Preservation Order and the South African/Australian Double Taxation Agreement

On 20 August 2015 the Supreme Court of Appeal delivered its judgment in the case of M Krok & Jucool Enterprises Inc. v The Commissioner for the South African Revenue Services which related to an appeal from the Gauteng Division of the High Court regarding the correctness of the confirmation of a preservation order granted by Fabricius J in the context of the South African and Australian Double Taxation Agreement (“DTA”).

The DTA was concluded by the two countries on 1 July 1999 and subsequently altered by way of a Protocol signed on 31 March 2008 which catered for the states to assist each other in the collection of taxes. During January 2012 and February 2013, the Australian Tax Office (“ATO”) requested the assistance of the Commissioner: South African Revenue Service to assist it in the collection of taxes allegedly due by Mr M Krok to the Australian Commissioner of Taxation in the sum of Australian $25 361 875.79 plus interest for the period 30 June 2004 to 30 June 2009. The ATO therefore required SARS’ assistance in the conservancy of Mr Krok’s assets located in South Africa pending the collection of the tax debt and a formal request was made accompanied by the certificate required under section 185 of the Tax Administration Act, No. 28 of 2011 (“TAA”).

Image courtesy of https://www.ato.gov.au 

Mr Krok emigrated to Australia from South Africa during April 2002 and prior to his emigration a trust of which he was a beneficiary vested the capital assets of that trust in Mr Krok. Thus, Mr Krok held the assets received from the trust in addition to his personal assets.

The distribution was made by the South African trust in order to reduce capital gains tax in the future and also to allow for the remittance of income under the exchange control regulations. Pursuant to Mr Krok’s emigration from South Africa, he contended that he ceded all South African income and assets to a foreign company, Polperro, held by a foundation located in Lichtenstein. Subsequently during December 2008 Mr Krok emigrated from Australia to the United Kingdom. Mr Krok contended that as part of his emigration planning to United Kingdom, Polperro was liquidated and the assets owned by him were transferred to Jucool Enterprises Inc., a company incorporated in the British Virgin Islands and held by a Jersey Trust.

During 2009 the ATO conducted an audit of Mr Krok’s tax affairs covering the period February 2003 to February 2010.

As a result of the ATO’s investigation into Mr Krok’s affairs, the ATO concluded that Mr Krok had failed to declare income derived by him for Australian tax purposes in respect of assets held by him in South Africa while an Australian resident. The various transactions whereby assets were transferred from Mr Krok to the foreign companies were never disclosed to SARS or the ATO. 

The ATO reached the conclusion that Mr Krok retained legal and beneficial interest in the assets and that the alleged assignment of his rights and interest of the capital and income of the assets to the foreign company violated South African exchange control regulations and was a sham. Consequently, the ATO adjusted Mr Krok’s tax returns and issued notices of assessment reflecting tax and penalties. The objections lodged by Mr Krok to those assessments were disallowed by the ATO.

As a result of the ATO’s request for assistance under the DTA, SARS launched an application for a preservation order under section 163 of the TAA. Mr Krok contended that the tax claimed by the ATO fell outside of the scope of the DTA on the basis that the Protocol came into effect on 12 November 2008 and therefore should only apply in respect of income or profits and gains of any year of income beginning after 1 July 2009.

Jucool contended that it had legal title to the assets and that the assets were therefore not owned by Mr Krok. Thus, Mr Krok’s primary argument was that the DTA did not apply on the basis that the tax in issue did not arise on or after 1 July 2009. The court considered the Vienna Convention on the Law of Treaties of 1969 and reached the conclusion that the Protocol concluded by South Africa and Australia applied to all tax debts, whether they arose before or after the date on which the Protocol was agreed to.

The court referred to the fact that the arguments raised by Mr Krok were dismissed in the case of Ben Nevis (Holdings) Ltd and Metlika Trading Ltd v Commissioners for HM Revenue and Customs. That case considered the provisions of the tax treaty between South Africa and the United Kingdom regarding an appeal in which similar issues to those raised in the Krok case were considered in the context of a similar article to a 2002 DTA between those two countries as amended by a 2010 Protocol. 

In the Metlika case the taxpayer argued that the 2010 Protocol precluded mutual assistance in the collection of tax debts which arose before 1 January 2003. The United Kingdom court disagreed with Metlika and accordingly allowed the United Kingdom Revenue to assist SARS in the collection of amounts allegedly due to it. The Supreme Court of Appeal therefore held that there was no merit in the taxpayer’s point on retrospectivity and that the provision of Article 25A allowing for reciprocal assistance in the collection of tax applied regardless as to when the income tax debt arose.

Furthermore, the court rejected Jucool’s contention that it was the beneficial owner of the assets in question and not Mr Krok.

Thus, the Supreme Court of Appeal confirmed the decision of the High Court authorising SARS to assist the ATO in recovering the tax allegedly due by Mr Krok to the ATO, despite the fact that the tax arose prior to the date on which the Protocol took effect.

Taxpayers therefore need to be aware that where they incur a tax debt in one country, that country may seek assistance in the recovery of those amounts from the assets held by a taxpayer in another country with which a DTA has been concluded.

Dr Beric Croome is a Tax Executive  at ENSafrica This article first appeared in Business Day, Business Law and Tax Review, October 2015. 

New South Africa and Mauritius Double Taxation Agreement

National Treasury published a media release on 17 June 2015 advising that a new Double Taxation Agreement (“DTA”) entered into force on 28 May 2015 between South Africa and Mauritius. The new tax treaty replaces the 1996 South Africa / Mauritius tax treaty.

National Treasury indicated that the primary reason for renegotiating the old tax treaty was to curtail abuse of the old treaty that existed between South Africa and Mauritius. 

The new treaty contains a revised test for establishing where a person, other than an individual, is resident and also deals with the question of withholding taxes on interest and royalties, as well as the liability of companies which are regarded as property rich. Each of these aspects will be dealt with below.

The new tax treaty has complied with all requirements under the Constitution of the Republic of South Africa and was gazetted on 17 June 2015 such that the new tax treaty took effect on 28 May 2015.

At the same time that the National Treasury published its media release, a Memorandum of Understanding concluded between the Mauritius Revenue Authority (“MRA”) and the South African Revenue Service (“SARS”) regarding the application of Article 4(3) which deals with the question of residence of persons other than individuals was published. 

This document should assist taxpayers in understanding what criteria will be relied on in establishing where, for example, a company is to be regarded as resident under the provisions of the tax treaty, that is either in Mauritius or South Africa.

The memorandum of understanding should assist taxpayers
in interpreting the provisions of the new Double Tax Agreement
between South Africa and Mauritius

It is questioned how many other Memoranda of Understanding SARS has concluded with other revenue authorities, particularly in light of the case of Ben Nevis Holdings Ltd & Another v Commissioner for HM Revenue & Customs [2013] EWCA CIV 578, where the court indicated that Memoranda of Understanding concluded by contracting states may have an important bearing on the position of taxpayers and that it is in the interest of fairness to taxpayers that such Memoranda of Understanding should be readily available to the public. 

Thus, the release of the Memorandum of Understanding concluded by SARS and its Mauritian counterpart must be welcomed, as it should assist taxpayers in interpreting the provisions of the tax treaty.

Article 4 of the treaty deals with the meaning of the term “resident” for the purposes of the tax treaty which provides that a resident of a contracting state means any person who under the laws of that state is liable to tax therein by reason of that person’s domicile, residence, place of management or any other criterion of a similar nature. Article 4(3) provides that in the case of persons other than an individual which is resident in both South Africa and Mauritius, the competent authorities of the contracting states shall decide where such person is resident. 

In the Memorandum of Understanding concluded by SARS and the MRA the authorities reached an understanding in relation to the factors to be taken into account when attempting to settle the question of dual residence in the case of persons other than individuals.

A person other than an individual will be deemed to be a resident for the purposes of the tax treaty taking account of its place of effective management, the place in which it is incorporated or otherwise constituted and any other relevant factors. 

The competent authorities of South Africa and Mauritius have indicated in the Memorandum of Understanding that the following factors will be considered in determining where a company is resident for purposes of the tax treaty:

·         where the meetings of the person’s board of directors or equivalent body are usually held;

·         where the Chief Executive Officer and other senior executives usually carry on their activities;

·         where the senior day to day management of the person is carried on;

·         where the person’s headquarters are located;

·         which country’s laws govern the legal status of the person;

·         where its accounting records are kept;

·         any other factors listed in paragraph 24.1 of the 2014 OECD Commentary (Article 4, paragraph 3), as may be amended by the OECD/BEPS Action 6 final report; and

·         any such other factors that may be identified and agreed upon by the Competent Authorities in determining the residency of the person.

Those companies which have been incorporated in South Africa and are wholly owned by South African companies need to ensure therefore that their primary activities are indeed conducted in Mauritius and not South Africa, thereby ensuring that the benefits available under the tax treaty will be available to such companies in Mauritius. 

Where a company has been incorporated in Mauritius but for all practical purposes is controlled in South Africa, such company will be regarded as resident in South Africa for purposes of the treaty. 

Thus, South African groups with companies in Mauritius should evaluate the manner in which the Mauritian company’s affairs are conducted so as to ensure that they cannot be said to be tax resident in South Africa under the provisions of the treaty concluded with Mauritius.

The old tax treaty provided for a zero withholding tax rate on interest and royalties on the basis that such amounts were only taxable in the state where the taxpayer receiving the interest or royalties resided.

The new tax treaty provides for a 10% withholding tax in the source country paying the interest. Furthermore, the new treaty allows for a 5% rate of withholding tax on royalties paid in the source country.

This means therefore that interest or royalties paid by a South African entity to a Mauritius person will be liable to a maximum withholding of either 10% or 5% as the case may be.

Under the old treaty, Mauritian companies were used to hold shares in South African companies  which owned fixed property located in South Africa. Where the shares in the Mauritian company were disposed of, South Africa could not, under the old treaty, subject that disposal to capital gains tax as is the case with other countries.

Thus, the new treaty now provides that a contracting state may tax capital gains realised on the disposal of shares deriving more than 50% of their value directly or indirectly from immovable property situated in that contracting state. 

Thus, with effect from taxable years commencing on or after 1 January 2016, any Mauritian company disposing of shares in a company owning fixed property in South Africa will attract capital gains tax in South Africa.

The new tax treaty also contains a new provision at Article 26 which allows for SARS to assist the MRA in recovering taxes due to MRA and in turn allows for SARS to seek assistance from MRA in collecting taxes due to SARS. An ever increasing number of tax treaties are catering for reciprocal assistance in the collection of taxes.

When reference is made to Article 28, which deals with the date on which the treaty enters into force, it would appear that the new tax treaty will generally apply with effect from 1 January 2016 in respect of taxes withheld at source relating to amounts paid or credited after 1 January 2016. Insofar as other taxes are concerned, the new treaty applies in respect of taxable years commencing on or after 1 January 2016.

Those South African groups that have operations in Mauritius need to review their affairs to ensure that they adhere to the Memorandum of Understanding concluded by SARS and MRA which will be utilised in determining where a company is resident for purposes of the tax treaty.

Dr Beric Croome is a Tax Executive Edward Nathan Sonnenbergs Inc. This article first appeared in Business Day, Business Law and Tax Review, August 2015.  

Tax Consequences of Foreign Companies Rendering Services in South Africa

Where a foreign company renders professional services to a South African company, it is important that the foreign entity considers whether, as a result of rendering such services, the foreign company will create a permanent establishment in South Africa. 

The reason why this becomes important is that where a foreign company creates a permanent establishment in South Africa, South Africa will under the provisions of a Double Taxation Agreement (“DTA”) concluded with another country, be entitled to subject that foreign entity to tax on the profit attributable to that permanent establishment created in South Africa.

In the case of X LLC, case number 13276 heard in February 2015, as yet unreported, the Tax Court had to determine whether X had created a permanent establishment in South Africa, and as a result thereof, was liable to tax in South Africa. The case involved a corporation incorporated in the United States of America and the court therefore had to consider the provisions of the DTA concluded by South Africa and the United States of America.

Article 7(1) of the DTA concluded by SA and the USA provides that the profits of an enterprise of the USA shall  be taxable only in USA, unless that enterprise conducts business in South Africa through a permanent establishment located in South Africa. 

Furthermore, the DTA provides that where business is carried on through a permanent establishment, the profits of the enterprise may be taxed in South Africa, but only to the extent that they are attributable to that permanent establishment.

Article 5(1) of the DTA in turn provides as follows:

“for the purposes of this Convention, the term ‘permanent establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on.”

In addition thereto, Article 5(2) of the DTA provides that the term ‘permanent establishment’ includes especially-

“(k)          the furnishing of services, including consultancy services, within a contracting state by an enterprise through employees or other personnel engaged by the enterprise for such purposes, but only if activities of that nature continue (for the same or connected project) within that state for a period or periods aggregating more than 183 days in any 12 month period commencing or ending in the taxable year concerned.”

The court had to decide how the DTA should be interpreted and whether it was necessary for X to have met the requirements of both Articles 5(1) and 5(2)(k) of the DTA.

The taxpayer contended that it is necessary that a permanent establishment be created first and only once that has occurred, is it then necessary to take account of the provisions of Article 5(2)(k) of the DTA. 

SARS on the other hand, argued that if X fell within the provisions of Article 5(2)(k) a permanent establishment exists and it is not necessary that X met the requirements of Article 5(1) of the DTA.

Vally J in his judgment handed down on 15 May 2015 reached the conclusion that Articles 5(1) and 5(2)(k) cannot be read disjunctively. He expressed the view that as a result of the usage of the words ‘includes especially’ Article 5(2)(k) of the DTA should be read as specifying those specific activities which will be regarded as creating a permanent establishment in South Africa. 

The Tax Court reached the decision that taking account of the number of days spent by X’s staff in South Africa, it met the time requirement specified in Article 5(2)(k) of the DTA and for that reason a permanent establishment had been created in South Africa. 

The court also reached the conclusion that X had a fixed base in the boardroom of its client in South Africa, and had therefore established a fixed place of business in South Africa while rendering services to its client in South Africa. 

It must be remembered that Article 5(1) of the DTA, in defining a permanent establishment, refers to ‘a fixed place of business through which the business of an enterprise is wholly or partly carried on’. 

The court expressed the view that it is not necessary that the non-resident carries out all of its business from the fixed place of business which is established in South Africa. 

The court reached the conclusion that a permanent establishment is created where X performs only some of its obligations in terms of a contract concluded with its client, and even if it conducted part of its business from its client’s boardroom.

In assessing X to tax in South Africa, SARS levied tax on the fees derived by X in South Africa, after deducting therefrom attributable expenditure and imposed additional tax of 100% and interest on the underpayment of provisional tax in accordance with section 89quat(2) of the Income Tax Act. 

The court reached the decision that the additional tax was not disproportionately punitive and therefore dismissed the appeal against the additional tax. Insofar as the imposition of interest is concerned, the court expressed the view that X should have familiarised itself with the taxation laws of the country within which it conducts its operations, and for that reason it was decided that X had been negligent in not seeking advice regarding the tax consequences of the contract concluded with its client. 

The court therefore came to the conclusion that SARS was correct in imposing interest on the underpayment of provisional tax.

Based on the above case, which admittedly deals with the interpretation of articles contained in the SA and USA DTA, it is important that non-residents rendering services to clients in South Africa must evaluate whether they will create a permanent establishment in South Africa, thereby triggering income tax on the profit attributable to the services rendered in South Africa.

Furthermore, if the non-resident creates an enterprise as envisaged under the provisions of the VAT Act, it would also be necessary to register for VAT purposes, and charge VAT on the fees received from the resident client and pay that to SARS. 

Furthermore, where persons from abroad are sent to South Africa to render the services that may, depending on the circumstances and the provisions of the DTA in question, give rise to the non-resident entity being required to register as an employer in South Africa with the obligation to withhold and deduct PAYE from amounts paid to persons sent to South Africa to render services here.

Clearly, any South African tax paid by the non-resident entity, would under the terms of the DTA be recognised as a credit claimable against tax paid in the home jurisdiction of the entity rendering the services in South Africa. Non-resident employees who become liable to tax in South Africa should also be entitled to claim such tax as a credit in their home jurisdiction under the DTA in question.

It is important therefore that non-resident entities rendering services into South Africa carefully consider how to plan and structure their affairs in South Africa, so that they do not fall foul of the provisions of the Income Tax Act read together with any applicable DTA.

Dr Beric Croome is a Tax Executive  at ENSafrica This article first appeared in Business Day, Business Law and Tax Review, June 2015. Image purchased from www.iStock.com