INTEGRITAS-#406255-v1-Integritax September 2012 Issue 156 · 2012. 8. 31. · SEPTEMBER 2012 – ISSUE 156 CONTENTS ANTI- AVOIDANCE 2099. Application of law ... connected person in

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SEPTEMBER 2012 – ISSUE 156

CONTENTS

ANTI- AVOIDANCE

2099. Application of law

INDIVIDUALS

2105. The taxation of insurance policy

benefits

CAPITAL GAINS TAX

2100. Disposal of a residence from a

company or trust

2101. Base cost of dividend in specie

TAX ADMINISTRATION ACT

2106. Persons liable for tax

COMPANIES

2102. Registration of external company

VALUE-ADDED TAX

2107. Compensation received

2108. Input VAT on professional fees

DEDUCTIONS

2103. Application of section 23K

SARS NEWS

2109. Interpretation notes, media releases and

other documents

DIVIDENDS TAX

2104. Cash versus in specie dividends

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ANTI-AVOIDANCE

2099. Application of law

(Published September 2012)

In a recent decision of the Supreme Court of Ireland in the case of O’Flynn Construction Limited

v the Revenue Commissioners (case no. 264/06 [2011] IESC 27 (2011)), the court was called on

to decide, for the purposes of the general anti-avoidance rule, whether a particular tax avoidance

scheme resulted in the misuse or abuse of a tax relief provision.

In 1958, the legislature in the Republic of Ireland sought to encourage the manufacture of

products for export by introducing an Export Sales Relief Scheme (ESR Scheme). In terms of the

ESR Scheme, profits earned from qualifying exports would be exempt from corporation tax and,

furthermore, dividends declared from such profits would also be relieved from income tax in the

hands of all shareholders until ultimately the dividend was received into the hands of an

individual.

Simplified, the facts were that a certain company that had an ESR reserve apparently did not

have the cash with which to pay a dividend that might be declared in respect of such reserve. A

scheme was thus devised by the taxpayers which in essence involved various loans to enable

ESR tax free dividends to be declared up the group structure but ultimately into the hands of

various shareholders who were not shareholders in the ESR earning company or a related

company at the time when the ESR profits were earned.

The issue before the court was whether, applying the general anti-avoidance rule, the scheme

resulted directly or indirectly in the misuse or abuse of the ESR provision having regard to the

purpose for which it was provided.

In a split decision, the majority of the judges having regard to both its substance and its form

stated that the transaction was highly artificial and contrived. According to the judges, the

scheme allowed the shareholders in a non-exporting company to benefit from ESR on the profits

of the non-exporting company and as such was surely a misuse or abuse of the ESR scheme

having regard to the purpose for which provision is provided.

The minority, in arguably a more lucid judgment, said that legislative policy must be anchored in

the language used by the legislature and that recourse should, where appropriate, be had to its

context as disclosed by the statute (or provision) as a whole. The minority commented that since

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its promulgation, the ESR provision was amended numerous times over a lengthy period but no

attempt was made to restrict or otherwise curtail the benefit of the exemption, as dividends

percolated through into the hands of the ultimate recipient. The minority were thus of the view

that the scheme did not result in a misuse or abuse of the ESR provision, even though the

dividends flowed ultimately to shareholders who were not shareholders of the exporting

company at the time the profit was derived.

It should be appreciated that the general anti-avoidance rule contained in section 80A of the

Income Tax Act, No 58 of 1962 (the Act) also contains a ‘misuse or abuse’ provision. However,

unlike its Irish counterpart, it does not expressly provide for regard to be had to the purpose for

which the provision of the Act (alleged to have been misused or abused) was provided. In other

words, there is no express statutory obligation to have regard to the purpose for which a

particular provision of the Act was enacted when determining whether a scheme results in a

misuse or abuse of such provision.

Nevertheless, SARS, in its Draft Comprehensive Guide to the General Anti-avoidance Rule,

states that the misuse or abuse provision "clearly requires a purposive approach to interpreting

the provisions of the Act, which is already the accepted approach to legislative interpretation in

South Africa." In this regard, SARS states that a mere literal interpretation of the provisions will

no longer safeguard a taxpayer who applies the provisions of the Act in a context or manner

which is not intended by the Act.

But, in reiterating the sentiments of the minority judges in the O’Flynn case, establishing the

purpose of a particular provision will generally not be an easy task. In doing so, the following

words of the minority judges will serve as a reminder to judges of the limits of their judicial

authority:

"Any suggestion that the courts could, having identified the legislative policy by whatever means,

apply that policy to influence, modify or alter the wording of a taxation provision, would be

tantamount to judicial intrusion into this key legislative sphere, and would be an usurpation of

such legislative power. Neither the formation of taxation policy nor the creation of a taxation

charge are matters for the judiciary. Such would be quite an inappropriate exercise of judicial

function."

As yet, there is no South African case law that deals with the misuse or abuse provision in

section 80A of the Act. It is considered that the proper implementation thereof will cause many a

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sleepless night for SARS officials, advisors and to a greater extent the members of the judiciary

charged with giving effect thereto.

Cliffe Dekker Hofmeyr

IT Act: Section 80A

CAPITAL GAINS TAX

2100. Disposal of a residence from a company or trust


SARS recently released the second issue of its guide dealing with the window of opportunity

(covering the period 1 October 2010 to 31 December 2012) for the disposal of a residence from a

company, close corporation or trust into the hands of qualifying individuals. When carefully

structured, these transactions will be free of transfer duty, capital gains tax and dividends tax

(previously secondary tax on companies).

A hotly debated topic is the question of who must acquire the residence, particularly in the

context of a multi-tiered structure. An example of a multi-tiered structure is where a trust holds

the shares in a company which in turn holds a residence. Paragraph 51A(6) of the Eighth

Schedule to the Income Tax Act, No 58 of 1962 (the Act) identifies the ultimate acquirer of the

residence as the natural person(s) referred to in paragraph 51A(1)(b), namely the person(s) who:

Used the residence mainly for domestic purposes from 11 February 2009 until the date of

acquisition by them of the residence; and

Are connected persons in relation to the company or trust at the time of disposal.

The conventional way of effecting a transfer of the residence in the said example is for the

company to dispose of the residence to the trust (its shareholder), which in turn disposes of the

residence to a qualifying natural person, that is to a natural person who used the residence mainly

for domestic purposes from 11 February 2009 until the date of acquisition by them of the

residence and who is a connected person in relation to the trust. In this regard, every beneficiary

of a trust is a connected person in relation to the trust as well as any person who is a connected

person in relation to such beneficiary. A founder or trustee of the trust could qualify as a

connected person in relation to the trust if such person is, for example, a spouse of a beneficiary

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or someone related to a beneficiary within the third degree of consanguinity (blood relationship).

Typically, this would include a parent, grandparent, sibling, child and grandchild.

If the residence is transferred in this conventional way it is a further requirement that the

company be liquidated, wound up or deregistered and also that the trust be terminated. The issue

that has been raised is that adverse estate duty and capital gains tax consequences often arise on

termination of the trust where it holds assets other than the residence (for example shares or a

commercial property).

The question is whether it is permissible to dispose of the residence from the company directly to

a beneficiary of the trust (that is to bypass the trust) and thus avoid having to terminate the trust.

It is refreshing that in the second issue of its guide SARS takes the view that in a multi-tiered

structure it is possible to circumvent the trust under the provisions of paragraph 51A(4) of the

Eighth Schedule. According to SARS, unlike paragraph 51A(3) which identifies the acquirer as a

shareholder, paragraph 51A(4) arguably does not. SARS states as follows:

'Paragraph 51A(4)(a) requires that the acquirer must disregard the disposal of "any share" in the

company upon its termination but does not specifically require that the person must actually hold

shares. Arguably this could be inferred. In view of the limited application of paragraph 51A and

the fact that one of its purposes is to reduce the number of companies on register, SARS will

accept that paragraph 51A(4) does not require a person acquiring a residence from a company to

be shareholder.'

A beneficiary of the trust in the multi-tiered example referred to above, will qualify as a

connected person in relation to the company by virtue of paragraph (bA) of the definition of a

'connected person' in section 1 of the Act. The reason is that the beneficiary is connected to the

trust and the trust is connected to the company. So, as long as the beneficiary used the residence

mainly for domestic purposes from 11 February 2009 until the date of acquisition by him of the

residence, then the requirements of paragraph 51A(6) read with paragraph 51A(1)(b) regarding

who may be an ultimate acquirer of the residence will be satisfied.

How then should one go about such a transaction to ensure that no transfer duty, capital gains

tax, dividends tax and donations tax is paid?

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Firstly, it should be appreciated that paragraph 51A does not specify how the residence must be

disposed of by the company or trust, as the case may be, in order to achieve the tax benefits.

Nonetheless, it is widely accepted that the transaction could be structured either as a sale of the

residence or a distribution thereof as a dividend in specie (in the context of a company or close

corporation) or a capital distribution in the context of a trust. In the multi-tiered example

mentioned above, the company will not strictly speaking be able to distribute the residence as a

dividend in specie as the residence is not disposed of to the trust itself as shareholder but rather

directly to a beneficiary of the trust.

If one considers implementing the transaction by way of a sale by the company to a beneficiary,

the question that arises, particularly in the context of donations tax, is for what value or purchase

price the residence should be sold. It bears noting that there is no specific exemption from

donations tax to deal with a donation that may arise in consequence of the disposal of a residence

under paragraph 51A.

The immediate reaction is to structure the sale at market value. However, this will result in the

company receiving the purchase price which, after the payment of any loan or other liabilities,

will be distributed as a dividend either before or in the process of winding up or deregistering the

company. Such distribution, being a cash distribution, will trigger the payment of dividends tax

by either the trust or a beneficiary of the trust, depending on who can properly be regarded as the

beneficial owner of the dividend.

Another possibility is for the company to sell the residence to a beneficiary for below market

value. Given the wide ambit of the term 'dividend' in section 1 of the Act, a below market value

sale by the company to the beneficiary at the instance or on behalf of the trust (as shareholder)

will arguably constitute a dividend but will in any event be exempt from dividends tax in terms

of section 64FA(1)(c) as constituting the disposal of a residence as contemplated in

paragraph 51A.

So far so good, but what about donations tax? In terms of section 58 of the Act, property is

deemed to have been disposed of under a donation where the Commissioner is of the opinion that

the consideration therefor is not an adequate consideration. A sale at less than market value will

generally constitute inadequate consideration, resulting in a deemed donation of an amount

equivalent to the difference between the market value and the actual consideration or purchase

price. In this context, section 57 will deem the donor to be a person other than the company

where:

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a company disposes of property at the instance of any person;

that disposal would have been treated as a donation had it been made by that person.

The residence will generally be disposed of by the company at the instance of the trust as

shareholder. This is so because the trust will be required to consent to the disposal of the

residence as constituting the sole or greater part of the assets of the company. In terms of

section 57 of the Act, the trust as shareholder will be treated as the donor provided that the

disposal would have been treated as a donation if it had been made by the trust itself (see the

second bullet point directly above). Relevantly, section 54 of the Act, the charging section in

respect of donations tax, limits the ambit of donations tax to donations made by a resident of

South Africa. Thus, where the trust is a resident of South Africa, the second requirement under

section 57 will be met and the trust will be regarded as the donor and donations tax will in

principle be payable.

Section 56 which contains a list of exemptions should be considered in turn. Of relevance is

section 56(1)(l), which provides that no donations tax is payable in respect of any property

disposed of under and in pursuance of any trust. This means that the disposal will be exempt

from donations tax if it is made to a beneficiary stipulated in and in accordance with the

provisions of the trust deed. In summary, the combined effect of section 58, section 57 and

section 56(1)(l) will be to treat the trust as the donor in respect of the below market value sale

but to exempt the sale from donations tax where a beneficiary of the trust acquires the residence.

A word of caution: if the trust is not a resident of South Africa, the second requirement of

section 57 is not met, in other words the disposal would not have been treated as a donation in

that donations tax is confined to residents of South Africa.

Where the transaction meets the requirements contained in paragraph 51A, any capital gain will

be treated on a roll-over basis and subject to capital gains tax when the individual subsequently

disposes of the residence. Depending on the circumstances, the primary residence exclusion

could operate to absorb or reduce the capital gain. The transaction will also not be subject to

transfer duty by virtue of section 9(20) of the Transfer Duty Act, No 40 of 1949 and to the extent

that it represents the distribution of the residence in specie will be exempt from dividends tax by

virtue of section 64FA(1)(c).

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From the above analysis, it is evident that one should exercise caution when availing oneself of

the potential tax advantages associated with paragraph 51A and the other related provisions. As

mentioned, there is no express provision exempting the transaction from donations tax and thus

one should not lose sight of the relevant donations tax provisions. In the context of a multi-tiered

structure, SARS' view is to be welcomed but each case should be examined on its merits with a

full appreciation of the attendant risks.

Although there is no cut-off date by which transfer of the residence is to take place under the

amnesty provisions, the date of disposal shall be a date not later than 31 December 2012. It is

recommended that those contemplating a transfer in terms of the amnesty provisions obtain

specialist advice well before the cut-off date so that all available options can be explored and

carefully considered.


IT Act: Sections 1; 54; 56; 56(1)(l); 57; 58 and 64FA(1)(c)

IT Act: Eighth Schedule paragraphs 51A; 51A(1)(b); 51A(3); 51A(4); 51A(4)(a) and 51A(6)

Transfer Duty Act: Section 9(20)

2101. Base cost of dividend in specie


The advent of dividends tax came with (and in some instances was preceded by) a host of

concomitant changes to the Income Tax Act No. 58 of 1962 (the Act) in respect of distributions

made by companies.

Some of these changes include:

a new definition of "dividend";

introduction of the term "contributed tax capital";

introduction of the term "return of capital"; and

amendments to Part XI of the Eighth Schedule to the Act in respect of the capital gains

tax consequences of company distributions.

Essentially, the new regime pertaining to company distributions separates company distributions

into dividends and returns of capital. Where a distribution constitutes a dividend, it is dealt with

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under the dividends tax provisions in Part XIII of Chapter 2 of the Act, and where a distribution

constitutes a return of capital it is dealt with under Part XI of the Eighth Schedule to the Act.

It would, however, appear that in the rush to bring about the new regime an important element

was left out in respect of distributions of assets in specie.

Obviously, the distribution of an asset in specie can constitute either a dividend or a return of

capital. However, irrespective of the nature of the distribution, a base cost will have to be

determined in respect of that asset in the hands of the recipient (assuming the asset is held on

capital account by the recipient).

Previously, irrespective of whether the distribution of an asset in specie constituted a dividend or

a capital distribution, its base cost in the hands of the recipient was determined by paragraph

76(3) of the Eighth Schedule to the Act, which read:

“Any distribution of an asset in specie received by or accrued to a shareholder must be treated

as having been acquired on the date of distribution and for expenditure equal to the market value

of that asset on that date, which expenditure must be treated as an amount of expenditure

actually incurred and paid for the purposes of paragraph 20(1)(a).”

However, paragraph 76(3) was amended by the Taxation Laws Amendment Act, No 24 of 2011

with effect from 1 April 2012, and now reads:

“Where a return of capital is effected by way of a distribution of an asset in specie, that asset

must be treated as having been acquired by the person to whom the distribution is made on the

date of distribution and for expenditure equal to the market value of that asset on that date,

which expenditure must be treated as an amount of expenditure actually incurred and paid for

the purposes of paragraph 20(1)(a).”

It is clear from the above that paragraph 76(3) no longer deals with the case where the

distribution of an asset in specie constitutes a dividend but only where it constitutes a return of

capital.

Accordingly, there is no specific provision dealing with the base cost of a dividend in specie in

the hands of the recipient. The general provisions under paragraph 20 of the Eighth Schedule to

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the Act cannot be employed as no expenditure will have actually been incurred by the recipient

of the dividend in specie. In fact, if paragraph 20 is applied, it could yield a base cost of zero.

In the absence of a provision deeming the base cost of the dividend in specie in the hands of the

recipient to be market value, there could potentially be double taxation. This is so because the

company making the distribution will have already had to account for capital gains tax calculated

using deemed proceeds equal to the market value of the asset in terms of paragraph 75. This is

despite the fact that the company would also be liable for dividends tax in respect of the dividend

in specie in terms of section 64EA(b).

It is therefore submitted that there is a lacuna in the tax legislation as it stands, and that the

legislature should correct it in the 2012 amending legislation.


IT Act: Section 64EA(b)

IT Act: Eighth Schedule paragraphs 20; 75 and 76(3)

COMPANIES

2102. Registration of external company


Section 23 of the Companies Act No. 71 of 2008 (the Act) that came into effect on 1 May 2011,

deals with the issue where a foreign company is required to register as an external company in

terms of the Act. The legislative framework in section 23 of the Act sets out the level of

activities that a company from a foreign jurisdiction is carrying on in South Africa, and in which

case must register as a branch. Note that the Act does not use the expression 'branch'.

As a corollary that follows from this, the question arises whether the registration of an external

company will create a permanent establishment in South Africa in terms of the tax legislation.

The effect of registration as an external company is that the foreign company is given legal

recognition in the Republic. Section 23(1) provides that an external company must register

within 20 days after it first begins to conduct business or non-profit activities in South Africa.

Section 23(2) goes on to tell you what conduct will make you cross the test in sub-section (1). It

stipulates that if you have one or more employment contracts in the Republic or have engaged in

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a course or pattern of activities over a period of six months, one could reasonably conclude that

you intended to continually engage in business and then you need to register.

Section 23(2A) goes on to stipulate a number of activities where the foreign company would not

be regarded as conducting business within the Republic. The categories included are establishing

or maintaining any bank account, establishing any office or agency within the Republic for the

transfer and exchange or registration of the foreign company’s own securities. Similarly

included, are creating or acquiring any debts within the Republic, any mortgages or security

interests or acquiring property, which also are not regarded as conducting business within the

Republic.

This legislative framework is well described by Heather Brownell writing in De Rebus magazine

(April 2012 at page 39), "So if a foreign company is engaged in any one of the section 23(2A)

activities, that in itself will not necessarily conclusively evidence the intention to continually

engage in business. The activities listed in section 23(2A) could, however, be indicative factors

that the company is 'conducting business'. Each of the activities listed in section 23(2A) that the

foreign company is engaged in or is conducting in South Africa would have to be considered in

the light of its broader activities in South Africa to determine whether or not the foreign

company is conducting business for the purposes of section 23(1)."

In Binding Private Ruling 102 (issued 4 May 2011) the South African Revenue Service (SARS)

considered the question in the context of registering as an external company in terms of section

322 of the old Companies Act of 1973. The facts in this matter were that the external company

would advance subordinated interest bearing loans to companies incorporated in the Republic

and subscribe for preference shares in these companies. Participation in the external company

was reserved for foreign investors only. The external company would be managed by a board of

directors, which would conduct board meetings in a foreign country, and conduct the affairs of

the external company in accordance with predefined investment objectives and strategies.

Investment advice would be given by a third party investment adviser which also would not be

situated in the Republic. The external company applied for the ruling on the basis that it would

not be resident in South Africa, as its place of effective management would be located in a

foreign jurisdiction and so it would not create a permanent establishment. But it did have to

register as an external company and as a consequence was a resident of South Africa for

exchange control purposes.

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SARS’s ruling was that the registration as an external company would not create a permanent

establishment for this company.

The ruling was based on the assumptions that:

The place of effective management was located in the foreign jurisdiction.

It did not have any employees or conduct any business activities in South Africa, other

than the maintenance of its external company status for exchange control purposes.

It did not have a dependent agent operating on its behalf in South Africa.

The issue is that the test for whether such a foreign presence or branch constitutes a permanent

establishment is distinct from the external company test in section 23 of the Act. In terms of

international tax law, where an enterprise carries on business in two distinct jurisdictions, the

profits of a Contracting State are taxable only in that State, unless the enterprise carries on

business in the other Contracting State through a permanent establishment situated there. Only

profits attributable to the permanent establishment may be taxed in the source state.

If we look at an indicative double tax treaty (such as United Kingdom), Article 5 stipulates that a

'permanent establishment' is a fixed place of business through which the business of an enterprise

is wholly or partly carried on. It then continues in Article 5(2) to specifically include a place of

management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry or

any other place of extraction of natural resources, and an installation or structure for the

exploration for natural resources. But it is clear that the permanent establishment needs a place of

business, which is fixed (that is a degree of permanence) and that the business of the enterprise is

carried on at the fixed place of business. The definition of a permanent establishment for

domestic law is contained in section 1 of the Income Tax Act No. 58 of 1962, which refers one

to the concept as it is defined from time to time in Article 5 of the OECD Model Tax

Convention. However, one will have seen from what has been said above, that the test applied by

the SARS in the context of the permanent establishment is quite different from the 'conducting

business' that the Act looks for to require registration as an external company.


Companies Act No. 71 of 2008: Sections 23; 23(1); 23(2) and 23(2A)

Companies Act No. 61 of 1973: Section 322

IT Act: Section 1

SA-UK DTA – Article 5 and 5(2)

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OECD MTC – Article 5

DEDUCTIONS

2103. Application of section 23K


The general purpose of section 23K of the Income Tax Act No. 58 of 1962 (the Act) is to

disallow interest deductions in respect of debt used in certain re-organisation transactions. One of

the targeted transactions is where a taxpayer has indirectly obtained interest deductions in respect

of debt used to purchase shares. Generally, interest paid on debt used to purchase shares is not

deductible because shares produce exempt dividend income.

The classic example of how a taxpayer could obtain such an indirect interest deduction in respect

of the purchase of shares is known as the debt push-down structure.

To illustrate, holding company A wishes to purchase the business of company B. It does not wish

to purchase the shares in company B because it would not be able to get an interest deduction if

it buys the shares with borrowed money. However, the shareholders of company B would prefer

to sell their shares to company A. In order to purchase the shares in company B and to get an

interest deduction, company A makes use of the debt push-down technique. Company A buys the

shares in company B and obtains bridging finance from a third party in order to settle the

purchase price of the shares. Company A then forms a subsidiary, company C. Since company B

and company C now form part of the same group of companies, company C purchases the assets

from company B in terms of section 45 intra-group transactions, without triggering any tax.

Company C obtains a long-term loan from a bank in order to settle the purchase price of the

assets. Company B distributes the cash up to company A, and company A uses it to settle the

bridging finance. In the result, shares have been bought into the group, and the group has

obtained interest deductions through the long-term loan to company C.

Such transactions are problematic to the state, especially in cases where the interest is paid to

foreign lenders, in which case the taxpayer gets a deduction, but the state cannot tax the interest

as income in the hands of the lender because the income is exempt in terms of section 10(1)(h) of

the Act.

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Editorial comment: With effect from 1 January 2013 interest accruing to a non-resident from a

South African source will be subject to a 15% withholding tax.

Section 23K(2) of the Act reads: "...no deduction is allowed in respect of any amount of interest

incurred by an acquiring company in terms of a debt instrument if that debt instrument was

issued or used directly or indirectly –

(a) for the purpose of procuring, enabling, facilitating, or funding the acquisition by that

acquiring company of any asset in terms of a reorganization transaction..."

A re-organisation transaction is defined in section 23K(1) of the Act as including an intra-group

transaction in terms of section 45 of the Act.

Interest deductions on such debt instruments used in respect of re-organisation transactions will

only be allowed if special application is made to the South African Revenue Service (SARS) for

a directive allowing such interest deductions (section 23K(3)), or if a specific prescribed

exclusion applies (section 23K(9)).

Consider the following scenario: Company A, and its subsidiaries company B and company C

are pre-existing companies. Company C has a long-term loan from a bank, which loan it has had

for many years and in respect of which it claims interest deductions. Company C purchases all

the assets of company B, its fellow subsidiary. Company C settles the purchase price by making

use of the funds from the long-term loan.

In terms of section 23K(2) of the Act, company C will no longer be entitled to claim interest

deductions on the loan because it has used the debt to fund the acquisition of assets in terms of a

section 45 intra-group transaction (assuming that no specific prescribed exclusion applies).

Company C will have to apply for a directive from SARS in order to continue claiming interest

deductions in respect of the loan.

It is therefore irrelevant whether the loan was specifically obtained for the purposes of acquiring

assets in terms of section 45 intra-group transactions. The mere fact that the loan funds were

used in respect of the section 45 intra-group transaction is sufficient to trigger the provisions of

section 23K of the Act.

(See also article 2060)

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IT Act: Sections 10(1)(h); 23K; 23K(1); 23K(2); 23K(3); 23K(9) and 45

DIVIDENDS TAX

2104. Cash versus in specie dividends


With the introduction of the new dividends tax on 1 April 2012, the distinction between cash

dividends and dividends in specie requires consideration.

Where a company declares and pays a dividend and that dividend consists of a distribution of an

asset in specie, the amount of the dividend is deemed to be equal to the market value of the asset

on the date that the dividend is deemed to be paid, that is, the earlier of the date on which the

dividend is paid or becomes payable by the company declaring the dividend.

In terms of the new rules, in the case of a cash dividend declared by a South African resident

company, or a foreign company if the share in respect of which that dividend is paid is a listed

share, the declaring company or regulated intermediary is liable to withhold the dividends tax.

The liability for the tax is, however, that of the beneficial owner thereof, that is, the person

entitled to the benefit of the dividend attaching to the share. Where the dividend is an in specie

dividend, the liability for the dividends tax is on the company declaring the dividend.

There are certain exemptions from the dividends tax. The main exemption that may apply in the

case of the declaration of a cash dividend is where the beneficial owner of such dividend is a

South African resident company. Other exemptions include dividends received by beneficial

owners that are Public Benefit Organisations and Pension Funds. Where a company declares and

pays a dividend in specie, the dividend would be exempt from the dividends tax to the extent that

it constitutes a distribution of an asset in specie if the person to whom the payment is made has,

by the date of payment of the dividend, submitted to the declaring company a declaration that the

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portion of the dividend that constitutes a distribution of an asset in specie would, if that portion

had not constituted an asset in specie, have been exempt from the dividends tax. Dividends in

specie are also exempt from the dividends tax where the beneficial owner forms part of the same

“group of companies”, as defined in section 41 of the Income Tax Act No. 58 of 1962

(the Act) as the company declaring the dividend. Finally, dividends in specie are exempt if the

dividend constitutes a disposal upon the cessation of South African residence by a company or

trust, or upon the liquidation, winding-up or deregistration of a company or trust.

Dividends tax is levied at a rate of 15% of the amount of the dividend paid. In certain instances,

a reduced rate of dividends tax may be applicable. In the case of cash dividends declared and

paid, and where the declaring company withholds dividends tax, the company must withhold

dividends tax at a reduced rate if the person to whom the payment is made has submitted to the

company a declaration that the dividend is subject to a reduced rate as a result of the application

of an agreement for double taxation (“DTA”). In addition, the recipient of the dividend must

submit a written undertaking to forthwith inform the company in writing should the beneficial

owner cease to be the beneficial owner. The same rules apply where the regulated intermediary

withholds the dividends tax.

A company that declares and pays a dividend that constitutes a distribution of an asset in specie

is liable for the dividends tax at a reduced rate in respect of that portion of the dividend that

constitutes the distribution of an asset in specie if the person to whom the payment is made has,

by the date of payment, submitted a declaration to the company stating that the portion of the

dividend in specie would, if that portion had not constituted a distribution of an asset in specie,

have been subject to a reduced rate as a result of the application of a DTA. In other words, in the

case of dividends in specie, there is no qualification for treaty relief since the liability for

dividends tax is on the declaring company, but the analysis should be performed as if the

dividend in question was a cash dividend in order to determine whether any treaty relief is

available. Where treaty relief is available, the declaring company would withhold dividends tax

at the applicable rate.

In the case of foreign dividends in specie, the non-resident beneficial owner may not be able to

utilise the dividends tax paid as a credit against the liability arising in its jurisdiction. This would,

however, depend on the jurisdiction in question. The South African Revenue Service (SARS)

indicated that foreign dividends in specie should be subject to normal tax in South Africa.

However, in terms of section 9(4) of the Act, foreign dividends are not regarded as being from a

South African source. As a result, and on the basis that section 9(4) does not distinguish between

17

cash and non-cash dividends, any foreign dividend should not suffer tax in

South Africa. This point may, however, still be open for debate insofar as it relates to non-cash

dividends.


Edward Nathan Sonnenbergs

IT Act: Section 9(4) and 41

INDIVIDUALS

2105. The taxation of insurance policy benefits


The provisions relating to benefits in respect of insurance policies changed with effect from

1 March 2012.

Paragraph 2(k) of the Seventh Schedule to the Income Tax Act (‘the Act’) is the starting point of

the new taxation provisions for employer-paid insurance policies.

Paragraph 2(k) provides that a taxable benefit shall arise if -

“the employer has during any period made any payment to any insurer under an insurance

policy directly or indirectly for the benefit of the employee or his or her spouse, child, dependant

or nominee.”

This paragraph states that the payment made by an employer to any insurer for an insurance

policy that benefits the employee in any way is a fringe benefit. This new provision now makes it

compulsory for an employer to raise a fringe benefit on all premiums paid as specified above,

including premiums paid in terms of an income replacement policy.

The underlined words “... to any insurer ...” removes from the ambit of paragraph 2(k) any

contributions that are paid to retirement funds (pension, provident and retirement annuity funds).

They are taxed and administered in terms of their own special provisions.

18

The cash equivalent value of the fringe benefit contemplated by paragraph 2(k) above is the total

value of the premiums paid by the employer during the tax year.

Paragraph 12C(2) provides that where a premium is paid in terms of a policy that covers, inter

alia, the loss of income as a result of illness, injury, disability or unemployment, the amount of

the premium paid by the employer is deemed to have been paid by the employee.

Employers will need to show the value of the premiums as a fringe benefit, and that same

amount will be deducted for employees’ tax purposes, so that effectively no tax obligation will

arise. The taxable benefit must be indicated under the income code 3801 on the 2013 IRP5

certificates and the employee will claim the same as a deduction on assessment.

Section 11(w) of the Act deals with the tax treatment of policy premiums incurred on or after

1 March 2012 by the employer. However, policies of insurance solely against an accident as

defined in section 1 of the Compensation for Occupational Injuries and Diseases Act, No. 130 of

1993, are not included within the ambit of section 11(w).

An ‘accident’ is defined as:

“an accident arising out of and in the course of an employee’s employment and resulting in a

personal injury, illness or the death of the employee;”

Accordingly, if a policy is solely against accidents as defined above, the provisions of section

11(w) will not apply. The provisions of section 11(a) will then have to be applied in order to

determine whether the employer paying the premiums on such a policy, will qualify for a

deduction.

Section 11(w) envisages two types of policies:

a life policy with an investment element; and

a pure risk policy.

In some cases the policy will be for the direct or indirect benefit of an employee or director, and

in some cases it will not. A policy will not be for the benefit of an employee or director where

the insurance pay-out is only for the employer’s benefit.

Section 11(w) is therefore split into two components:

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section 11(w)(i) dealing with risk and investment policies where the premiums paid by

the employer are taxed as a fringe benefit in the hands of an employee or director;

section 11(w)(ii) dealing only with risk policies (which have no cash value or surrender

value) and the premiums are not taxed as a fringe benefit in the hands of an employee or

director.

Under section 11(w)(i), an employer may deduct premiums paid by it under a policy of insurance

if all of the following apply:

The employer is the policyholder.

The policy relates to the death, disablement or severe illness of an employee or director.

The premiums paid by the employer are taxed as a fringe benefit in the hands of the

employee in terms of paragraph 2(k) of the Seventh Schedule, read with paragraph 12C

of that schedule.

In terms of section 11(w)(ii), for employer-owned policies, the deductibility of the employer-paid

premiums depends on whether the policy is a ‘conforming’ or a ‘non-conforming’ policy.

A conforming key person policy is one that conforms to the criteria specified in section 11(w)(ii):

The policy insures the employer against any loss due to death, disablement or severe

illness of the employee.

The policy is a risk policy only and has no surrender (or cash) value.

The policy is the property of the employer at the time of paying the premiums, but can be

held by a creditor of the employer as security for a debt of the employer.

Further, if the key person policy conforms to the above criteria, the employer must declare that

the policy falls under section 11(w)(ii) in one of two ways depending on the age of the policy –

1. if the policy was entered into on or after 1 March 2012, the policy agreement must state

that section 11(w)(ii) applies in respect of premiums payable under that policy; or

2. if the policy was entered into before 1 March 2012, it must be stated in an addendum to

the policy agreement by no later than 31 August 2012 that section 11(w)(ii) applies in

respect of premiums payable under that policy.

A non-conforming policy is one that does not conform to the above criteria, and is the ‘default’.

If it is a conforming key person policy –

the premiums paid by the employer are deductible when paid; and

20

the benefit is taxable if and when the insured risk happens.

If it is a non-conforming key person policy –

the premiums paid by the employer are not deductible when paid; and

the benefit is normally tax-free if and when the insured risk happens.

It is suggested that employers seek professional advice in order to ensure that the correct tax

treatment is applied to benefits of this nature.


Edward Nathan Sonnenbergs

IT Act: Sections 11(a) and 11(w)

IT Act: Seventh Schedule paragraphs 2(k); 12C and 12C(2)

TAX ADMINISTRATION ACT

2106. Persons liable for tax


The Tax Administration Bill (TAB) is expected to be promulgated during the course of 2012 and

although it is unlikely that all sections in the TAB will come into force immediately due to,

among others, system constraints, we wish to highlight important aspects pertaining to certain

new types of persons potentially liable to tax.

Editorial comment: This Bill was promulgated as the Tax Administration Act No. 28 of 2011 on

4 July 2012, but has not yet come into force.

As stated in many South African Revenue Service (SARS) publications, the object of the TAB is

to provide a single body of law that outlines common procedures, rights and remedies and to

achieve a balance between the rights and obligations of both SARS and taxpayers in a

transparent relationship. Essentially, the TAB seeks to consolidate the administrative sections of

the various Acts administered by the Commissioner for SARS.

21

Chapter 10 of the TAB, dealing with tax liability and payment, introduces certain new categories

of persons liable to tax and the capacity (personal or representative) in which those persons may

be liable for tax debts. The categories discussed for purposes of this article are:

person chargeable to tax;

representative taxpayer;

withholding agent; and

responsible third party.

Person chargeable to tax

Although not technically a new type of person liable for tax, clause 152 of the TAB states that a

person chargeable to tax is a person on whom the tax liability for tax due under any Act

administered by the Commissioner for SARS is imposed and who is personally liable for the tax.

In essence, this is the primary person liable to tax (for example, an individual or company).

Representative taxpayer

Clause 153 of the TAB states that a representative taxpayer means a person who is responsible

for paying the tax liability of another person as agent, other than a withholding agent (see

below). A representative taxpayer includes a representative taxpayer under the Income Tax Act,

No 58 of 1962 (the Act), a representative employer under the Fourth Schedule to the Act and a

representative vendor under the Value-Added Tax Act, No 89 of 1991 (the VAT Act). It is

important to note that a principal taxpayer is not relieved from any liability where a

representative taxpayer has been appointed to pay any tax liability. A representative taxpayer

will also be provided with the right to indemnity after paying the relevant tax debt.

A representative taxpayer may, however, be held personally liable for tax payable in a

representative capacity if, while the tax debt remains unpaid, a representative taxpayer:

alienates, charges, or disposes of amounts in respect of which the tax is chargeable; or

disposes of or parts with funds or monies, which are or came into the possession of the

representative taxpayer after the tax is payable, if the tax could legally have been paid

from those funds or monies.

Withholding agent

A withholding agent, under clause 156 of the TAB, is a person required to withhold an amount

of tax and pay it to SARS. Pay-As-You-Earn (PAYE) is an example of a tax that must be

withheld by a withholding agent. A withholding agent may be held personally liable for an

amount of tax:

22

withheld and not paid to SARS; or

which should have been withheld under a tax Act but was not so withheld.

A withholding agent will also be provided with the right to indemnity after paying the relevant

amount of tax.

Responsible third party

The final category of person liable to tax is a responsible third party, which is a person who

becomes otherwise liable for the tax liability of another person, other than as a representative

taxpayer or withholding agent, whether in a personal or representative capacity.

A senior SARS official may, by notice to a person who holds or owes or will hold or owe any

money for or to a taxpayer, require that person to pay the money to SARS in satisfaction of the

taxpayer’s debt. Where a person receiving notice, parts with money contrary to the notice, that

person then becomes personally liable.

Further, to the extent that negligence or fraud is present, a person who controls or is regularly

involved in the management of the overall financial affairs of a taxpayer may be held personally

liable for the tax debts of a taxpayer. The aforementioned is similar to provisions already

contained in the Fourth Schedule to the Act.

Shareholders of a company (which excludes a listed company or its shareholders) may also incur

a personal liability for a company’s tax debts under the TAB. Clause 181 of the TAB, dealing

with shareholder liability, applies where a company is wound up other than by means of an

involuntary liquidation without satisfying its tax debts including its liability as a responsible third

party, representative taxpayer, withholding agent, employer or vendor.

Persons who are shareholders of the company (other than a listed company) within one year prior

to its winding up are jointly and severally liable to pay the unpaid tax to the extent that:

Those shareholders receive assets of the company, in their capacity as shareholders

within one year prior to the company’s winding up, and

The tax debt existed at the time of receipt of the assets or would have existed had the

company complied with its obligations under a tax Act.

A final aspect we wish to note under this section is the liability of a transferee for tax debts,

which could be applicable in the case of an asset sale / disposal of a business. In essence, a

23

transferee who receives an asset from a taxpayer who is a connected person in relation to the

transferee without consideration or for consideration below the fair market value would be liable

for the tax debts of the taxpayer.

It is clear the TAB will have a significant impact on the daily administrative interactions with

SARS and taxpayers are cautioned to familiarise themselves with these provisions.


Tax Administration Bill, 2011 (No. 11 of 2011)

VALUE-ADDED TAX

2107. Compensation received


We previously reported on the Western Cape Tax Court (Tax Court) case involving Stellenbosch

Farmers' Winery Limited (Farmers) and the Commissioner for the South African Revenue

Service (SARS).

The parties in the meantime appealed to the Supreme Court of Appeal (SCA). The SCA handed

down its judgment on 25 May 2012 (Stellenbosch Farmers' Winery v Commissioner for SA

Revenue Service (511/2011 and 504/2011) [2012] ZASCA 72.

To recap, in 1991 United Distillers plc (Distillers), a United Kingdom company, and Farmers, a

local company, signed a distribution agreement in terms of which Farmers was appointed as the

exclusive distributor for resale in Southern Africa of the Bell's, Haig and Dimple whiskies for a

period of 10 years.

In 1997, the group that Distillers formed part of was restructured. As a result Distillers

approached Farmers to end the distribution agreement about 41 months early. In 1998 the parties

concluded a dissolution agreement to this effect.

Distillers agreed to pay Farmers compensation of R67 million.

24

Two questions arose: first, was the compensation amount of R67 million subject to income tax

because it was of a revenue nature (and not of a capital nature)? Second, was the amount subject

to VAT at the rate of 14% or at the rate of 0% because Farmers had made a supply of services to

a non-resident?

The Tax Court answered the first question in the affirmative. It held that the amount paid by

Distillers to Farmers was of a revenue nature, and not of a capital nature as Farmers had

contended.

In regard to the second question, the Tax Court held that the supply made by Farmers was zero-

rated as Distillers was not resident in South Africa.

The SCA did not agree with the Tax Court on the first issue. The SCA found in favour of the

taxpayer holding that, on the facts of the case, the amount of the compensation was of a capital

nature and, accordingly, was not subject to normal tax.

The SCA found that the Tax Court had erroneously focused on only physical assets and should

have focussed instead on the much more valuable incorporeal assets constituted by the exclusive

distribution rights that were lost. The Court held that the 'compensation for the impairment of the

taxpayer's business constituted by that loss is properly to be viewed as a receipt of a capital

nature'.

The following are the important principles that can be distilled from the case:

If, in the valuation of the right to receive compensation for giving up a right, a taxpayer

has regard to the profits anticipated from the use of the right, it does not necessarily mean

that the compensation for giving up the right is of a revenue nature.

The way that a receipt is subsequently dealt with for accounting purposes does not

determine the nature of the receipt (revenue or capital) for income tax purposes.

The way that a receipt is subsequently dealt with by the taxpayer (e.g. by paying a

dividend), does not determine the nature of the receipt for income tax purposes.

The SCA emphasised that the dissolution agreement referred to payment of full

compensation for the closure of Farmers' business relating to the exercise of the

distribution rights; the agreement made no reference to a payment for loss of profits.

Taxpayers should accordingly know that, particularly where uncertainty may arise as to

the treatment of amounts for tax purposes, the words they use in agreements (provided of

25

course that the words accord with their intentions) are of great importance. Taxpayers

should get advice from tax professionals when drafting agreements.

The SCA agreed with the reasoning and finding of the Tax Court in relation to the second issue,

relating to VAT, and again held in favour of the taxpayer.

However, the SCA also said obiter (in passing) that it agreed with the finding of the Tax Court

that the exclusive distribution right, which was incorporeal property, was not situated in South

Africa but was situated where the debtor resides (in this case, in the United Kingdom).

This is an important (albeit, non-binding) finding because – by analogy – it implies that persons

who are not resident in South Africa and who make available incorporeal property in South

Africa against, say, payment of a royalty need not register for VAT in South Africa for that

reason alone.

The taxpayer was successful in the SCA on all fronts.


VAT Act: Section 11

2108. Input VAT on professional fees


An article appeared in our February 2012 Integritax Newsletter (Issue 149) on XYZ Co v The

Commissioner for the South African Revenue Service [2011], now reported as ITC 1853 73

SATC 293. This case dealt with the services of the English merchant bank in advising De Beers

on a scheme of arrangement under section 311 the old Companies Act. The court's conclusion

was that these services from the English merchant bank did not constitute 'imported services'

because the services had been used and consumed by the taxpayer for the making of taxable

supplies and in the course or furtherance of its enterprise of mining and selling diamonds.

This matter was taken by SARS on appeal to the Supreme Court of Appeal (SCA). Judgment

was handed down on 1 June 2012. There were two judgments written for the court – a lengthy

26

judgment written jointly by Navsa and van Heerden JJA, and a separate concurring judgment

written by Southwood AJA (Leach JA and Maclaren AJA concurring with that separate

judgment). The judgment of Navsa and van Heerden sets out the background in the matter very

clearly – that this English merchant bank had been retained to advise the independent committee

of directors as to whether the consortium's offer to buy out the diamond business was fair and

reasonable to independent unit holders. There were, of course, a complex set of relationships

between the Oppenheimer family, Anglo American plc and De Beers. The critical issue before

the court was whether the English merchant bank’s services were utilised or consumed by De

Beers for the purpose of making taxable supplies in the course or furtherance of its enterprise of

buying and selling diamonds.

De Beers' contention was that the provision of these services was a necessary concomitant of its

mining and its commercial enterprise as a public company. The requirements of the independent

committee of directors and the formalities involved in section 311 were statutory obligations that

are incurred by a company that conducts its operations as a public company having raised money

from the public. They argued that these supplies can rightly be said to have been wholly utilised

or consumed in the making of supplies in the course of the commercial enterprise. As such they

did not fall within the definition of imported services.

The Commissioner was arguing for a restrictive approach to this question of what is an

enterprise, and seeing it as "the nuts and bolts of the operational diamond business and excluding

statutory duties imposed on the company in the interest of shareholders" (Navsa and van

Heerden JJA at paragraph 23). These two judges said that in the case of a public company, there

is a clear distinction between the enterprise with its attendant overhead expenses and the special

duties imposed on a company in respect of its shareholders. The duty imposed on a public

company that is the target of a takeover is too far removed from the advancement of the VAT

enterprise to justify characterising the services acquired in the discharge of that duty as services

acquired for the purposes of making taxable supplies (at paragraph 27). The two judges said that

the submissions on behalf of the Commissioner were undoubtedly correct. The Canadian and

Australian cases referred to were particular to the facts of those cases and the task of the court

was to interpret and apply the VAT legislation to the facts put before them.

De Beers pointed out that the advice from the English merchant bank was, to a large extent,

related to De Beers' holding of shares in Anglo American. It did not have a discrete non-

enterprise activity of holding Anglo American shares for investment, which was separate from its

diamond business. The court was unconvinced by this argument and did not see the investment

27

as constituting an enterprise in the meaning of the Act. Given this finding there was quite

substantial argument on the question of where the supplies by the English merchant bank were

consumed – whether in London or in Johannesburg. The court's view that De Beers was a South

African company with its head office in Johannesburg – that was where the independent

committee of directors had met and resolved to acquire the services of the English merchant

bank (and other local service providers). That was the place where the board met to receive and

approve the recommendation of the subcommittee and the section 311 scheme of arrangement

was approved and implemented in South Africa. The court's overwhelming conclusion was that

the services had been consumed in South Africa.

The cross-appeal in the case related to input credits in respect of the legal services rendered to

the company as part of the section 311 scheme of arrangement. The court had found that the

purchase consideration that a unit holder received was partly a share buy-back in terms of which

they received new shares in another company, and then the cancellation leg that gave the unit

holder an amount in cash. The matter had accordingly been referred back to SARS to determine

an appropriate ratio to which a percentage of the services would constitute a deductible input

credit.

In the SCA, the judges' view was that the legal services of formulating and executing the

section 311 scheme of arrangement, obtaining the tax rulings in terms of section 60 of the

Income Tax Act, No 113 of 1993, and the exchange control requirements for the distribution of

the unbundled Anglo shares, was subject to the same reasoning as those applying to the English

merchant bank’s services. The intention of these services was to ensure that the scheme

conceived by Mr Oppenheimer was carried out. As such, this was not part of De Beers' diamond

mining enterprise.

The separate concurring judgment of Southwood AJA dealt with a tight analysis of the

provisions of the VAT Act, No 89 of 1991 (the VAT Act). The majority judges said that if one

looked to the definition of 'enterprise' and proviso (v) that any activity to the extent it involves

the making of exempt supplies is not deemed to be the carrying on of an enterprise. To be

entitled to deduct 'input tax' against his VAT payable, the vendor must be carrying on an

enterprise and must have paid VAT on goods and services which he acquired wholly for the

purpose of consumption, use or supply in the course of supplying the goods or services which are

chargeable to tax under section 7(1)(a) of the VAT Act. Section 17 provides for the

apportionment method where the deductible input tax is acquired partly for consumption, use or

supply in the course of making taxable supplies. Then, having regard to the definition of

28

'imported services' the question is whether the services are not utilised or consumed in the

Republic or if they are utilised or consumed in the Republic they are utilised or consumed for the

purpose of making taxable supplies, then the services would not be imported services.

Accordingly, the question was the nature of the enterprise because the purpose of acquiring the

services and whether they were consumed or utilised in making taxable supplies could only be

determined in relation to the enterprise (at paragraph 51). In the circumstances of the case, the

majority held that De Beers was not a dealer in shares and that the holding of shares and the

receipt of dividends did not fall within the definition of 'enterprise'. De Beers' enterprise for the

purposes of the VAT Act consisted of mining, marketing and selling diamonds. Having arrived

at this conclusion, it was clear that the English merchant bank’s services were not acquired to

enable De Beers to enhance its VAT enterprise of mining, marketing and selling diamonds. The

services of the English merchant bank did not contribute in any way to the making of De Beers

taxable supplies (at paragraph 53).

This was not a good outing to Bloemfontein for the taxpayer. While the judgment of Davis J was

narrow in its finding and related very much to the facts, it would be of little value as a precedent.

The finding of Navsa and van Heerden JJA in paragraph 27 is the finding that SARS will have

left Bloemfontein very satisfied with, the enterprise of a holding company having been judicially

ruled on.


Companies Act No. 61 of 1973: Section 311

IT Act No. 113 of 1993: Section 60

VAT Act: Sections 7(1)(a) and 17

SARS AND NEWS

2109. Interpretation notes, media releases and other documents

Readers are reminded that the latest developments at SARS can be accessed on their website

http://www.sars.gov.za

29

Editor: Mr P Nel

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI

Mitchell, Prof L Olivier, Prof JJ Roeleveld, Prof PG Surtees.

The Integritax Newsletter is published as a service to members and associates of The South

African Institute of Chartered Accountants (SAICA) and includes items selected from the

newsletters of firms in public practice and commerce and industry, as well as other contributors.

The information contained herein is for general guidance only and should not be used as a basis

for action without further research or specialist advice. The views of the authors are not

necessarily the views of SAICA.

All rights reserved. No part of this Newsletter covered by copyright may be reproduced or copied

in any form or by any means (including graphic, electronic or mechanical, photocopying,

recording, recorded, taping or retrieval information systems) without written permission of the

copyright holders.

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INTEGRITAS-#406255-v1-Integritax September 2012 Issue 156 · 2012. 8. 31. · SEPTEMBER 2012 – ISSUE 156 CONTENTS ANTI- AVOIDANCE 2099. Application of law ... connected person in