential elements have been retained they have been expanded upon and defined more clearly.
A transaction, operation or scheme is now termed an ‘arrangement’. This term also encompasses an agreement or understanding (whether enforceable or not), including all steps therein or parts thereof. The reason for the inclusion of the last mentioned phrase is due to the interpretation of the courts that if the overall scheme is not tax-motivated, individual steps, could not be attacked even if these specific steps were purely tax driven.
An ‘avoidance arrangement’ is defined as an arrangement which results in a tax benefit.
An ‘impermissible avoidance arrangement’, is as an avoidance arrangement where the sole or main purpose is to obtain a tax benefit and the following requirements are met:
• In the context of business:
– the avoidance arrangement was entered into or carried out by means or in a manner which would not normally be employed for bona fide business purposes (this requirement is the same as the abnormality requirement contained in s 103(1)); or
– the avoidance arrangement lacks commercial substance.
• In a context other than business:
– the avoidance arrangement was entered into or carried out by means or in a manner which would not normally be employed for a bona fide purpose, other than obtaining a tax benefit (this requirement is the same as the abnormality requirement contained in s 103(1)); or
• In any context:
– the avoidance arrangement has created rights and obligations which would not normally be created between persons dealing at arm’s length (this requirement is the same as the abnormality requirement contained in s 103(1)); or
– the avoidance arrangement would result directly or indirectly in the misuse or abuse of the provisions of the Act.
Therefore, although the abnormality requirements originally included in s 103(1) have also been adopted in the definition of an impermissible avoidance arrangement, two new concepts have also been introduced i.e. the lack of commercial substance concept and the concept of the misuse or abuse of the provisions of the Act.
The concept of misuse or abuse has not been defined in the Act and therefore, presumably, the common law meaning would have to be ascribed to this concept in the application of the GAAR.
Lack of commercial substance
The general rule is that an avoidance arrangement lacks commercial substance if it would result in a significant tax benefit for a party but does not have a significant effect upon either the business risks or the net cash flows of that party (other than the effect attributable to the tax benefit).
Indicators of a lack of commercial substance include (but are not limited to):
• Where the legal substance of an avoidance arrangement as a whole differs from the legal form of its individual steps i.e. the concept of ‘substance versus form’.
• The inclusion or presence of:
– round trip financing;
– an accommodating or tax indifferent party;
– elements that have the effect of offsetting or cancelling each other. This indicator is targeted primarily at complex schemes, typically involving complex financial derivatives, that seek to exploit perceived loopholes in the law through transactions in which one leg generates a significant tax benefit while another leg effectively neutralises the first leg for non-tax purposes; or
• The absence of a reasonable expectation of pre-tax profit or an expectation of pre-tax profit that is insignificant in comparison to the amount of the expected tax benefit.
Round trip financing
This includes any avoidance arrangement in which funds are transferred between or among parties and such transfer results, directly or indirectly, in a tax benefit and a significant reduction, offset or elimination of business risk incurred by any party to the avoidance arrangement.
In applying the above, no regard will be had to whether or not the round-tripped amounts can be traced to funds transferred to or received by an party; or the timing or sequence in which the amounts are transferred or received; or the means by or the manner in which the round-tripped amounts are transferred or received.
Accommodating or tax-indifferent party
A party to an avoidance arrangement is an accommodating or tax-indifferent party
(accommodating party) if:
• Any amount derived by the accommodating party is not subject to normal tax in SA or is significantly offset by any expenditure or loss; and
• The participation of the accommodating party (directly or indirectly):
– has the result that an amount that would have been included in the gross income of another party now becomes capital in the accommodating party’s hands;
– has the result that an amount that would have been non-deductible in another party’s hands now becomes deductible in the accommodating party’s hands;
– has the result that an amount that would have been included in the gross income of another party now becomes exempt in the accommodating party’s hands; or
– involves a prepayment to another party.
A person will qualify as an accommodating party whether or not that person is a connected person in relation to any party.
In order to ensure that normal business transactions do not fall within the net the following exclusions to the definition of an accommodating party have been incorporated:
• The amounts derived by the accommodating party are cumulatively taxable in another country in an amount equal to at least two-thirds of the tax that would have been payable in SA; or
• If the accommodating party continues to engage directly in substantive active trading activities in connection with the avoidance arrangement for a period of at least 18 months and the activities are attributable to a proper place of business (which is equivalent to a foreign business establishment as defined in s 9D of the Act if it were located outside SA and the accommodating party were a CFC).
The Commissioner is empowered to treat connected persons as one and the same person, or to disregard any accommodating party, or to treat any accommodating party and another party as one and the same person.
Tax consequences of impermissible avoidance arrangements
The Commissioner may determine the tax consequences under the Act of any impermissible avoidance arrangement for any party by:
• Disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement;
• Disregarding any accommodating or tax-indifferent party or treating any accommodating or tax-indifferent party and any other party as one and the
• Deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;
• Reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst
• Re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or
• Treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit.
It should be noted that SARS is, subject to the normal three year prescription rules, obliged to make compensating adjustments to ensure consistent treatment of all parties to the impermissible avoidance arrangement. Therefore, if SARS re-characterises a dividend received as interest received, the dividend paid should be treated as interest paid.
An avoidance arrangement is presumed to have been entered into or carried out for the sole or main purpose of obtaining a tax benefit unless and until the party obtaining the tax benefit proves that, reasonably considered in light of relevant facts and circumstances, obtaining a tax benefit was not the sole or main purpose of the avoidance arrangement.
The Commissioner’s decision to invoke the provisions pertaining to impermissible avoidance arrangements is subject to objection and appeal.
The Commissioner is obliged to give notice to the taxpayer (the notice) that the provisions of the GAAR may apply in respect of an arrangement and include in this notice the reasons therefore.
The taxpayer must, within 60 days (or such longer period as the Commissioner has allowed) after the date of the notice, submit reasons to the Commissioner why the provisions of the GAAR should not be applied
The Commissioner must, within 180 days of receipt of the reasons or the expiry of the 60 day period referred
• Request additional information;
• Inform the taxpayer that the notice has been withdrawn; or
• Determine the tax by invoking the GAAR.
If the GAAR is successfully invoked, interest on underpayment of provisional tax cannot be waived.