The case of TLD Limited v The Commissioner for the South African Revenue Service heard before the Tax Court raises the interesting issue of the interplay between the imposition of capital gains tax in the context of the Eighth Schedule to the Income Tax Act and the application of a Double Tax Agreement.
The facts of the case were that an investment holding company, incorporated in South Africa, resolved at a board meeting held in Luxembourg during 2002 that all future board meetings be held in Luxembourg. Subsequent to this decision, one of the executive directors of the company remained in South Africa until he relocated to Europe in 2003. This sequence of events ultimately led to the company ceasing to be a resident of South Africa in February 2003 as the company was exclusively resident of Luxembourg in terms of the applicable Double Taxation Agreement as provided for in the exclusion to the definition of a resident in the Income Tax Act.
It was contended by the Commissioner that by ceasing to be a resident of South Africa, this triggered a capital gain in terms of paragraph 12 of the Eighth Schedule which contains certain provisions relating to events which are treated as disposals. In this case, paragraph 12(2)(a) refers to the case when a person ceases to be a resident as a trigger for there being a disposal of assets (ie. there is the ability to tax any capital gains which may have arisen during its time as a resident).
However, the Court interestingly did not consider it necessary to rely on the provisions of paragraph 12(2)(a) of the Eighth Schedule to reach its decision. Rather, the reasoning adopted in this case turned on the application of the Double Taxation Agreement between South Africa and Luxembourg. The Court held that any gains from the alienation of property would only be taxable in Luxembourg on the basis of Article 13(4) of the Double Taxation Agreement which provides that gains from the alienation of any property is taxable only in the State in which the alienator is a resident.
The attempt by the Commissioner to draw a distinction between the “alienation of any property” as referred to in the Double Taxation Agreement and the deemed disposal of property as referred to in paragraph 12(2)(a) of the Eighth Schedule was not accepted by the Court which held at paragraph 14 that –
“I am unable to accept this argument. In terms of para 2(1)(a) of the Schedule, capital gains tax becomes payable in respect of ‘the disposal of any asset of a resident’. Subparagraphs 12(1) and (2) of the Schedule provide that upon an event occurring in terms of those provisions ‘a person will be treated for the purposes of this Schedule as having disposed of an asset’. I am unable to see any reason why a deemed disposal of property should not be treated as an alienation of property for purposes of article 13(4) of the DTA. I agree in this regard with counsel for the appellant, who argued that it would be absurd if a taxpayer were to be protected in terms of art 13(4) from liability for tax resulting from a gain from an actual alienation of property, but not from a deemed alienation of property.”
The case raises the question of whether in all similar instances reference will only be made to the relevant Double Taxation Agreement to the exclusion of any current legislative provisions. It appears that the basis of the reasoning adopted in the case turns on the determination of the residence of the taxpayer concerned. It has been commented in The Taxpayer that by shifting the place of effective management, the taxpayer ceases to be a resident and the combined simultaneous effect is that the provisions of the Double Taxation Agreement will apply.
The consequences of this approach are interesting from the perspective of understanding the timing of any deemed disposal in terms of paragraph 12 of the Eighth Schedule. Reference was not made in the judgment to the provisions of paragraph 13(1)(g) of the Eighth Schedule where it is indicated that a deemed disposal in terms of paragraph 12(2)(a) will occur on the date immediately before the day that the event occurs. It is possible that in terms of paragraph 13(1)(g) of the Eighth Schedule, the time of the disposal will be immediately prior to the decision to change residency and that the Double Taxation Agreement may not be applicable (ie. on such date the taxpayer concerned is regarded as a resident of South Africa only on the date of the disposal). However, this issue does not appear to be a consideration from a reading of the judgment where it was emphasised that the Double Taxation Agreement will prevail in determining the residency of the taxpayer.
The relative ease with which a taxpayer may change its residence without the negative consequences of any capital gains being triggered in the context where there is a Double Taxation Agreement is noteworthy. The case confirmed that the place of effective management may simply be established by adopting board resolutions in Luxembourg. This approach was not queried by the Commissioner as reported in the judgment.
The judgment may further give comfort to non-residents that when shares are disposed of by a non-resident where there is a prevailing Double Taxation Agreement, any taxation consequences will only be in the jurisdiction of the non-resident and not in South Africa.