Davis Committee
Submission: Base
Erosion and Profit
Shifting (First Interim
Report)
Keith Engel: Deputy CEO of SAIT
(31 March 2015)
Factual Information Overview
Limited Information Available
Quick Summary of Reserve Bank
Numbers
Categories
Intellectual Property
Percentage
Increase from
2008 to 2011
Under 10% per
annum
Impact
Non-significant
Legal, accounting and
Approximately
management consulting 50% aggregate
services
increase
Biggest stated concern
Advertising and market
research
Declined
Non-significant
R&D
Approximately
3%
Non-significant
Architectural,
Approximately
engineering and technical
8%
services
Approximately
Agriculture, mining etc.
29%
Non-significant
Significant
Preliminary Thoughts
•
Tax and Economic Recession
– No proof exists in SA or internationally that an economic decline leads to
greater tax avoidance by multinationals
– To the extent that a BEPS problem exists, it predates the recession (note:
OECD harmful tax practice concerns in the late 1990s)
– Most companies are focusing on core compliance; while tax avoidance
exists, many have taken far less aggressive positions due to the growing
audit risk and reputational risk
•
Some causes for the numbers
– The legal, accounting and management fee numbers could be a cause for
concern, but the high usage by State-owned enterprises runs contrary to
this thought (the BEPS risk is with connected persons such as
multinationals, not with state-owned enterprises which are independent
from the service-provider)
– Many companies are reducing labour costs and are accordingly centralising
back-office functions (tax often not a consideration)
– Global mining has been cutting middle-management in South Africa to
reduce their risk profile given the local political aversion to mining – other
businesses are doing the same
Marketplace
•
Traditional source of tax avoidance
– Finance transactions
• Circular financing flows (boutique firm driven but increasingly resisted)
• Conversion of taxable income to exempt amounts – e.g. interest converted
to dividends (sophisticated financiers)
– Mergers and acquisitions
– Global supply chain management (BEPS concerns tax but it is only one leg;
often other cost savings)
•
Overall climate
– Multinationals are cutting tax staff (which is seen as a cost)
– Most South African operations of foreign multinationals have only 2/3 tax
staff and have most of their pricing and cross-border structuring set by the
foreign global office
– Increasing focus is on normal tax compliance given the rising efforts of
revenue officials
– Reputational issues and administrative hassle are reducing aggressive
planning
– However, company tax directors may take aggressive positions to preserve
expected levels of tax (often if the original estimate is in error)
Need for Better Forms (and
Capturing)
Traditional Income Tax Form
• IT14 Company Tax Form
– No distinction between a
local company versus a
foreign company operating
in SA, except a box
checkmark
– SARS does not divide the
two into separate audit
tracks
• But rise of IT14SD for
transfer pricing
Cross-Border Withholding
• Outgoing royalty form
• Outgoing interest form (in
progress)
• Outgoing services
(pending)
• Need:
– Country-by-country
breakdown
– Need for statistical claims
of tax treaty protection
Debt (Picture Unclear)
Recent Numbers
• “Public corporation” debt
increases from R12,608 million
to R27,407million from 2007 to
2013
– Jumped in 2007/2008 and again
2010/2011
– Does this include State-owned
enterprises?
•
•
Private debt stayed in the same
band
Countries to watch for:
– Netherlands R268,328 million;
Luxembourg R29831 million;
Malta R17829 million;
Switzerland R15,026 million;
Mauritius (R10 510 million);
others Bermuda and Singapore
Anti-avoidance Legislation
• Hybrid Debt (2013/14)
• Section 23M overall limits
(2014/15)
• Section 23N acquisition debt
limits and old section 23K
(2011 – 2015)
• Transfer pricing (2011/2012
plus tightening enforcement)
• General judicial enforcement
plus GAAR
Some Conceptual Thoughts
Background BEPS
“Base Erosion Profit Shifting”
Targets
• Level 1: Shareholder-level considerations
(not a BEPS focus/but an African focus)
• Level 2: Underlying company level considerations
– Concerns about excessive interest deductions
– Concerns about other excessive deductions (e.g. technical
fees)
– Use of withholding as a blunt instrument
• Level 3: Tax treaties
– Treaties are a compromise on sovereignty
– Increased desire for information exchange
– UN interpretations are generally preferred by African countries
BEPS Versus Developing Country
Focus
Foreign Holdco
(No/Low Foreign Tax)
100%
Capital gains & dividends
SA Subsidiary
(28% tax base)
• Base Erosion and Profit Shifting (OECD concern):
Preservation of the SA Subsidiary tax base (28%)
• India (developing country concern): Preservation of local
tax on foreign dividends/SA subsidiary
Deductible Payments Paid
Offshore
South
Payment African
type
Company
Level
Foreign
Shareholder
Level
Company
income with 5% or 10%
Dividends
no deduction dividends tax
(R100)
Deductible
amounts
(BEPS)
Company
(typically income with
interest,
deduction
Often no tax
royalties
(R100 –
and
R100)
manageme
nt fees)
•
Potential Answers to BEPS:
– Deny/limit deductions if the
payee has no global taxable
income
– Increase tax at the shareholder
level
• Increased withholding taxes
(but note that a tax on gross
can be very distortionary)
• Limit the application of
treaties
– Rebalance the profit so the profit
arises where the true economic
substance lies
BEPS Risks and Options
Category
Services
Royalties
Interest
Dividends
SA Payor
Foreign Payee
Policy Options
Deductible
Treaty relief for
foreign source
or limited SA
1. Transfer pricing
source (i.e. no
PE)
Deductible
Treaty rates
often reduced
to 0/5%
2. Cross-border
reporting
Deductible
Treaty rates
often reduced
to zero
3. Deny / limit
deductions if not
discriminatory
Not Deductible
Treaty rates
reduced to
5/10%
4. Change treaty
(e.g. rates plus
anti-avoidance
rules)
Action Points
Comments
Action Plan #1: Digital Economy
(Income Tax)
•
Agree no urgency here
–
While SA has modernised to a degree, SA economy has not reached the US,
European level (e.g. most internet companies in Africa remain small and
relatively unprofitable)
•
•
–
–
•
There is a danger in enacting source rules in opposition to the international grid
(i.e. tax treaties do not resolve conflicts in source only residency/source
conflicts)
Is there any evidence of a foreign taxpayer within South Africa utilising ecommerce as a means of avoiding the status of a permanent establishment?
Query
–
–
–
–
Not seeing the rise of local e-commerce businesses from abroad (other than Amazon)
Little CFC risk
Is e-commerce really something separate? Is it only a means of connecting an
underlying activity? Or does it just blur the line?
Examples: E-books – are they a purchase of a book or a right of use (the latter
being taxable on a payor source principle like a royalty)?
Often e-commerce can merely be a means of transmitting a service
To restate, it is hard to impose a consumption principal for income tax (that is
for VAT), the same concept may be better expressed as a payor principle (like a
royalty)
Action Plan #1: Digital Economy
(VAT)
• Regulations (primarily intended to cover B2C)
Educational services
Games of chance
Internet-based auction service
Miscellaneous services (e-books, audio-visual content, still
images and music)
– Subscription services
–
–
–
–
• Why is business-to-business included at all? The
compliance cost of these items outweigh the tax?
• Note on Bank VAT systems (blocked or real-time): The
banks are increasingly becoming agents of SARS. These
costs are not insignificant. Any VAT system of this nature
will be very expensive with costs eventually passed onto
customers
Action Plan #2: Hybrid
Instruments
•
Note – not just a cross-border problem: The debt/equity distinction is
important because taxpayers should not be able to choose tax results
based solely on form:
– Debt label (deduction for payor/income for payee)
– Dividend label (no deduction for payor/payee either exempt or subject to a
5/15% rate)
– Hence, sections 8E, 8EA, 8F and 8FA may have to be retained for domestic
law purposes
•
As a cross-border concern, there is a lot to be said for reliance on
foreign tax law
– Current law: The participation exemption does not apply if payment in
respect of the foreign counter-party is deductible in the foreign country
– Proposal: Section 11 deductions should not apply if the receipt of payment
does not treat the amount as interest income in the foreign country
– What to do with intermediary zero-tax countries (payment of interest on
debt to low tax country followed by a dividend from the low tax country to
the third country)
– Are there other mismatch instruments? (financial leases? Services versus
royalties in terms of e-commerce?)
Action Plan #2: Hybrid Entities
• It is not entirely clear whether hybrid entities are a
significant base erosion tactic in the South African context
• Current law applies partnership principles to a foreign entity
that is treated as a foreign tax partnership; silence exists
as to foreign tax company status
– Not clear what impact the rule has?
– What happens if more than 2 countries are involved
• The probable big threat
– US check-the-box regulations
– An SA company treated as a US tax partnership (bigger issue
is the undermining of the US CFC rules)
– Alternatively, the SA tax system probably treats a foreign LLC
as a company unless the foreign country treats the entity as a
foreign tax partnership
Action Plan #2: Note on Excessive
Debt
• Exchange control fully controls the maximum interest rate;
at issue is excessive debt with reasonable interest
– Excessive debt has terms like normal debt and no explicit
hybrid features (except actual payment is effectively not
required if unavailable)
– There comes a point excessive debt acts like equity
• The excessive debt rules are incomplete
– Three-parts initially envisioned
• Safe harbour (transfer pricing)
• Facts-and-circumstances (transfer pricing)
• Per se bad (section 23M)
– Section 23M is too broad because the 50% threshold fails to
account for genuine minority/independent interests (BEE)
Action Plan #5: Harmful Versus
Acceptable Tax Preferential Regimes
• Late 1990s revisited
– Does the local regime fully apply to local activities or just
external activities?
– Things like local special economic zones are acceptable
because the local activity is real and the local country is
sacrificing its own tax base
– A harmful tax practice compromises another country’s tax base
(e.g. the Mauritius GBL1 & 2)
• Is the substantial activity test really useful?
– Note: Most low-tax countries actually want activity
– The history of these tests is not exciting (note: the CFC foreign
business establishment test)
Action Plan #5:
Headquarter Company Regime?
• Concerns mitigating against the regime
– Lack of activity required?
– Makes SA politically vulnerable
• On the other hand
– Many European countries are doing the same (e.g. royalty
boxes)
– Mauritius GBL
– Need for SA as a financial gateway location?
• Query
– If the report wants the regime to operate as headquarter
versus a holding company regime, why is section 6quin on the
list for termination (the purpose of section 6quin was to
provide service gateway status both inside the tax preferential
regime and all other companies to avoid the harmful criteria)?
Action Plan #6:
Prevent Tax Treaty Abuse (Overall
Comments)
• Application of GAAR/SA law
– Clarify the role of section 108
– Check to ensure that local GAAR/judicial precedent is in line
with tax treaty principles
• Tax treaties
– Tax treaties with low tax countries should be terminated or
treated with greater care (less preferential terms); too much
has been given in the past to risky countries
– Not in favour of the US limitation on benefits (just a complex
activity test)
– A tax treaty GAAR should be introduced
• Note: Not all treaty benefits cause a risk for SA – only
payments that are deductible in SA like interest payments
(whereas, outward dividends do not threaten the local tax
base)
Action Plan #6: Treaty Abuse
(Problematic Tax Treaties)
• Interest article: Switzerland, Luxembourg and Netherlands
• Mauritius Article: Revised treaty supported – the only
question may be the tie-breaker clause for residence given
Exchange Control (i.e. use of foreign incorporated SA tax
residence entities to avoid exchange control without tax
relief)
• Zambia: SA should place some pressure for a revised
treaty
• Brazil: Removal of tax credit schemes
• Should SA introduce a technical fee article like most African
countries (impose tax at 5%)?
• Tax sparing: Not a real consideration other than Mauritius;
most tax sparing clauses require further secondary
negotiation
Action Plan #8: Transfer Pricing
and Intangibles (Need for Action?)
• Report rightly points out:
–
–
–
–
–
–
Section 31 transfer pricing fully in place
Exchange control rules
Section 23I for former SA intellectual property
GAAR/beneficial ownership tests
Statistics do not show an overwhelming concern
Note: Most charges contain only a 5% mark-up
• Can SA go further? Check the royalty rates of certain low
tax jurisdictions not known for developing intellectual
property
Action Plan #8: Focus on
Services?
• In South Africa (like the rest of Africa), the bigger issue is
services
• Types
– Stewardship (central management)
– Offshore technical support
– Local technical visits (focus on high mark-up activities – e.g.
management consulting/technical engineering
• Is there something to be said for local and foreign
withholding at 5%
– Note: Taxpayers often engage with a local company for
indirect foreign technical service support
– Note: There is also a local tax evasion problem
• Can the new withholding tax on service rules be improved
so the compliance costs are reasonable?
Action Plan #13: Transfer Pricing
Documentation
• Practice Note 7
– It should be updated as suggested by the Committee
– The Practice note should not restate the OECD guidelines
word-for-word but merely refer to guidelines that will be
followed (to avoid unintended differences)
– However, some relief should exist for investments into “Rest of
Africa”; services are often undercharged for non-tax reasons;
these low-cost services are really indirect capital contributions
to offshore subsidiaries (alternative to section 6quin)
• Forms
– Are the current forms relating to transfer pricing the most
effective?
– Can SARS see the supply chain?
Action Plan #13: Materiality
•
Rationale for Materiality
– Company compliance costs are rising
– Tax staffs are much smaller than one realises (foreign-owned
entities typically do not have more than 4 full-time personnel)
even if part of a large company group
– Pricing is set globally based on a global mandate in which SA is
typically very small
– There are simply too many small transactional items to keep
control (in terms of time and operational activity)
•
Safe harbours or semi-safe harbours
– Offshore royalties rarely have a mark-up exceeding 5%
– One can have a safe harbour and per se risk areas (perhaps by
shifting burdens of proof)
– Note: The problem is often not in the mark-up but in how
centralised services are allocated (e.g. turnover method or per
country-method)
Action Plan #13: Training?
• Like most of the world, SA suffers a severe shortage in
Transfer Pricing expertise
– One must either create simplifying presumptions to reduce the
numbers; or
– Increase skills
• How to increase skills?
– Is there a way to create a combined institution for training?
(“a shared understanding”)
– Need for business and SARS to work together (government
knows the policy/taxpayers know the business)
Action Plan #14: Multinational
Instrument
• Multinational instruments are supported
– Speed
– SA stays in sync with international practice (i.e. does not lose
competitive advantage)
• Country-by-country reporting
– Inevitable
– How do we prevent over-reaching leading to double taxation?
• Enforcement of taxpayer rights
– While it is accepted that treaties should not lead to double
taxation, how can we ensure that treaties are actually applied
to prevent double taxation (i.e. competent authority)
– Should competent authority remain solely with SARS (e.g. Tax
Ombud)?
Thank you