A recent tax court ruling has thrown new light on the interpretation of South Africa’s double-taxation treaties with other countries.
The ruling comes as South Africa is tightening up its tax framework to ensure companies pay their fair share to the countries where they operate. Double-taxation agreements between nations are intended to prevent companies and individuals from paying tax in both jurisdictions. They can be exploited through treaty shopping as a way for companies to shift profits to low tax havens and minimise the taxes owed.
In its first interim report on base erosion and profit shifting, the Davis tax committee found that South Africa’s double-tax treaty regime left it vulnerable to schemes designed to avoid paying withholding taxes on dividends, interest and royalties.
Natalie Napier, a partner in the tax practice at law firm Hogan Lovells, said the ruling in the tax court “definitely refines our understanding of how we apply double-tax treaties in a South African context”.
The tax court found two United States-based companies, contracted to provide services to a South African firm, had to pay tax in South Africa after it took a broader view of what a “permanent establishment” is. The court treated the two companies, part of a global advisory group, as one entity.
The appellant was contracted to provide “strategic and financial advisory” services to a South African company for a three-phase project spanning 2007 and 2008, when it operated from the South African company’s premises. The total taxable amount, according to the judgment, came to almost R64-million.
No necessity for a physical presence
Napier said the traditional test for a permanent establishment, under the double-taxation agreement with the US, was whether a firm operated from a fixed place of business. In this case, the court relied on one of the sub-definitions in the treaty, “where there wasn’t a necessity for a physical presence”, she said.
The judgment had implications for foreign firms operating in South Africa and for local firms contracting with foreign companies. Local companies needed to have a good understanding of any potential value added tax liabilities as well as whether any withholding taxes would apply to the business, she said.
South Africa introduced a withholding tax on dividends in 2012 and a withholding tax on interest from March this year. These taxes, generally at a rate of 15%, are most effective when there is no double-taxation treaty in place, according to the committee.
Amid global efforts to curb base erosion and profit shifting Napier said there was a “heightened awareness of the potential [for] people to use tax treaties for arbitrage purposes”.
The committee said: “Where a double-tax treaty exists, the rate at which withholding taxes may be levied by South Africa as source countries is usually limited,” noting most of South Africa’s double-taxation treaties “do not contain favourable withholding tax rates for South Africa”.
In some cases, double-taxation agreements, such as the one between South Africa and the Netherlands, allow for some withholding taxes to be reduced to zero. Treaty shopping potential “has become more significant in South Africa especially with the introduction of the new withholding taxes on dividends and interest”, the committee said.
South African authorities have about 87 double-taxation treaties and protocols in place with other countries, according to the South African Revenue Service’s website; about 24 are being renegotiated. These numbers could not be confirmed because Sars did not respond to questions.
The state has renegotiated its agreement with Mauritius, which was seen as a conduit for tax abuses. Napier added that the state proposed to implement withholding tax on service fees, such as technical, managerial and consultancy services.
Although mooted in 2013, its implementation was pushed to 2016 to allow for more refinement, according to the national treasury. The committee flagged “cross-border non-goods transactions”, transactions relating to legal, accounting and management consulting services as a threat to tax revenue.
In 2011, payment outflows for these services increased more than 50%, and totalled well over R100-billion from 2008 to 2011, according to the committee. The “prevalence of cross-border non-goods transactions” showed “illicit tax base migration through avoidance schemes and practices could be taking place”, it said.