JUNE 2012 ISSUE 153 CONTENTS INTERNATIONAL TAX SOURCE SARS NEWS

Transcription

1 CAPITAL GAINS TAX JUNE 2012 ISSUE 153 CONTENTS INTERNATIONAL TAX Consequences of the changes in inclusion rates DEDUCTIONS Future expenditure on contracts Wear and tear allowance DIVIDENDS TAX Beneficial owner ESTATE PLANNING Competence to appropriate trust assets GENERAL Banking secrecy Assessments and trading stock Foreign tax credits SOURCE Application of amnesty TAX ADMINISTRATION Personal liability for tax debts VALUE ADDED TAX Joint ventures SARS NEWS Interpretation notes, media releases and other documents CAPITAL GAINS TAX Consequences of the changes in inclusion rates In the Budget Speech of 22 February 2012 it was announced that the Capital Gains Tax (CGT) inclusion rates would be increased. In particular, it was indicated that the effective CGT rates would be: 13,3% in the case of individuals 18,6% in the case of companies 26,6% in the case of trusts 1

2 Effectively, the inclusion rates are to be increased in the case of individuals to 33,3% and in other cases to 66,6%. Given the fact that the changes were to come into effect for the disposal of assets from 1 March 2012, a number of agreements were concluded with haste on the basis that they were implemented by 29 February Effectively, the time of disposal of an asset is defined in paragraph 13 of the Eighth Schedule as: In the case of an agreement that is subject to a suspensive condition, the date on which the condition is satisfied. In the case of an agreement that is not subject to a suspensive condition, the date on which the agreement is concluded. Parties had to ensure that all suspensive conditions were satisfied by 29 February Lo and behold, the Rates and Monetary Amounts and Amendment of Revenue Laws Bill that was released on 13 March 2012 refers to the fact that the increase in the rates is to come into operation on 1 March 2012 "and applies in respect of years of assessment commencing on or after that date." In other words, should the year of assessment of a company end on 30 June 2012, it has until such date to enter into transactions at the lower CGT rate. Unfortunately this change in wording does not apply to individuals on the basis that the year of assessment commenced on 1 March However, companies (and in some instances trusts) have now been offered a grace period on the basis that transactions can still be entered into at the lower CGT rate depending on when the year of assessment ends. It is a pity that the correct terminology was not used when the change in the tax rates were announced, as it could have saved a lot of anxiety and costs on the part of companies that were in the process of entering into transactions pertaining to the disposal of assets. Those companies that thought that they missed the opportunity can still reconsider this given the change in the wording of the proposed legislation. Cliffe Dekker Hofmeyr IT Act: 8 th Schedule para 10 DEDUCTIONS Future expenditure on contracts Advance payments are often received under contracts which are entered into in one year of assessment for goods to be delivered or services to be rendered in a later year. As amounts are taxed at the earlier of receipt or accrual, these advance payments are included in a taxpayer s taxable income in the year in which they are received. 2

3 The purpose of section 24C of the Income Tax Act No. 58 of 1962 is to give relief to a taxpayer who has received an advance payment, in terms of a contract, and who will incur expenditure under that contract in future. In other words, the allowance provides relief where a mismatch between income and expenditure occurs in a tax year by putting the taxpayer in the same position as he would have been had he earned the income and incurred the expenditure in the same tax year. If the income of a taxpayer includes an amount received or accrued in terms of any contract and the Commissioner is satisfied that such amount will be used to finance (in whole or part) future expenditure which will be incurred by the taxpayer in performing his obligations, the Commissioner may grant the taxpayer an allowance in respect of such future expenditure. The allowance cannot exceed the amount received or accrued in terms of the contract and must be added back to the taxpayer s taxable income in the following year. It is important to note that the allowance is at the Commissioner s discretion. In other words, the deduction is not automatic and a claim for the deduction must be motivated by a taxpayer. A taxpayer is, in essence, required to accurately estimate the expenses that need to be incurred in order to meet their obligations under the specific contract. The South African Revenue Service ( the SARS ) will, however, generally accept a calculation that is based on the ratio that the total estimated expenditure bears to the estimated gross income to be derived from the contract (i.e. the contract s gross profit percentage). Taxpayers tend to forget that the allowance is not automatic and simply claim it without ensuring that all of the requirements of the section have been met. Further, it is common practice for taxpayers to simply base their section 24C allowance on the costs used to calculate their gross profit. We note that as it is a discretionary allowance, the SARS may disallow it on the basis that it does not accurately represent the future estimated expenditure to be incurred under the specific contract. And, while the difference is merely a timing one, it may lead to additional tax, penalties and interest. On the basis that determining a gross profit percentage on a contract-by-contract basis may be difficult for the taxpayer to determine, it is recommended that taxpayers consider disclosing the methodology adopted for calculating their section 24C allowance to the SARS and agreeing a basis for purpose of calculating it in the future to avoid unnecessary additional tax, penalties and interest. Editorial comment: In practice the Commissioner s discretion will be exercised upon assessment or audit of the case. Ernst & Young IT Act: s24c 3

4 2073. Wear and tear allowance There are several provisions in the Income Tax Act No. 58 of 1962 (the Act) that allow a deduction from taxable income for the benefit of taxpayers investing in assets to be used in carrying on a trade. The sections that are most commonly applied include section 11(e) (wear and tear allowance), section 11D (allowance in respect of assets used for purposes of research and development) and section 12C (assets used by manufacturers or hotelkeepers, aircraft and ships and in respect of assets used for storage and packing of agricultural products). There are other sections available to be applied but are in most instances specific to a taxpayers trade or very specific in terms of the nature of the asset. Section 11D and section 12C specifically deem the cost of the asset for purposes of determining the relevant allowance to be the lesser of actual cost or market value. Section 11(e) on the other hand refers to the term value for purposes of determining the relevant allowance. Furthermore sub-paragraph (vii) of section 11(e) states that where the value of an asset for purposes of section 11(e) is to be determined having regard to cost, such cost shall be deemed to be the cost which a person would, if he had acquired such asset under a cash transaction concluded at arm s length, have incurred in respect of the direct cost of the acquisition of such asset, including the direct cost of the installation or erection thereof. The term value is not defined in the Act and the purpose of the inclusion of sub-paragraph (vii) in section 11(e) is not clear. In particular, there is no provision in section 11(e) which requires the value of an asset to be determined having regard to its actual cost! Consequently it has been the subject of much debate whether the term value in the context of section 11(e) can be interpreted to refer to the market value of the asset, where the market value exceeds the actual cost incurred. To illustrate this point let s assume that Taxpayer A acquires furniture to be used in the carrying on of trade from an unconnected person for a cash cost of R10,000. Based on several different adverts for the exact same furniture from other suppliers, the actual market value of the furniture is in the region of R20,000. The question arises whether the section 11(e) wear and tear allowance must be calculated on the R10,000 (actual cost) or the R20,000 (market value). SARS provided guidance on the issue in Interpretation Note 47 (Issue No.2) (IN47) and confirmed therein that the taxpayer s cost of acquisition of an asset (that is, the cash cost excluding finance charges) is to be used when determining the section 11(e) allowance. Normally an Interpretation Note is simply an explanation of SARS view and does not create legal binding precedent. This appears to be the case with the remainder of IN 47 which doesn t address the two points mentioned above. But IN 47 states that it is a Binding General Ruling (BGR) made under section 76P, in relation to section 11(e) in so far as the determination of the value of an asset for purposes of section11(e), 4

5 and the determination of the amount which will qualify as an allowance, is concerned. A BGR is binding on SARS in terms of section 76H(3) and (6) read with section 76P of the Act. Further, on 11 April 2011 SARS issued Binding General Ruling: No 7 (BGR7) dealing with section 11(e). BGR7 states that SARS policy has always been, unless otherwise prescribed, to regard the value of an asset for purposes of determining the section 11(e) allowance as the taxpayer s cost of acquisition (that is, the cash cost excluding finance charges). SARS substantiates this policy with the findings in ITC 1546 [1992] 54 SATC 477 where a landlord acquired second-hand furniture and fittings at a bargain price from the liquidator of its tenant. The landlord attempted to claim the wear and tear allowance on a revalued amount, based on sub-paragraph (vii) of the proviso to section 11(e). This argument was rejected by the court, which held that the allowance was properly claimable only on the cost of the articles. SARS explains that the only exception to this policy is where the asset is acquired by way of a donation, inheritance or as a distribution in specie, in which case the allowance is based on the market value of the asset, subject to the Commissioner s discretion. Alternatively, where the asset is acquired from a connected person the provisions of section 23J need to be applied. BGR 7 reiterates what is already confirmed in IN 47 and seems to be SARS attempt to rule out any uncertainty and that value for purposes of determining the section 11(e) allowance is the actual cash cost incurred, excluding finance charges (unless the asset in question is acquired by way of a donation, inheritance, as a distribution in specie or from a connected person). However a BGR is not binding on the taxpayer. Neither is ITC 1546 binding on the taxpayer as it is merely a tax court case. BGR 7 and IN 47 do not clarify the reason for the deeming provision of sub-paragraph (vii) in section 11(e). Therefore although BGR 7 and IN 47 suggest that a taxpayer will have to go to court to use value in the context of a section 11(e) allowance, if a taxpayer has enough at stake, there may be merit in pursing the matter. Hence the uncertainty referred to may not quite be ruled out! Ernst & Young IT Act: s11(e), s11d, 12C BGR 7 IN 47 DIVIDENDS TAX Beneficial owner The Tax Court of Canada handed down its long awaited judgment in the Velcro case (Velcro Canada Inc v The Queen 2012 TCC 57) on 24 February By way of background, Velcro Canada Inc. (VCI) paid royalties to a sub-licensee in the Netherlands (the Sub-Licensee), which 5

6 in turn was obliged to pay 90% thereof to the licensor. In terms of the Treaty concluded between Canada and the Netherlands, the royalty was reduced to 10% compared to the general rate of 25% that would have applied. Ultimately the question was whether the Sub-Licensee in the Netherlands was the beneficial owner of the royalties that were paid by VCI. In approving the approach that was adopted in the Prévost Car case (Prévost Car Inc v The Queen [2008] TCC 231), it was indicated that one would not be the beneficial owner of an amount if the recipient had no discretion as to the use or application of funds put through it as a conduit without any right to do other than what the ultimate recipient instructs it to do. In the Prévost case it was indicated that the beneficial owner of dividends is the person who receives the dividends for his own use and enjoyment and assumes the risk and control of the dividend he received. It was indicated in the Velcro case that there are four elements that one should consider to determine whether the recipient is the beneficial owner of the payment, being: possession use risk; and control Ultimately one should thus have determined whether the sub-licensee received the payments for his own use and enjoyment and assumed the risk and control of the payments that it received. In analyzing the cash flows, it was indicated that the Netherlands sub-licensee had discretion to utilise the royalties received. The royalties were commingled with other monies and were used to do a variety of things. The sub-licensee had exclusive possession and control over the accounts and various charges were deducted before the ultimate licensor was paid. It was also indicated that the sub-licensor assumed the risk in relation to the royalties. Apart from currency conversion, the royalties were available to the creditors of the sub-licensor. There was also no predetermined flow of funds even though the sub-licensee paid approximately 90% of the royalties to the licensor. Ultimately it was indicated that the sub-licensee was not a nominee acting on behalf of the licensor. It was indicated that the sub-licensee was not a conduit or a channel through which the funds were paid. The approach adopted by the Tax Court in the Velcro case is quite important in a South African context given the introduction of the dividends tax. In particular, the dividends tax is reduced to 5% in terms of some of the Treaties concluded by South Africa compared to the 15% that will generally apply. The dividends tax is imposed with reference to the receipt of the dividend by the beneficial owner. The beneficial owner is defined in section 64D of the Income Tax Act as the person entitled to the benefit of the dividend attaching to a share. Should the approach of the Tax Court in the Velcro case be adopted, the fact that the recipient may in turn pay dividends to its own shareholder would not in itself result in the recipient not being the beneficial owner. 6

7 Ultimately the question is whether the recipient is a mere conduit or whether it would assume the risk and control of the dividends that are to be received. Cliffe Dekker Hofmeyr IT Act: s64d ESTATE PLANNING Competence to appropriate trust assets The concept of a trust originated in English law and has been called the most distinctive and creative achievement of English jurisprudence. Because of its flexibility, the trust is an oft-used tax and estate planning tool. The English trust concept originated during the 12th and 13 th century Crusades. English land ownership was still a feudal system. A Crusader leaving England would grant ownership of his estate to a trusted acquaintance with the understanding that his land would be restored to him on his return. The King s Courts regarded the Crusader s land as belonging to the trustee who had no obligation to return same. The returning Crusader could, however, petition the King who referred such disputes to the Lord Chancellor. The Lord Chancellor decided matters according to his conscience and so developed the notion of equity. Over time, the Lord Chancellor s court continuously recognised the returning Crusaders claims. The principle developed that the legal owner (the trustee) only held the land for the benefit of the original owner (the beneficiary) until his return, at which stage the trustee then had to return the land. The term use of land was coined and eventually developed into the trust concept. Fast-forward a couple of centuries. Recently, the South Gauteng High Court (Saldulker J and Mayat J) in Rees & Others v Harris & Others [2011] JOL (GSJ) had to deal with the question of whether a trust was merely the alter ego of one Dean Rees. Rees allegedly acted in collaboration with Barry Tannenbaum in running a fraudulent Ponzi scheme. Over some years, Harris and trusts affiliated to him had invested more than R80 million with Rees. Now disgruntled, Harris stated in Court that the Aljebami Trust had been misused by Rees as his alter ego, because: The Trust was a family trust with Rees and his wife at its helm as trustees. Rees was the founder of the Trust and he and his family were the beneficiaries. Rees controlled all the Trust s assets. The decision-making in regard to the Trust vested primarily with Rees. 7

8 Saldulker J had to decide whether the Trust s assets could effectively be taken to be Rees own assets. The Rees case is not a tax case, but it does contain a handy analysis of the circumstances under which a trust could potentially be stripped of the facade of a separate legal personality. Saldulker J started off by referring to legal precedent laying down the following general principles: The fundamental attribute of corporate personality (i.e. separate legal existence) can only be retracted when the level of mismanagement of the corporation s affairs exceeds the merely inept or incompetent and becomes heedlessly gross or dishonest. To disregard the separateness of a company from its shareholders (i.e. the piercing of the corporate veil), is something exceptional. Each case has to be decided on its own facts. The Judge quoted extensively from the judgment by Cameron JA in Land & Agricultural Development Bank of South Africa v Parker & others [2005] (2) SA 77 (SCA), and sounded this warning: Thus, in appropriate circumstances, the veneer of a trust can be pierced in the same way as the corporate veil of a company. Consequently, where the trustees of a trust clearly do not treat the trust as a separate entity, and where special circumstances exist to show there has been an abuse of the trust entity by the trustee, the veneer must be pierced. It follows that if a legitimately established trust is used or misused in an improper fashion by its trustees to perpetrate deceit, and / or fraud, the natural person behind the trust veneer must be held personally liable. In these circumstances, if it is demonstrated that a trustee who has de facto control of the trust assets effectively acquired and owned such assets for his own benefit only, such assets can in appropriate circumstances be considered to be those of the said trustee. Ultimately the Judge held that...there is nothing to suggest on a balance of probabilities, that the assets of the Aljebami Trust were in fact the assets of Rees in his personal capacity. The burden of proof had not been discharged, since... the onus was on Harris to establish on a balance of probabilities that Rees (exclusively of his wife) controlled the Aljebami Trust to such an extent that the assets of the trust were effectively Rees s own. This required irrefutable primary facts rather than the vague and unsubstantiated inferences and generalisations contained in Harris s affidavits. Saldulker J contrasted the facts before him with those of Badenhorst v Badenhorst [2006] (2) SA 255 (SCA). In last- mentioned case Badenhorst had full control of the trust assets and had used the trust as a vehicle for his business activities. 8

9 Editorial comment: Thus when Badenhorst s marriage floundered, Mrs Badenhorst succeeded in procuring that the assets of the Trust were treated as his own for purposes of dividing the assets as part of the divorce proceedings. Cliffe Dekker Hofmeyr IT Act: s7 Estate Duty Act: s3(3)(d) GENERAL Banking secrecy For bank secrecy across the globe it s the end of the world as we know it. For High Net Worth Individual (HNWI) taxpayers impacted by this, there s unfortunately no reason to feel safe. A quick stock-take of recent events, evidencing the crumbling of the impenetrable bank secrecy offered in glossy marketing brochures, reveals the havoc: In 2009 the United States (US) Justice Department and Internal Revenue Service (IRS) settles with UBS. The Swiss bank has to pay $780 million and hand over thousands of client names. In early 2011 four Credit Suisse bankers are prosecuted under a US tax evasion investigation. It is said that the bank maintained thousands of secret accounts holding $3 billion in untaxed assets. The IRS investigation soon expands to include Israeli and Asian banks. It seems Swiss banks merely told clients to move assets to other countries rather than disclose same to the US. March 2011 sees the Swiss bank regulator reprimand HSBC s Geneva-based private bank for internal and IT controls. This after the theft of data covering thousands of international clients. In early February 2012 Swiss Wealth Manager, Julius Baer announces that it was looking to gain assets because a tax evasion crackdown in the US and Europe had forced fund withdrawals. Julius Baer earlier paid Germany 50 million to end an investigation over undeclared client assets. Baer also expects to hand over client data to US authorities as part of a final settlement. On 2 February 2012 Wegelin & Co (the oldest Swiss bank founded in 1741) becomes the first overseas bank facing criminal charges in the US (despite it having no branches in the USA). Wegelin is accused of enabling wealthy Americans to evade taxes on some $1.2 billion since On 10 February Wegelin is declared a fugitive after its no-show at a Manhattan Federal Court hearing. 9

10 Currently the US Justice Department s criminal investigation involves 11 Swiss banks. A Swiss-American lobby group has urged restraint. Swiss officials are hoping for a settlement covering the entire Swiss banking industry, i.e. more than 300 banks. Wegelin is no more. It has since broken itself up. Apparently US Justice officials were really annoyed when the bank wrote a Farewell, America letter to its clients following the 2009 UBS settlement. One has recently seen approaches by South Africans who did not enter the 2010/11 Tax and Exchange Control Voluntary Disclosure Programs (Tax and Excon VDP s). Their question: what is really the risk, and where do we go from here? The bad news: The South African Revenue Service (SARS) and the South African Reserve Bank (SARB) entertain no late VDP applications. The 31 October 2011 cut-off was in terms of statute (for the Tax VDP) and Regulation 24 (for the Excon VDP) and hence no extension by officialdom is possible. But there is some good news... unfortunately, it comes at a price. SARB s Financial Surveillance Department s Investigations Division does allow for the administrative regularisation of previously undisclosed Excon contraventions. SARB s guideline at the moment is a penalty of between 20 40% of the Excon contravention amount. No set-off of the unutilised portion of the R4 million Foreign Investment Allowance is, however, allowed. On the tax front there is currently not a formal VDP available. Any disclosure to SARS in relation to previously undeclared off-shore income/capital gains will thus depend on SARS waiving penalties and/or interest in terms of its normal statutory discretions. Such disclosure would have to be made at the local SARS office where the taxpayer is on register. It will require presentation of the matter to the relevant SARS Committee(s) at that particular office. Recent experiences show this to be quite cumbersome and the outcome somewhat unpredictable. But there is hope. The current Tax Administration Bill (TAB) provides in Chapter 16, Part B, sub-section for a permanent voluntary disclosure mechanism. The TAB s disclosure dispensation by and large follows the model of the statutory Tax VDP which terminated on 31 October Taxpayers would be able to declare previously undisclosed off-shore income/capital gains under the Tax Administration Act (TAA), once signed into law. However, the penalty and/or interest relief will certainly be less generous than for past VDPs. [Promulgation of the TAA can probably be expected towards the middle of 2012.] Any taxpayer deciding to take his/her chances should take cognisance of section 78 (1A), (1B) and (1C) of the Income Tax Act No 58 of

11 Those sections apply where the Commissioner has reason to believe that any resident has not declared or accounted for any funds held in a foreign currency or any assets owned outside South Africa, alternatively any income or capital gain attributable to such resident. Sub-section (1A) empowers SARS to estimate ( shall estimate ) the amount in foreign currency of any such funds or the market value in foreign currency of such assets. In making the said estimate SARS could take into account, amongst others, the funds or assets originally transferred from South Africa and the period elapsed since transfer. Under section 78 (1B) SARS shall estimate an amount of taxable income derived from such off-shore funds and/or assets by applying the official rate of interest (normally used for fringe benefit tax purposes) to such funds or to the value of such assets. [Taking into account the low interest rates that have prevailed off-shore the last number of years, this basis of calculation would definitely be hugely prejudicial to a South African taxpayer.] The estimated amount is then converted into Rands at the ruling exchange rate for inclusion in the taxpayer s taxable income for assessment purposes (sub-section (1C)). SARS estimate(s) as set out above are subject to objection and appeal). What should South Africans exposed to the above-mentioned risks do? Firstly, accept that bank secrecy no longer guarantees non-detection. Secondly, to move monies/assets to another bank or jurisdiction might just heighten the detection risk taking into account banks strict know your client rules and the controls that apply to cross-border currency flows. Thirdly, be aware that any head-in-the-sand strategy could trigger SARS use of its powers to estimate the undisclosed overseas income/capital gain once SARS becomes aware of any concealed off-shore funds and/or assets. Fourthly, should there be a real risk of detection (e.g. data theft), consider approaching the SARB and/or SARS under the available (and soon to be available) disclosure regimes for Excon contraventions and Tax defaults respectively. And manage such process carefully. The rules of the game have changed. Individuals resident in South Africa for Excon and tax purposes take note. Cliffe Dekker Hofmeyr IT Act: s78(1a), s78(1b), s78(1c) Tax Administration Bill No.11 of 2011: ss Assessments and trading stock In Commissioner for the South African Revenue Service v South African Custodial Services Louis Trichardt (Pty) Ltd [2011] (74 SATC 61) (ZASCA), the taxpayer concluded a 25 year concession contract with the Department of Correctional Services (DCS) in August 2000 for the design, construction, financing and operation of a prison on land owned by the DCS. The contract specifically provided that notwithstanding occupation of the land by SACS for the 11

12 duration of the concession, all rights of ownership in the land would remain with the DCS, and SACS would be prohibited from encumbering the land in any manner whatsoever. A special purpose vehicle was established in terms of which the DCS could look to one locus for the due performance of all services under the contract. SACS was directly responsible for the management and supervision of the DCS approved sub-contractors who in fact performed all the contractual services on behalf of SACS. In order to fund the development and operation of the prison, SACS obtained certain loans, security for which was provided by way of guarantees issued by the DCS and the shareholders of SACS in favour of the relevant financial institutions. SACS incurred interest and a slew of fees on such funding. The prison was brought into use in February The Commissioner for the South African Revenue Service (SARS) argued the finality of SACS 2002 assessment and disallowed the deduction of certain expenditure claimed by SACS against which it successfully appealed to the court below. SARS appeal from the decision of the court below to the Supreme Court of Appeal is under consideration here. It is of significance as it addresses three important tenets of tax law: 1. What constitutes an assessment? 2. The interpretation and application of section 22(2A) of the Act; and 3. The meaning of related finance charges in section 11(bA) of the Act. SACS argued the deductibility of the expenditure in contention on the following bases: Section 22(2A) operated to deem the prison to be trading stock held and not disposed of by it, and included in the cost thereof, in terms of section 22(3A), pre-production interest, raising and other related finance charges in accordance with generally accepted accounting practice; alternatively The pre-production interest, raising and other finance fees were deductible under section 11(bA) in 2002, the year of assessment in which the prison was brought into use. The Court of Appeal held: 1. SARS letter dated 4 May 2007 notifying SACS of a determination by the Commissioner constituted an assessment as defined. It is not only an official IT34 notification that constitutes as assessment. Accordingly SACS original 2002 assessment dated 1 June 2004 had been superseded by the revised assessment contained in the Commissioner s letter of assessment dated 4 May 2007, resulting in the original assessment not having become final as the three year prescription period had not run its course. 2. The taxpayer s sub-contractor had built the prison on the DCS land. Accordingly section 22(2A) applied to deem the prison to be trading stock of the sub-contractor and not SACS. SACS was denied a deduction in respect of the cost of the prison. 12

13 3. In accepting SACS alternative argument, the interest incurred on the loans taken to enable SACS to pay its sub-contractor to construct the prison, was deductible under section 11(bA), having been actually incurred by the taxpayer. Further, the various fees (including raising, guarantee, introductory, financial advisory, margin, commitment, initial, administration and legal) qualified as related finance charges and were deductible under section 11 (ba). The Court referred the decision as to the quantum of the deduction back to SARS on the basis of the principle enunciated in the Caltex Oil (SA) Ltd v SIR [1975] (37 SATC 1) (A)) case that the interest and fees had to have been actually incurred in the year of assessment in which the deduction was sought. We are gratified by the Court s findings regarding what constitutes an assessment ; as to the breadth of meaning it accorded related finance charges, the judgment will be subject to much debate and we urge caution. Regrettably the same may not be said for its conclusion that SACS could not avail itself of section 22(2A), which, in our view ought to have been available to both the taxpayer by virtue of its contractual relationship with the DCS, and its sub-contractor within the context of their contractual relationship, with a resultant cascading effect and an accurate deferral of deductions in accordance with the completion of the various contractual relationships. In light of this judgment, we recommend that those who subcontract on any level and rely upon the provisions of section 22(2A), seek advice to determine whether their method of calculating tax is correct. Ernst & Young IT Act: s11(ba), s22(2a), s22(3a), INTERNATIONAL TAX Foreign tax credits In recent years, with the growth of SA investment in and trade with sub-saharan Africa, many SA companies have been subjected to withholding taxes that are imposed by foreign jurisdictions on remittances to them by residents of a jurisdiction where the payment was in respect of services rendered from South Africa. Typical examples are professional fees of consulting engineers and management fees levied on subsidiaries by the holding company. The law relating to the allowance of a rebate of foreign taxes has permitted the credit of the foreign taxes paid against SA taxes payable only if the source of the income is outside the Republic. This left the SA recipient with penal double tax exposure on these remittances, having incurred withholding tax and being liable to declare the income for SA purposes as well. No rebate but a deduction was allowed 13

14 SARS and National Treasury were not unsympathetic to the plight of the SA residents who were caught in this scenario and caused legislation to be enacted in 2007, which provided a partial solution to the problem. In effect, they said, taxpayers in this position may claim a deduction in respect of the foreign taxes, and pay tax on the net amount that was remitted to them. On this basis the maximum relief that could be enjoyed was 28% of the taxes withheld at source. New provisions rebate or deduction The Taxation Laws Amendment Act 2011, introduced legislation with effect from 1 January 2012 that is even more beneficial. Taxpayers may now claim a rebate in respect of foreign taxes incurred, not only where the amount payable in respect of services rendered in South Africa is subject to withholding taxes at source imposed by a jurisdiction with which South Africa has a valid double tax agreement, but also where tax is imposed on the amount in any other circumstances by any foreign government. The rebate is limited to the lesser of the SA tax attributable to the relevant amount or the foreign taxes incurred in respect of the amount. The relief cannot be claimed in addition to the deduction that was previously available but taxpayers have the right to elect deduction or rebate in each case. The rand equivalent of the foreign taxes is determined by translating the foreign tax at the average exchange rate for the year of assessment. No rebate without proof A further amendment to these provisions came into effect on 1 April This denies the right to claim a rebate in respect of taxes withheld by a treaty partner jurisdiction, unless a declaration in prescribed form of the amount withheld is submitted to SARS within 60 days of the date on which the amount was withheld. pwc IT Act: s6quin SOURCE Application of amnesty A fortunate outcome There is a saying that hard cases make bad law. A recent decision in the South Gauteng Tax Court (reported as ITC 1844 (73 SATC 45) appears to be such a case. The matter concerned the application of the Exchange Control Amnesty and Amendment of Taxation Laws Act, An employee of a South African subsidiary of a US parent company, 14

15 working in South Africa, had over a number of years been awarded options to acquire shares in the US parent in terms of a group share incentive scheme. In contravention of the exchange control regulations, he had, on exercise of the incentive options, arranged for the relevant securities to be sold and for payment of the proceeds into an offshore account. The income derived in these transactions was taxable in terms of section 8A of the Income Tax Act. He had omitted to report this income in his returns of income for the relevant years. He had therefore made application for and was granted tax and exchange control amnesty in respect of these infractions. Amnesty The legislation provided for amnesty under two specific sections, namely, section 15 in respect of receipts or accruals from a source outside the Republic (foreign source income) or section 17, which dealt with amounts accumulated as or converted to foreign assets (domestic source income). The taxpayer had applied for and been granted amnesty in terms of section 15. SARS subsequently determined that the amnesty was inapplicable, as the declaration by the taxpayer that the amounts were derived from a foreign source was incorrect, and amnesty should have been sought under section 17. SARS raised an assessment for the employee share option benefit derived in the 2002 year of assessment, to which the taxpayer objected, stating that the amnesty prevented SARS from assessing him to tax. After denial of the objection, the matter came before the Tax Court on appeal. One s sympathies lie with the taxpayer in this matter. He had taken up the invitation to clear the slate, as it were, and had disclosed all the information that had previously been withheld. In the circumstances, he felt that he was fully protected by the amnesty. In the judgment of the Court (CJ Claassen J), the crucial issue was identified in paragraph [18] (at page 52): What is important for this case, is whether or not the income received by the appellant fell within the four corners of s 15 or s 17 of the Amnesty Act. Section 15 clearly refers to undeclared foreign income from a source outside the Republic, whereas s17 refers to income of undeclared amounts which have arisen within the Republic. SARS argument was that the benefit from an employee share incentive scheme is a benefit of employment. The taxpayer had become entitled to the benefits in respect of services rendered in the Republic. Therefore, the income was derived from a source within the Republic. The taxpayer should have applied for amnesty in terms of section 17 and not section 15. In short the application was defective and the amnesty ineffective. To most observers, SARS logic is straight out of Tax 101 the source of income is not the location from which it is paid, but the quid pro quo given in return for the income received, and the location of the source is the place where the services were performed. An employee stock option is a benefit of employment and the source is therefore located at the place where the services were rendered. 15

16 The Court was not persuaded by this approach, and ruled that the evidence overwhelmingly indicated that the amounts were from a source outside the Republic. This was concluded because all of the activities in the operation of the share option scheme took place in the USA, with the funds then being deposited in the Isle of Man, and that the option contract was concluded in the USA, in terms of the principles for establishing the place of contract. Wrong approach It is submitted, with respect, that the approach taken by the Court to establish the source of the income was wrong. The question was not where the relevant amounts had arisen, but the source of such amounts a very different issue. An employee share option provides the opportunity to the employee to profit from appreciation in the value of the underlying shares between grant (the date he accepts the option) and vesting (the date when the option may be freely exercised). Employee share incentive schemes typically require that the employee should remain in the service of the employer until the benefit vests, with penal forfeiture provisions if the services of the employee should terminate prior to the vesting date. This leads to an inescapable conclusion that the benefit afforded by such an option represents remuneration for services rendered or to be rendered. The source of income taxable in terms of section 8A of the Income Tax Act was considered by the High Court in SIR v Kirsch [1978] (40 SATC 95). In that matter a SA company had allotted shares at a bargain price to service directors of a subsidiary who were employed in Israel. Inland Revenue sought to tax one of these persons, who was also a director of the SA Company, arguing that the benefit was remuneration from a source within the Republic arising from his services as director and not as employee. The Court rejected this argument, stating (at 100): During argument it became clear that the appellant had lost sight of the fact that these allottees, referred to as service directors of the Company in Israel at the directors meeting, were not the only directors of International... It seems to me that this fact utterly contradicts the suggestion that respondent received the shares qua director and indeed it establishes that the causa was his work as a service director in Israel. Once that is so there is no basis for saying that the income was from a source within or deemed to be within the Republic... This was a unanimous decision of the Full Bench of the Transvaal Provincial Division. It was almost the exact reverse of the matter that was being adjudicated in ITC 1844 involving acquisition of shares in an SA company by a foreign based employee of a foreign subsidiary. The principle is crystal clear though the services are the source (causa) of the income. One would have thought that the Tax Court of South Gauteng was bound by the doctrine of stare decisis to apply the principles from this judgment. Silke on South African Income Tax (at 5.8) states the law on source of remuneration to be the following: While the Supreme Court has yet to consider the point, the Special Court for Hearing Income Tax Appeals (now the Tax Court) has consistently laid down that the source or originating cause 16

17 of income from employment and other services rendered is the services, irrespective of the place where the contract is made or the remuneration is paid. That said, serious doubts remain as to the correctness of this decision, and, if the matter has been taken on appeal to a higher court, the Supreme Court of Appeal may yet have an opportunity to consider the point. pwc IT Act: s8a Exchange Control Amnesty and Amendment of Taxation Act No. 12 of 2003: s15, s17 TAX ADMINISTRATION Personal liability for tax debts We have recently seen SARS issuing letters styled Notice of Personal Liability of Representative Taxpayer. The letter alleges: The SARS has reason to believe that you in your capacity as the public officer/representative taxpayer/vendor either alienated, charged or disposed of income in respect of which a tax is chargeable or that you disposed of all or parts of funds or monies which were in your possession or came to you after the tax liability become (sic) payable and same amount of monies could have been utilised to pay the outstanding tax liability. Lengthy verbatim quotations from the Income Tax Act, No. 58 of 1962 ( the Income Tax Act ) and the Value-Added Tax Act, No. 89 of 1991 ( the VAT Act ) follow. Then the demand Consequently and in terms of s74a and 74B(1) of the IT Act and in terms of s57a and s57b(1) of the Vat Act this office [here it was Gauteng Central Enforcement, High Value Debt, Mega Watt Park] requires you to provide a comprehensive written representation (emphasis added) as to why SARS should not hold you personally liable for the current debt owing to SARS as indicated above Furthermore.. this office may at any time submit any of the information presented to it for further scrutiny, for either civil and/or criminal investigation purposes. Should the requested information not be furnished within ten working days, the consequence will be that...the Commissioner shall have no alternative but to come to the reasonable conclusion that you are personally liable for the outstanding tax liability. It closes by stating that the Commissioner can... exhaust all legal remedies available to it in order to recover the full outstanding tax liability from you. Mere mention that the representation made might later be used for civil and/or criminal investigation purposes. will probably scare many an addressee. 17

18 So, when exactly can SARS actually hold an individual (e.g. the director or shareholder of a company/member of a CC/trustee of a trust etc) personally liable for the legal entity s tax debt? A legal entity like a company, CC or trust (for tax purposes) has a separate legal persona. SARS must respect that. Ochberg v Commissioner for Inland Revenue [1931] 5 (5 SATC 93) held: The law endows a company with a fictitious personality. The wisdom of allowing a person to escape the natural consequences of his commercial sins under the ordinary law, and for his own private purposes virtually to turn himself into a corporation with limited liability may well be open to doubt. But as long as the law allows it the court has to recognise the position. But then too the person himself must abide by that. A company being a juristic person remains a juristic person separate and distinct from the person who may own all the shares, and must not be confused with the latter. SARS could attempt to brush aside the entity s legal persona by applying the piercing of the corporate veil doctrine. That s not easy though. ITC 1611 (59 SATC 126) described piercing of the veil as a radical step and held... a court can lift the veil only if that is legitimate by application of established doctrines, such as the plus valet rule or the fraus legis rule (or in other cases of fraud or dishonesty) or, possibly, the actio pauliana, that is if the requirements for such application are present, or a finding of a true relationship of principal and agent. There is, we consider, no self-standing doctrine of piercing the veil. The same logic applies for a trust: Recently Rees & others v Harris & others [2011] JOL (GSJ) (not a tax case) held: Thus, in appropriate circumstances, the veneer of a trust can be pierced in the same way as the corporate veil of a company. Consequently, where the trustees of a trust clearly do not treat the trust as a separate entity, and where special circumstances exist to show there has been an abuse of the trust entity by the trustee, the veneer must be pierced. It follows that if a legitimately established trust is used or misused in an improper fashion by its trustees to perpetrate deceit, and/or fraud, the natural person behind the trust veneer must be held personally liable. Consequently, SARS point of departure must be that liability for the tax debt of a company, CC or trust rests with the legal entity in the first place. Normally directors, shareholder, members and trustees would not be personally liable for the entity s tax debts where it cannot pay SARS. The 1973 Companies Act provided in section 424 that someone could be personally liable for a company s debt where the individual knowingly was party to the carrying on of the business of the company recklessly or with intent to defraud creditors of the company. [See Philotex (Pty) Ltd and others v Snyman and others [1998] (2) SA 138 (SCA) at 146G for what would be needed to prove same.] In the past SARS has not relied on s424 to establish personal liability. Perhaps the evidentiary burden relating to fraudulent and reckless trading was regarded as insurmountable? 18

19 The 2008 Companies Act provides in section 22 (1) that a company must not carry on its business recklessly, with gross negligence, with intent to defraud any person or for any fraudulent purpose. The liability of directors and prescribed officers is covered in section 77. Section 77(3)(b) provides that a director is liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the director having been a party to an act or omission by the company despite knowing that it was being conducted in a manner prohibited by section 22(1). However, under section 77(9), a court may relieve the director from liability on any terms the court considers just if it appears that (a) the director acted honestly and reasonably; or (b) regarding the circumstances, it would be fair to excuse the director. Case law, both the old and new company law provisions as well as the relevant criteria set out in the Income Tax and VAT Acts themselves make it clear that SARS has a mountain to climb before it can pin personal liability on directors, shareholders, members and trustees. Perhaps it s easier said (or rather threatened?), than done. In future, the question of personal liability for a legal entity s tax debt will be regulated by the soon to be promulgated Tax Administration Act (TAA) Chapter 11, Part D specifically deals with the Collection of Tax Debt from Third Parties. Section 180 provides that a person could be personally liable for any tax debt of the taxpayer (e.g. a company, CC or trust) to the extent that the person s negligence or fraud resulted in the failure to pay the tax debt if: the person controls or is regularly involved in the management of the overall financial affairs of the taxpayer, and a senior SARS official (defined term) is satisfied that such person is or was negligent or fraudulent in respect of the payment of the tax debts of the taxpayer. When exactly a person will be seen to control or [to be] regularly involved in the management of the overall financial affairs of any entity is a question of fact. Each case will depend on its own facts. So will the entity s Financial Director, alternatively the back-office clerk responsible to make the EFT payment of the tax due, incur personal liability? Unfortunately the Draft Explanatory Memorandum to the TAA gives no guidance. Seemingly the omnipotent senior SARS official will make the calls regarding the degree of involvement in the management of the overall financial affairs of the entity as well as whether there had been any negligence or fraud. Under section 184 (1), SARS has the same powers of recovery against the assets of a person referred to in Part D as it has against the taxpayer s own assets (i.e. those of the company, CC or trust). Sub-section 184(2)(a) affords the person potentially facing personal liability an opportunity to make representations before the section 180 liability is established (as long as that does not jeopardise the collection of the tax debt), alternatively, under sub-section 184(2)(b), as soon as practical afterwards. 19