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JANUARY 2016 – ISSUE 196

CONTENTS

CAPITAL GAINS TAX 2476. Cross issue of shares and tax-

free corporate migrations 2477. Disposal of sectional title units

to shareholders

INTERNATIONAL TAX 2483. Retroactive application of

double tax agreement 2484. Withholding tax on interest (WTI)

COMPANIES 2478 Asset-for-share transactions

2479. The definition of ‘controlled

group company’ and ‘equity

share’

TAX ADMINISTRATION 2485. SARS powers and policies 2486. International standards

DEDUCTIONS 2480. Trade losses

TRUSTS 2487. Disposals by incentive trusts

EMPLOYEES’ TAX 2481. Emolument attaching orders 2482. Contributions to retirement

funds

SARS NEWS 2488. Interpretation notes, media

releases and other documents

CAPITAL GAINS TAX 2476. Cross issue of shares and tax-free corporate migrations In the 2015 Budget, the Minister of Finance indicated that paragraph 11(2)(b) of the Eighth Schedule to the Income Tax Act of 1962 (the Act), which deals with

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the issue of shares by a company, would be reviewed. The Taxation Laws Amendment Bill 2015 specifically addresses paragraph 11(2)(b). The issue of shares by a company (whether for cash, shares or other assets) generally does not constitute a disposal for capital gains tax purposes, although there may be capital gains tax consequences in terms of section 24BA of the Act to the extent that there is a mismatch between the value of the shares issued and the cash or assets received. In 2013, paragraph 11(2)(b) was amended to specifically provide that the issue of shares by a resident company in exchange for shares in a foreign company (whether directly or indirectly) would constitute a disposal. This was a 'blunt instrument' approach to dealing with certain transactions that resulted in tax-free corporate migrations. These transactions involved the issue of shares by a resident company to a non-resident company, in exchange for shares in that or some other non-resident company. The resident company would then be stripped of its foreign assets in a tax effective manner by relying on paragraph 64B of the Eighth Schedule. Following a change in the place of effective management of the resident company, it would become a non-resident, and the exit charge would be minimal given the preceding disposal of foreign assets. The 2013 amendments to paragraph 11(2)(b) halted these transactions because it would result in an immediate capital gain for the resident company equal to the market value of the foreign shares, the shares issued by the resident company having a zero base cost. However, the fact that paragraph 11(2)(b) applies to the direct or indirect exchange for shares in a foreign company had unintended consequences. Even if the resident company issued the shares for a cash amount, but the amount is ultimately settled by the acquisition of shares in any

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foreign company, or the resident company in any other manner ends up with foreign shares, there would be a disposal. The economic consequence is that it hampers the acquisition by local companies of foreign entities and the growing of South African multinationals. The 2015 amendments effectively reverse those made in 2013 in that the issue of shares by a resident company in exchange for shares in a non-resident company, no longer constitutes a disposal for purposes of capital gains tax. Rather, paragraph 64B will be amended to provide that the disposal of shares in a foreign company by a resident company to a connected person would be subject to capital gains tax. In other words, the exemption in paragraph 64B would not apply if the foreign shares are disposed of to a connected person. In addition, section 9H of the Act, which deals with changes in tax residence, will be amended to provide that any benefits that a resident company enjoyed under paragraph 64B and/or section 10B(2)(a) of the Act within three years prior to ceasing to be a resident, will be reversed upon ceasing to be a resident. The amendments are proposed to apply retrospectively with effect from 5 June 2015.

Cliffe Dekker Hofmeyr ITA: Sections 9H, 10B(2)(a), 24BA, and paragraphs 11(2)(b) and 64B of the Eighth Schedule 2477. Disposal of sectional title units to shareholders The South African Revenue Service (SARS) released Binding Private Ruling, No 206 (the Ruling) on 14 September 2015. The Ruling dealt with the disposal by a share block company of sectional title units to its share block holders.

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A resident company (Applicant), and a resident trust (Trust), held shares in a resident share block company (Share Block Company). The Share Block Company owned three sectional title units. It was proposed that the Share Block Company would dispose of the sectional title units to the Applicant and the Trust. The Applicant and the Trust would then surrender their share block certificates and rights of use to the Share Block Company. These would then be cancelled. Effectively, after the completion of the transaction, the Applicant and the Trust would directly hold the sectional title units, and would no longer hold shares in the Share Block Company. On the assumption that the Applicant and the Trust held their shares as capital assets, SARS ruled that paragraph 67B of the Eighth Schedule to the Income Tax Act of 1962 (the Act) would apply to the disposal of the sectional title units by the Share Block Company. Paragraph 67B of the Eighth Schedule to the Act effectively provides that, where a person has a right of use of a part of the property of a share block company, conferred by reason of that person holding a share in that share block company, and that person subsequently acquires ownership of that part of the property upon disposal by the share block company:

• The share block company must disregard any capital gain or loss resulting from the disposal.

• The person must disregard any capital gain or loss resulting from the disposal of its shares in the share block company.

In addition SARS ruled that, to the extent that the disposal by the Share Block

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Company of the sectional title units constitutes a dividend in specie, it would be exempt from dividends tax in terms of section 64FA(1)(d) of the Act. Presumably this would only be relevant to the Trust. For purposes of Value-Added Tax (VAT), SARS ruled that the supply of the sectional title units by the Share Block Company would be deemed to have been made in the course and furtherance of an enterprise, as contemplated in section 8(19) of the Value-Added Tax Act of 1991 (the VAT Act). The value of the supply would also be deemed to be nil in terms of section 10(27) of the VAT Act. Accordingly, the output VAT would be zero. In terms of section 9(19) of the Transfer Duty Act of 1949, the transfer of the sectional title units would also be exempt from transfer duty. Effectively, the provisions referred to above provide for roll-over relief where a share block company disposes of its property or parts thereof to a shareholder who has rights in respect of that property or part. The Ruling illustrates the application of these provisions rather well, and also makes it clear that the provisions apply to undivided interests in sectional title units owned by share block companies. Cliffe Dekker Hofmeyr ITA: Section 64FA(1)(d) and paragraph 67B of the Eighth Schedule VAT: Sections 8(19) and 10(27) Transfer Duty Act: Section 9(19) BPR 206 Editorial comment: Published SARS rulings are necessarily redacted summaries of the facts and circumstances. Consequently, they (and articles discussing them) should be treated with care and not simply relied on as they appear.

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COMPANIES 2478. Asset-for-share transactions Section 42 of the Income Tax Act of 1962 (the Act) provides for tax roll-over relief in respect of asset-for-share transactions as defined. Such a transaction generally entails the disposal by a person of an asset to a company, and the issue of new shares by that company to the person, as consideration. One of the requirements is that the nature of the asset must be retained. In other words, if the person held the asset as trading stock, the company must acquire it as trading stock, and if the person held it as a capital asset, the company must acquire it as a capital asset. If the person held the asset as a capital asset, the company may acquire it as trading stock if the person (where the person is a company) and the company do not form part of the same group of companies. However, asset-for-share transactions can create an opportunity for a person holding assets as trading stock, to dispose of such assets to a company by way of an asset-for-share transaction, and subsequently sell the shares as capital assets. To prevent such an abuse of asset-for-share transactions, section 42(5) of the Act contains an anti-avoidance provision. If a person disposes of any share received in terms of an asset-for-share transaction within 18 months after the date of acquisition, and immediately prior to such disposal more than 50% of the market value of all the assets disposed of by that person to the company is attributable to allowance assets or trading stock, that person will be deemed to have disposed of the relevant shares as trading stock. The deeming provision only operates to the extent that the amount received by the person for the disposal of the shares is less than or equal to the market value of the shares at the beginning of the 18 month period. In other words, the person

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disposing of the shares will be deemed to have disposed of the shares on revenue account, but only up to the amount of the market value of the shares at the beginning of the 18 month period. If the person receives more than that as consideration for the disposal of the shares, the normal rules will apply in respect of determining whether the disposal is on revenue or capital account. The restriction does not apply to the disposal of a share by means of:

• An intra-group transaction in terms of section 45 of the Act.

• An unbundling transaction in terms of section 46 of the Act.

• A liquidation distribution in terms of section 47 of the Act.

• An involuntary disposal in terms of paragraph 65 of the Eighth Schedule to the Act.

• The death of the person. An amalgamation transaction in terms of section 44 is not excluded. However, see Binding Private Ruling No 159, in which the South African Revenue Service ruled that, based on the particular facts at hand, shares acquired in terms of a section 42 transaction could be disposed of by way of a section 44 amalgamation transaction and would not be deemed to be on revenue account but on capital account. One of the amendments in the Taxation Laws Amendment Bill 2015 concerns the clarification of section 42(5) of the Act. There appears to be a concern that the current wording "creates unintended anomalies and potentially converts the nature of the equity shares to assets held as trading stock". It is proposed that, instead of formulating the anti-avoidance provisions as a deeming provision, whereby the person is deemed to dispose of shares as trading stock, the person must rather be directly obliged to include the relevant consideration in income. The inclusion in income will, therefore, not be as a

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result of the shares being deemed to be trading stock, which could have caused confusion considering accompanying transactions. It is important to appreciate that the restriction contained in section 42(5) should be read together with the requirement that the person must retain a "qualifying interest", as defined, in the company for a period of at least 18 months. The consequences for not doing so are described in section 42(6) of the Act. Even though it is possible for the person to dispose of the shares received within 18 months of the implementation of the transaction without section 42(5) necessarily applying (for example, if less than 50% of the value of the assets is attributable to trading stock), the person should take care not to dispose of so many shares as would cause the person to no longer hold a qualifying interest in the company. Cliffe Dekker Hofmeyr ITA: Sections 6, 42, 44, 45, 46, 47 and paragraph 65 of the Eighth Schedule BPR 159 Editorial comment: Published SARS rulings are necessarily redacted summaries of the facts and circumstances. Consequently, they (and articles discussing them) should be treated with care and not simply relied on as they appear. 2479. The definition of ‘controlled group company’ and ‘equity share’ The South African Revenue Service (SARS) released Binding Private Ruling No 205 (Ruling) on 11 September 2015. The Ruling considers the meaning of 'controlled group company' and 'equity share'. An approved venture capital company (VCC) in terms of section 12J of the Income Tax Act of 1962 (the Act), resident company A (Company A), and resident company B (Company B), proposed to incorporate a new company (RentalCo).

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RentalCo would lease certain movable goods under operating leases to existing clients of Company A. The VCC would subscribe for 20% of the issued shares in RentalCo, but at a disproportionate subscription price of 75% of the issued share capital of RentalCo. The VCC would be issued with class A ordinary shares. Company A and Company B would subscribe for class B and class C ordinary shares respectively, totalling 80% of the issued shares in RentalCo. The class A ordinary shares would entitle the VCC to a first distribution of profits or capital equal to the capital invested and a return of prime plus 2%. Once the distributions in respect of the class A shares have been settled, the holders of the class B and C shares would be entitled to a second distribution of profits or capital equal to prime plus 2% in proportion to their respective shareholding. Thereafter all ordinary shares would rank pari passu. All ordinary shares would at all times carry equal voting rights. The VCC intends to enter into similar transactions in future with partners whereby companies would be incorporated for purposes of leasing goods to clients. The VCC will always hold less than 70% of the shares in issue because a 'qualifying company' for purposes of section 12J of the Act may not be a controlled group company in relation to the VCC. The VCC will always subscribe for cash. SARS ruled that the class A ordinary shares would constitute 'equity shares' for purposes of the definition of 'qualifying share' in section 12J(1) of the Act. In other words, they are not shares that "neither as respects dividends nor as

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respects returns of capital, carr[y] any right to participate beyond a specified amount in a distribution". SARS also ruled that the company into which the VCC will invest (such as RentalCo), would not constitute a 'controlled group company' for purposes of the definition of 'qualifying company' in section 12J(1) of the Act to the extent that the VCC holds less than 70% of the number of equity shares in issue. This is so despite the fact that the VCC might invest more than 70% of the share capital. The company into which VCC will invest would not be a 'qualifying company' as defined if the sum of the 'investment income' derived during any year of assessment exceeds 20% of gross income. 'Investment income' includes rental from immovable property, but not movable goods. SARS therefore ruled that the rental income received by the company into which the VCC will invest would not constitute' investment income' as defined in section 12E(4)(c) of the Act. Cliffe Dekker Hofmeyr ITA: Sections 12E and 12J BPR 205 Editorial comment: Published SARS rulings are necessarily redacted summaries of the facts and circumstances. Consequently, they (and articles discussing them) should be treated with care and not simply relied on as they appear.

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DEDUCTIONS 2480. Trade losses Where an accident or other mishap results in a taxpayer incurring an involuntary loss, a question can arise as to whether that loss is deductible for income tax purposes in terms of the general deduction formula laid down in section 11(a) of the Income Tax Act of 1962 (the Act) as having been incurred in the production of income. In Port Elizabeth Electric Tramway Co Ltd v CIR [1936] 8 SATC 13, Watermeyer J expressed the underlying principle by saying that – “all expenses attached to the performance of a business operation bona fide performed for the purpose of earning income are deductible whether such expenses are necessary for its performance or attached to it by chance or are bona fide incurred for the more efficient performance of such operation provided they are so closely connected with it that they may be regarded as part of the cost of performing it.” Particular risks are inherent in certain trades In Joffe & Co (Pty) Ltd v CIR [1946] 13 SATC 354, the taxpayer company carried on business as engineers in reinforced concrete. A concrete structure erected by the company collapsed and killed a workman employed by the building contractor. In an action brought by the deceased’s dependants, the court held that the taxpayer company had been negligent in its construction of the collapsed structure and it was ordered to pay damages and costs. The taxpayer sought to deduct these damages and costs for income tax purposes. In holding that the taxpayer’s damages were not deductible, Watermeyer J said that –

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“There is nothing . . . to suggest that such negligence, and the consequent liability which negligence entailed, were necessary concomitants of the trading operations of a reinforced concrete engineer . . .” This dictum seems to be the origin of the principle that, where the taxpayer incurs a liability for damages, those damages are tax-deductible only if that risk was inherent in the taxpayer’s trade. Thus, in COT v Rendle [1965] 26 SATC 326, the Appellate Division of the High Court of Rhodesia held that the deductibility of fortuitous expenditure depends on whether the chance or risk of its being incurred is sufficiently closely connected with the taxpayer’s business operations, and that the taxpayer must show that the risk of the mishap which gives rise to the expenditure was inseparable from or a necessary incident of the carrying on of the particular business. It is, however, no easy matter to determine what risks are inherent in particular trades. Is theft or misappropriation an inherent risk of trading? In Lockie Bros Ltd v CIR [1922] 32 SATC 150 at 151 it was held, in essence, that theft by subordinate employees of the firm was an inherent risk of the business, but theft by the managing director was not. Perhaps morals have declined, or perhaps the freer flow of information in the modern era has resulted in revelations of dishonesty in high circles that was previously kept under wraps. In any event, the recent decision of the High Court of Zimbabwe in Z Co (Pvt) Ltd v Zimbabwe Revenue Authority [2015] 77 SATC 82 signals a sobering

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judicial acknowledgement of the new morality or lack of morality in state institutions. In this case, it was held, on the basis of the principles laid down in Rendle, that where the taxpayer, a registered tobacco merchant, had deposited funds with the Reserve Bank of Zimbabwe to be used by the taxpayer for the purchase of tobacco in terms of exchange control regulations, and where some US$2.2 million of those funds had gone missing, having been ‘lost’ while in the hands of the Reserve Bank, such a loss was a risk inherent in the taxpayer’s business. In other words, the risk of the misappropriation of a taxpayer’s funds held by a state agency is an inherent risk of the taxpayer’s trade. Or, to put it in the more cautious language of the judgment, that loss was ‘fortuitous expenditure and not an outlay of a capital nature, incurred in the ordinary course of the business operations of [the taxpayer]’ and was therefore deductible in terms of the Zimbabwean Income Tax Act. PwC ITA: Section 11(a) EMPLOYEES’ TAX

2481. Emolument attaching orders A recent, much publicised decision in the Western Cape High Court declared certain provisions in the Magistrates’ Court Act (MCA) relating to the issuing of emolument attachment orders (EAO) to be invalid and unconstitutional.

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In the matter of University of Stellenbosch Legal Aid Clinic and Others v Minister of Justice and Correctional Services and Others (Case No. 16703/14) [2015] ZAWCHC 99 application was made to have EAOs issued against a number of clients of the applicant declared invalid. An EAO permits the attachment of a debtor’s earnings and obliges the debtor’s employer (garnishee) to pay a specified amount out of the debtor’s earnings to the creditor or the creditor’s attorney until the debt and legal costs have been fully paid. Issuance of an EAO is governed by section 65J of the MCA. The principal requirement is that the EAO must be issued from the court of the district in which the employer of the judgment debtor resides, carries on business or is employed. Secondly, an EAO may not be issued unless:

• the debtor has consented to its issue or a court has authorised its issue; or

• notice has been given by registered post, sent to the debtor’s last known address, warning that an EAO will be issued if the amount is not paid within ten days after posting of the notice, and an affidavit is given confirming that this procedure has been followed.

The EAO is prepared by the creditor or his attorney, signed by the creditor or his attorney and the clerk of the court, and served on the garnishee. The reason for declaring the EAOs unconstitutional The evidence before the Court placed considerable doubt on the validity of consent to the issuing of the EAOs. In addition, it was clear that the primary jurisdictional requirement that an EAO be issued from the court of the district in which the employer resides had not been met.

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However, the judgment is of interest in its examination of the constitutionality of the EAO process. Desai J observed at paragraph [5] that section 65A of the MCA gives a creditor the right to require a debtor to give evidence before a magistrate to enable the court to inquire into his or her financial affairs and to make an order which is ‘just and equitable’. In the matters before the Court, the EAOs had been issued by the clerk of the court without any judicial oversight. In a review of international law and practice, Desai J considered the International Labour Organisation’s Protection of Wages Convention as well as the United Nations’ Guiding Principles on Business and Human Rights, which were ‘highly persuasive’, and noted at paragraph [74]: “It seems to be firmly established in international law that states have a duty to protect their citizens against the abuse of human rights by business enterprises in their territory. Where such abuses do occur, states have a duty to provide victims with an effective remedy. These duties should be taken into account in the interpretation of the provisions of the MCA and the Constitution” EAOs do not meet international norms inter alia to the extent that they may be issued by the clerk of the court without involvement of a judicial officer and the debtor is not given an opportunity to make representations before the EAO is issued. Desai J noted further at paragraph [76] that: “The Constitutional Court has emphasised the general principle that there must be judicial oversight where an applicant seeks an order to execute against or seize control of the property of another person”. The Constitutional Court’s decisions related to the attachment and sale in execution of property of a debtor. However, Desai J observed at paragraph [80] that, in two of these decisions:

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“… the impugned sections prescribe a process for execution similar to the process prescribed in section 65J(2) of the [MCA]. In all these cases the absence of judicial supervision and the consequences of the execution process infringes [sic] several of the debtors’ constitutional rights”. The EAOs were considered to be unconstitutional for the reasons set out in paragraph [84] of the judgment: “The process of issuing an EAO requires an evaluation of the amount of money to be attached per month as compared to the amount needed by the debtor to support herself and her family. On the reasoning of the Constitutional Court [in Gundwana v Steko Development CC & Others 2011 (3) SA 608 (CC)], judicial oversight over the issue of an EAO must be mandatory (rather than being subject to the discretion of the clerk of the court) and must occur when the execution order is issued (not subsequently, when an attempt might be made to have the execution order varied or set aside)”. The Tax Administration Act (the TAA) Section 172 of the TAA gives SARS the power to seek a civil judgment against a defaulting tax debtor. Section 172(1) states: “(1) If a person has an outstanding tax debt, SARS may, after giving the person at least 10 business days’ notice, file with the clerk or registrar of a competent court a certified statement setting out the amount of tax payable and certified by SARS as correct”. Furthermore, if SARS is satisfied that the giving of notice would prejudice the collection of tax, it may seek a judgment without giving notice, in terms of section 172(3).

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The certificate must be filed with the clerk of the court that has jurisdiction over the taxpayer concerned. Upon filing, the certified statement acquires the status of a civil judgment, under section 174, which states: “A certified statement filed under section 172 must be treated as a civil judgment lawfully given in the relevant court in favour of SARS for a liquid debt for the amount specified in the statement”. It is therefore possible for SARS to take a civil judgment against a taxpayer without following the normal procedures for the prosecution of a debt claim and, in certain circumstances, without giving the taxpayer notice. Section 179(1) of the TAA confers even stronger powers on SARS: “(1) A senior SARS official may by notice to a person who holds or owes or will hold or owe any money, including a pension, salary, wage or other remuneration, for or to a taxpayer, require the person to pay the money to SARS in satisfaction of the taxpayer’s outstanding tax debt”. In effect, without reference to a court, SARS may obtain the equivalent of an EAO or an order of attachment of moneys against a taxpayer. In light of the University of Stellenbosch Legal Aid Clinic decision and the Constitutional Court cases cited by Desai J in that matter, it would appear that the provisions of section 179 of the TAA would fail the test set out by the Constitutional Court, namely that judicial oversight should be mandatory. Desai J stated in paragraph [85] of the judgment in the Stellenbosch University Legal Aid Clinic matter, with reference to sections 65J(2)(b)(i) and (ii) of the MCA, that these provisions:

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“… are in the circumstances constitutionally invalid to the extent that they allow for EAOs to be issued by a clerk of the court without judicial oversight. This is so both with regard to international law and to the current jurisprudence of the Constitutional Court”. SARS regularly issues attachment orders requiring banks to transfer client funds to SARS in settlement of tax debts which are owed by the banks’ clients. In these instances, the intervention of a court is not required. There appears to be no constitutional checks in place to establish whether these procedures are, in the circumstances, just and equitable. It is difficult to comprehend how, under the Constitution, the exercise of powers by the State in the collection of taxes can be viewed differently than the exercise of powers by a civil judgment creditor in collecting a debt. The purpose of the procedures is the same, and the constitutional checks and balances should be identical. PwC Magistrates’ Court Act: Sections 65A and 65J(2)(b) TAA: Sections 172, 174, and 179 (1) 2482. Contributions to retirement funds The date of implementation of new rules relating to the tax treatment of contributions to retirement funds, which were expected to take effect on 1 March 2015, was postponed until 1 March 2016, in terms of the Taxation Laws Amendment Act of 2014. Among other changes, the new rules will affect the employees’ tax implications of employer contributions to retirement funds, and the deductibility for income tax purposes by the member of such contributions, thus affecting both participating employers and members. In addition, depending on the nature of

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the benefits available to members, the retirement fund may be obliged to provide information to the participating employer in respect of contributions for specific categories of fund members. The implications of some of these changes are highlighted below. Fringe benefits Current position The current position is that contributions to a pension fund or a non-contributory provident fund, which an employer is required to make in terms of the rules of the applicable fund in respect of its employees, do not constitute a taxable benefit under the Seventh Schedule to the Income Tax Act 58 of 1962 (the Act). However, any contribution by an employer to the retirement annuity fund of an employee does constitute a taxable benefit in the employee’s hands in terms of the Seventh Schedule to the Act. Proposed new rules Under the proposed new rules, employer contributions to any retirement fund will be taxable in the hands of the employee for whose benefit they were made. Thus, with effect from 1 March 2016, any contribution by an employer for the benefit of any employee to any pension fund, provident fund or retirement annuity fund will constitute a taxable benefit under the Seventh Schedule to the Act. The proposed new rules also set out new valuation rules which provide for the calculation of the taxable value of contributions made by employers to retirement funds for purposes of determining the taxable fringe benefit amount to be included in the employee’s remuneration. In terms of the proposed new valuation rules, as they currently read, the value of the taxable benefit arising in respect of contributions made by an employer to a retirement fund must be determined based on the “fund member category” (as defined), and the nature of the retirement benefits to which each category of fund members is entitled. The

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retirement benefits are classified into a defined benefit component, a defined contribution component, an underpin component and risk benefits. In this regard, where the benefits payable to members in respect of a fund member category of a pension, or a provident or retirement annuity fund consist solely of defined contribution components (as defined), the value of the taxable benefit will be the value of the amount contributed by the employer for the benefit of the employee who is a member of that fund. However, where the benefits payable to members in respect of a fund member category of a pension, or a provident or retirement annuity fund consist of components other than only defined contribution components, the value of the taxable benefit must be determined based on a formula. In this case, the pension fund is required to calculate the “fund member category factor”, as specified in the regulations to be issued by the Minister of Finance, and provide a contribution certificate to the employer of the employees who are members of the fund. Draft regulations were issued on 16 October 2014 regarding the determination of the fund member category factor and the information to be contained in these contribution certificates. In terms of the proposed new rules, no value must be placed on the taxable benefit derived from employer contributions for the benefit of a member of that fund who has retired from that fund or in respect of the dependants or nominees of a deceased member of that fund. To the extent that a taxable benefit arises in respect of employer contributions to a retirement fund, the amount of the taxable benefit would be included in the remuneration of the employee and would be subject to employees’ tax. In determining the employees’ tax payable in respect of the taxable benefit, the employer may take into account the tax deduction to which the employee may be entitled in respect of his or her retirement fund contributions. Accordingly,

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the employees’ tax liability arising in respect of the taxable benefit that is attributable to the employer contributions may be offset to the extent that the employee qualifies for a tax deduction in respect of the aggregate retirement fund contributions. Deductibility of contributions Current position The current position is that the tax deductions that may be claimed by an individual in respect of contributions that were made to a pension fund, a provident fund or a retirement annuity fund are determined separately for each type of retirement fund. Proposed new rules The proposed new rules introduce a consolidated tax deduction provision for individuals in respect of the aggregate contributions to all pension funds, provident funds and retirement annuity funds. Thus, with effect from 1 March 2016, it is proposed that a deduction may be claimed for any amount contributed during a year of assessment to any pension fund, provident fund or retirement annuity fund in terms of the rules of that fund, by a person that is a member of that fund, subject to certain limitations. The total deduction allowable in respect of a year of assessment may not exceed the lesser of R350 000 or 27,5% of the higher of the person’s remuneration (as defined) or taxable income. Any employer contributions that have been taxed in terms of the Seventh Schedule, as outlined above, would be included in the employee’s contributions to the relevant retirement fund for the purposes of calculating the tax deduction that may be claimed by the employee.

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Conclusion In light of the proposed changes soon to come into effect next year, retirement funds should assess their obligation to provide contribution information to participating employers in respect of the fund member categories of the fund. Where the members of a retirement fund have flexibility regarding the amount of contributions to be made to the fund, the tax changes should be communicated by employers to their employees to enable them to consider their aggregate contributions across all the retirement funds in which they participate. ENSafrica ITA: Seventh Schedule INTERNATIONAL TAX 2483. Retroactive application of double tax agreement On 16 October 2015, a Protocol amending the double tax agreement (DTA) between South Africa and Cyprus was published in the Gazette. In normal circumstances, the promulgation of a protocol does not cause much excitement. However, one of the articles in the Protocol raises unusual issues. Article IV of the Protocol contains two paragraphs: The first paragraph provides that each of the states shall notify the other of the completion of the procedures required by its domestic law to bring the Protocol into effect, and that the Protocol shall come into effect on the date of receipt of the later of these notifications. The operative date in that respect was 18 September 2015. The second states that the provisions of the Protocol shall apply from the date of the introduction in South Africa of the system of taxation at shareholder level of dividends declared, namely 1 April 2012.

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The principal amendment wrought by the Protocol was to permit the source state to tax dividends paid to a resident of the other state. Under the original Article 10 of the DTA, prior to its amendment, only the country of residence enjoyed the right to tax the dividends. How will SARS apply the Protocol? From 1 April 2012 and prior to 18 September 2015, residents of Cyprus deriving dividends from South African resident companies would have received the dividends free of any dividend tax, provided that they had complied with the formal requirements entitling them to the reduced rate specified in the DTA. In theory, at least, all of the declarations that were filed are a misstatement of a material fact. The persons making the declarations would have stated that they are entitled to a reduction in the rate of tax in terms of the DTA. However, by a fiction, the entitlement which they had claimed never existed! This raises questions whether SARS will:

• pursue the shareholders and claim payment of the tax;

• levy penalties and interest on late payment;

• penalise the local withholding agents for failing to withhold the tax; or

• make the company or regulated intermediary a responsible third party and enforce collection of the tax from subsequent dividend remittances.

It is submitted that any action to recover taxes that were lawfully not payable on the date that the dividends were paid would be unwarranted and reprehensible. In all instances, the shareholders, companies and regulated intermediaries would have acted in strict compliance with the law in force at the time of the payment of the dividends, and, regardless of whether the law recognises the retroactive

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effect of the agreement, these parties cannot be presumed to have known law which had not yet been promulgated. There is a presumption in law that retroactive legislation is deemed to have come into force from the date on which it is deemed to come into effect, and there may be an argument that SARS can fix a shareholder with liability. However, the withholding obligations are administrative provisions and one cannot re-enact the payment, so there would appear to be little expectation that the companies or regulated intermediaries should be held to account. It would seem that SARS’ only resort would be to pursue the shareholders in Cyprus, which would appear to be a lengthy and costly endeavour. One is left pondering what the motive for Article IV(2) of the Protocol could possibly have been. If there was nothing to gain from retroactive application, why was it considered necessary? We await further developments with interest. PwC Double Tax Agreement between Cyprus and South Africa Article IV(2) of the Protocol amending the double tax agreement between Cyprus and South Africa

2484. Withholding tax on interest (WTI) The Taxation Laws Amendment Bill 2015 (the Bill) proposes the insertion of a definition for the term ‘interest’ in section 50A of the Income Tax Act 58 of 1962 (the Act) to clarify the meaning of interest for purposes of the WTI. ‘Interest’ is to be defined in section 50A of the Act with reference to paragraphs

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(a) and (b) of the definition of ‘interest’ under section 24J(1), meaning that for WTI purposes, ‘interest’ includes “the gross amount of any interest or related finance charges, discount or premium payable or receivable in terms of or in respect of a financial instrument;” or “the amount (or portion thereof) payable by the borrower to a lender in terms of a lending arrangement as represents compensation for any amount which the lender would, but for such lending arrangement, have been entitled”. The Explanatory Memorandum to the Bill states that while the meaning of ‘interest’ is defined in terms of section 24J of the Act, which definition is referenced in the hybrid instruments rules and source rules; uncertainty has prevailed regarding the meaning to be ascribed to ‘interest’ for purposes of the WTI. ‘Interest’ is defined in section 24J(1) of the Act as the: “(a) gross amount of any interest or related finance charges, discount or premium payable or receivable in terms of or in respect of a financial arrangement; (b) amount (or portion thereof) payable by a borrower to the lender in terms of any lending arrangement as represents compensation for any amount to which the lender would, but for the lending arrangement, have been entitled; and (c) absolute value of the difference between all amounts receivable and payable by a person in terms of a sale and leaseback arrangement as contemplated in section 23G throughout the full term of such arrangement, to which such person is a party, irrespective of whether such amount is:

(i) calculated with reference to a fixed rate of interest or a variable rate of interest; or (ii) payable or receivable as a lump sum or in unequal instalments during the term of the financial arrangement.”

A ‘lending arrangement’ in turn is defined in section 24J of the Act as:

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“any arrangement or agreement in terms of which: (a) a person (in this section referred to as the lender) lends any instrument to another person (in this section referred to as the borrower); and (b) the borrower in return undertakes to return any instrument of the same kind and of the same or equivalent quantity and quality to the lender.” Section 23G of the Act is an anti-avoidance provision which effectively treats sale and leaseback arrangements involving payments to lessors or lessees that do not constitute income in their hands under the Act, as financing arrangements and denies any capital allowances that would otherwise be available in respect of the asset sold and leased back. Qualifying repurchase and resale agreements are effectively treated as loans and the differential between the sale price and resale price of the underlying asset constitutes interest for purposes of section 24J of the Act. As is apparent, ‘interest’ is exceedingly broadly defined under section 24J of the Act, embracing interest on all forms of debt, payments economically equivalent to interest, and expenditure incurred in relation to raising finance. The WTI was introduced into the Act in terms of section 50A – H, and came into effect on 1 March 2015. In order for the WTI to be levied in terms of section 50B of the Act, interest is required to be paid by any person to or for the benefit of any foreign person to the extent that such amount is regarded as having been received or accrued from a source within South Africa in terms of section 9(2)(b) of the Act. When the initial WTI legislation was released, the provisions contained a definition of interest which included, inter alia, interest as defined in section 24J of the Act. However, no such definition found its way into the current incarnation of section 50A, and while the Standing Committee on Finance

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reported that the WTI would apply to common law interest, this comment does not have the force of law. With reference to the section 24J definition of ‘interest’, it is noted that section 50B of the Act refers to the source provisions contained in section 9(2)(b) of the Act, which apply exclusively to interest as defined in section 24J. On this basis, the interest subject to WTI could have been interest as defined in s24J. However, the section 24J definition of ‘interest’ exceeds what is understood as common law interest. The definition includes any discount or premium in respect of a financial arrangement as well as compensation payable by a borrower to a lender in terms of any lending arrangement. In addition, as noted above, the provisions of section 24J of the Act treat qualifying repurchase and resale agreements as loans and deem the differential between the sale price and resale price of the underlying asset to be interest. As such, the former absence of a definition of ‘interest’ in section 50A meant that the application of the WTI could conceivably exceed the ambit originally foreseen by the legislator. In addition to the foregoing uncertainty, another concern arises regarding the application of the WTI. The WTI is required to be levied on interest that “is paid by any person to or for the benefit of any foreign person to the extent that the amount is regarded as having been received or accrued from a source within the Republic in terms of section 9(2)(b);” that is, interest incurred by a South African resident, unless that interest is attributable to a permanent establishment located outside South Africa; or interest received in respect of the utilisation or application in South Africa by any person of any funds or credit obtained in terms of any form of interest-bearing arrangement. This means that interest paid by a non-resident borrower to a foreign lender may be subject to the WTI should the non-resident borrower have utilised or applied

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the funding obtained from the foreign lender in South Africa. In consequence, it would be incumbent on a non-resident to withhold the tax on interest. This potential inter-jurisdictional quagmire brings another issue to light: the definition of ‘interest’ in the double taxation agreements (DTAs) to which South Africa is party. Since the bulk of DTAs to which South Africa is party are formulated in accordance with the OECD Model Tax Convention on Income and on Capital (OECD MC), the logical point of departure is Article 11 (interest) of the OECD MC: The term ‘interest’ as used in this Article means income from debt-claims of every kind, whether or not secured by mortgage and whether or not carrying a right to participate in the debtor’s profits, and in particular, income from government securities and income from bonds and debentures, including premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late payment shall not be regarded as interest for the purposes of this Article. The above constitutes a wholly autonomous definition of ‘interest’ which the Commentary on the OECD MC states is preferable because it encompasses practically everything regarded as interest in the various states’ domestic laws, offers greater security because it is unaffected by changes in domestic laws, and references in the OECD MC to domestic law should be avoided if at all possible. However, the Commentary goes on to provide that states are at liberty to include items covered by the domestic law definition of interest. Certain of South Africa’s DTAs contain an ‘interest’ definition that is wholly autonomous and corresponds with the OECD MC ‘interest’ definition (e.g. South Africa’s DTAs with France, the Netherlands and the United Kingdom (UK)). Other DTAs, however, extend the definition of ‘interest’ to include all other income treated as interest by the domestic tax law of the state in which

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such income arises (e.g. South Africa’s DTAs with Australia, Germany and the United States (US)). In addition to the potential interpretational issues referred to above, many of South Africa’s DTAs deny the right to tax interest in the jurisdiction where it arises, effectively emasculating South Africa’s WTI (e.g. South Africa’s DTAs with France, the Netherlands, the UK and the US); alternatively they limit the rate at which such interest may be taxed at source (e.g. South Africa’s DTAs with Australia and Germany limit the rate at which interest may be taxed in the jurisdiction of source to 10%). As such, the WTI will apply predominantly when the non-resident interest recipient’s country of residence does not have a DTA with South Africa. Where a DTA does exist between South Africa and the non-resident’s country of residence, the DTA terms will have to be renegotiated or a protocol signed to take cognisance of the WTI. As is apparent from the DTAs referred to above, most of which are modelled on the OECD MC, the rate at which withholding tax may be levied at source is limited. This does not bode well for South Africa. Given the WTI rate of 15%, DTAs to which South Africa is party require renegotiation. Regrettably DTA amendments progress very slowly. Since the implementation of the WTI was motivated by the desire to protect South Africa’s tax base from erosion, one must question its ability to achieve such end given South Africa’s extensive DTA network. At least the Bill provides clarity as to the meaning of ‘interest’ for the WTI, but whether the WTI itself is capable of shoring up South Africa’s tax base against erosion, remains unclear. Cliffe Dekker Hofmeyr ITA: Section 9(2)(b), 23G, 24J and 50A- H OECD MC: Article 11

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TAX ADMINISTRATION 2485. SARS powers and policies

While the Tax Administration Act of 2011 (the TAA) determined and consolidated the powers and duties of South African Revenue Service (SARS) officials engaged in the administration of a tax Act, it also, to a certain extent, codified the rights and obligations of taxpayers to whom the TAA applies. Due to the fact that the TAA has now been in effect for a couple of years since its commencement date of 1 October 2012, there is a greater understanding of how the legislation is being practically implemented. Recent experience indicates that there may be a growing disconnect between the internal policies being implemented by SARS officials and the actual powers provided for in the enabling legislation. This article briefly highlights two examples recently encountered in practice. Section 164 – requests for suspension of payment of a tax debt Section 164 of the TAA governs requests for the suspension of payment of a tax debt pending the outcome of an objection and appeal. Section 164(2) of the TAA, in particular states the following: “A taxpayer may request a senior SARS official to suspend the payment of tax or a portion thereof due under an assessment if the taxpayer intends to dispute or disputes the liability to pay tax under Chapter 9.” While it is clear that section 164 does not actually require that the notice of objection is lodged, it has recently come to our attention that the relevant SARS committees will not consider the section 164 request for suspension of payment of the tax debt unless a copy of the taxpayer’s objection lodged with SARS is provided. It is very important that taxpayers do not without good reason refrain from settling debts due and payable to SARS, however there is nevertheless an

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important purpose for the inclusion of the words “intends to dispute” in the legislation. It is submitted that by insisting on being provided with a copy of the objection, such action disregards the enabling legislation, is beyond the scope of the powers of SARS and is in effect prejudicial to a taxpayer. For example, a taxpayer may desperately require a valid Tax Clearance Certificate but is unable to obtain it as there is an outstanding tax debt owing to SARS and a request to suspend payment has not been considered under section 164 of the TAA as SARS insists on a copy of the submitted objection. The difficulty which often arises, however, is that the objection cannot be submitted due to a number of factors beyond the control of the taxpayer, including delays by SARS in providing adequate reasons. The prejudice to a taxpayer far outweighs the prejudice to SARS, particularly as SARS has the ability to immediately revoke the section 164 request for suspension to the extent that an objection is not ultimately lodged and in that instance, SARS will receive interest retrospectively on the amount of tax allegedly due. The insistence by SARS of a copy of the submitted objection does not therefore correctly reflect what is required in the TAA. Prescription – Section 99(2) of the TAA Ordinarily, SARS cannot make an assessment three years after the date of assessment of an original assessment by SARS and in the case of self-assessment (i.e.: VAT and PAYE), the period of prescription is extended to five years. This period of limitation creates much needed certainty and stability and similar periods of prescription in respect of fiscal matters are recognised the world over. Having said that, section 99(2) allows SARS to re-open an assessment beyond the three or five year limitation periods to the extent that the full amount of tax

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chargeable was not assessed, was as a result of fraud, misrepresentation and/ or non-disclosure of material facts on the part of the taxpayer. Recent experience indicates that SARS is not as concerned as it should be whether it can be shown that there has been fraud, misrepresentation or non-disclosure of material facts but is rather more concerned whether it has a strong case insofar as the underlying merits are concerned. In other words, there is a view within SARS that the primary consideration in raising an assessment beyond the three year period is the strength of the underlying merits of the case and the issue of prescription is merely secondary and in essence is just a box that needs to be ticked. This is a worrying trend, as fraud, misrepresentation and non-disclosure of material facts are very serious allegations to make against a taxpayer which must be very carefully considered before being alleged. It is always difficult to predict certain issues which may arise when the legislation is being drafted and often practical issues only arise subsequent to the promulgation of tax Acts. Having said that, it is understandable that the TAA in its infancy is still creating much uncertainty of treatment and interpretation by SARS, taxpayers and tax advisers alike. It is hoped that the issues raised above are merely isolated incidents and not evidence of a worrying trend that SARS is implementing policies that disregard the enabling legislation. Nevertheless, it is important that taxpayers fully understand their rights and obligations as contained in the TAA and where there is uncertainty, they should raise such issues through the formal SARS complaints mechanisms as well as consult professional advisers. ENSafrica TAA: Sections 99(2), 164 and Chapter 9 Editorial comment: The Tax Administration Laws Amendment Bill 2015 has proposed extending the prescription periods under certain conditions.

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2486. International standards (Refer to article 2470 December 2015 Issue) The purpose of the Tax Administration Act of 2011 (the TAA), is to ensure the effective and efficient collection of tax, by aligning the administration of the tax Acts to the extent practically possible, prescribing the rights and obligations of taxpayers and other persons to whom the TAA applies, prescribing the powers and duties of persons engaged in the administration of a tax Act, and generally giving effect to the objects and purposes of tax administration. The TAA provides that the South African Revenue Service (SARS) is responsible for the administration of the TAA under the control or direction of the Commissioner of SARS. The administration of a tax Act means, inter alia, to give effect to the obligation of the Republic to provide assistance under an international tax agreement, which means, a) an agreement entered into with the government of another country in accordance with a tax Act, or b) any other agreement entered into between the competent authority of the Republic and the competent authority of another country relating to the automatic exchange of information under the aforementioned agreement. On 27 October 2015, the Tax Administration Laws Amendment Bill, 2015 (TALAB 2015), was introduced in the National Assembly by the Minister of Finance. In terms of the TALAB 2015, it is proposed that the administration of the TAA under section 3 of the TAA should include giving “effect to an international tax standard”. It is further proposed in the TALAB 2015, that a new definition i.e. “international tax standard” would be introduced into the TAA and would be defined as “(a) the Standard for Automatic Exchange of Financial Account Information in Tax Matters; (b) the Country-by-Country Reporting Standard for Multinational Enterprises specified by the Minister; or (c) any other international standard for the exchange of tax-related information between countries specified by the Minister, subject to such changes as specified by the Minister in a regulation issued under section 257.”

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In addition, it is proposed that section 3 of the TAA be amended to include the instance where “SARS, in accordance with an international tax standard, obtained information of a person”. In this regard, “SARS may retain the information as if it were relevant material required for purposes of a tax Act and must treat the information obtained as taxpayer information.” According to the Draft Memorandum on the Objects of the Tax Administration Laws Amendment Bill, 2015 (“Explanatory Memorandum”) paragraph (a) of the proposed new definition of “international tax standard” “is required to implement a scheme under which SARS may require South African financial institutions to collect information under an international tax standard, such as the OECD Standard for Automatic Exchange of Financial Account Information in Tax Matters, which encompasses the Common Reporting Standard (CRS), that was endorsed by G20 Finance Ministers in 2014. In order to implement the standard on a consistent and efficient basis, certain financial institutions must report on all account holders and controlling persons, irrespective of whether South Africa has an international tax agreement with their jurisdiction of residence or whether the jurisdiction is currently a CRS participating jurisdiction. This will substantially ease the compliance burden on reporting financial institutions as they would otherwise have to effect system changes and collect historical information each time a jurisdiction is added to the CRS or South Africa concludes a new international tax agreement. The reporting financial institutions will, pursuant to this amendment, be obliged by statute to obtain the information and provide it to SARS.”

In addition, the Explanatory Memorandum provides that paragraph (b) of the proposed new definition of ‘‘international tax standard’’ “includes the country-by-country reporting standard for multinational enterprises. This originates from a report in September 2014 by the countries involved in the OECD/G20 BEPS Project titled ‘‘Guidance on Transfer Pricing Documentation and Country-by-Country Reporting’’. This report described a three-tiered

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standardised approach to transfer pricing documentation that consists of a master file, a local file and a country-by-country (CbC) Report. Its inclusion is part of establishing the framework for obtaining CbC Reports, irrespective of whether South Africa has international tax agreements with all the jurisdictions in which a group does business or whether the jurisdictions are currently CbC participating jurisdictions.” In light of the above, it is clear that the National Treasury aims to amend domestic tax legislation so as to ensure, inter alia, that SARS will be able to adhere to international tax standards. The goal is to create greater transparency and more consistent and efficient automatic exchanges of information between foreign tax authorities. ENSafrica TAA: Sections 3 and 257 Tax Administration Laws Amendment Bill, 2015 and related Objects Protection of Personal Information Act, 2013 TRUSTS 2487. Disposals by incentive trusts Generally, where an employer establishes a trust to hold certain shares for future distribution to its employees as part of a share incentive scheme, the scheme is structured in such a manner that there are no capital gains or losses for the trust upon distribution. In this regard, reliance is usually placed on paragraph 11(2)(j) of the Eighth Schedule of the Income Tax Act of 1962 (the Act), which provides that: “(2) There is no disposal of an asset: …

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(j) which constitutes an equity instrument contemplated in section 8C, which has not yet vested as contemplated in that section…” However, according to the explanatory memorandum to the Taxation Laws Amendment Bill 2015 (Bill), it is indicated that “paragraph 11(2)(j) of the Eighth Schedule has been misinterpreted to mean that there is no disposal event at all by the trust in respect of an equity instrument”. Accordingly, the Bill makes five amendments to the Eighth Schedule of the Act in order to ‘clarify’ the tax treatment of disposals by incentive trusts. Firstly, paragraph 11(2)(j) of the Eighth Schedule will be deleted. Secondly, a new paragraph 13(1)(a)(iiB) will be inserted to deal with the time of disposal of equity instruments by trusts: “13(1) The time of disposal of an asset by means of: (a) a change of ownership effected or to be effected from one person to another because of an event, act forbearance or by operation of law is, in the case of: … (iiB) the granting by a trust to a beneficiary of an equity instrument contemplated in section 8C, the time that equity instrument vests in that beneficiary as contemplated in that section…” Accordingly, the granting of an equity instrument by a trust will constitute a ‘disposal’, but the ‘time of disposal’, and therefore any capital gains tax effect, is postponed until such time as the equity instrument vests. Thirdly, a new paragraph 64C will be inserted to deal with instances where an employee exchanges an equity instrument that has not yet vested for another instrument, as contemplated in section 8C(4)(a) of the Act, or where the employee disposes of the equity instrument to a connected party as

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contemplated in section 8C(5)(a) of the Act. In these circumstances, any capital gain or loss must be disregarded, because the tax consequences will be rolled over to the new instrument, or the connected party. Fourthly, an amendment will be introduced to paragraph 80(1) of the Eighth Schedule, which will effectively exclude the disposal by a trust of a section 8C equity instrument to an employee beneficiary from the flow-through principle, and capital gains or losses will not be attributed to the employee. However, the flow-through principle as contained in paragraph 80(2) will still apply where the trust disposes of the shares and then makes a cash distribution of any capital gain to the employee. Lastly, a new paragraph 80(2A) will be inserted in the Eighth Schedule of the Act, which will exclude the operation of paragraph 80(2) as mentioned above to the extent that the capital gain is distributed to the employee by reason of the vesting of an equity instrument in that employee in terms of section 8C of the Act. Gains resulting from a share exchange or forfeiture in terms of section 8C(4)(a) or section 8C(5)(c) respectively will also be excluded. Cliffe Dekker Hofmeyr ITA: Section 8C, Paragraphs 11(2)(j), 13(1)(a)(iiB) 64C and 80 of the Eighth Schedule SARS NEWS 2488. 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.

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Editor: Ms S Khaki Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC Foster 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.