Synopsis March Tax today* Europe gets serious about combating tax evasion. *connectedthinking

Transcription

1 Synopsis March 2008 Tax today* Europe gets serious about combating tax evasion *connectedthinking 1

2 In this issue Europe gets serious about combating tax evasion No such thing as a tax-free holiday Amounts paid in terms of a settlement agreement: income or capital? Europe gets serious about combating tax evasion Germany s call in March 2008 for a clampdown on European tax havens was supported by a majority of the European Union s 27 member states who have made it known that they are determined to clamp down on bank secrecy, which they believe is encouraging tax evasion. There has been new momentum in this regard since German tax authorities paid an informant at Liechtenstein s LGT banking group a large sum to hand over data on secret accounts held in that country, which revealed that 600 Germans held millions of euros in anonymous trusts in Liechtenstein. Editor: Ian Wilson Written by R C (Bob) Williams Sub-editor and lay out: Carol Penny Tax Services Johannesburg Distribution: Elizabeth Ndlangamandla Tel (011) Fax (011) The German finance minister said that this was not only a tax scam but a social and moral issue. He also criticised Austria, Luxembourg and Belgium for their secrecy and for negotiating double tax agreements with tax havens in the Far East that fell short of the EU s code on tax transparency. The revelation of the Liechtenstein data has also placed the tax havens of Andorra and Monaco in the spotlight. Brussels is looking into ways to combat tax evasion in non-eu states such as Hong Kong and Macao. In Italy, magistrates in Rome have begun an investigation into some 400 Italians who are suspected of evading tax by holding secret bank accounts in Liechtenstein. Spain, Australia and Greece began similar investigations last month. Liechtenstein, a country of some inhabitants, lies between Austria and Switzerland. Over the years, it has lured thousands of rich investors across the 2 world with a promise of confidentiality, and is on an international blacklist of tax havens. A review of anti-evasion legislation has been brought forward EU finance ministers have ordered the European commission to bring forward a review of legislation to counter tax evasion. Under the EU s 2005 tax directive, states are obliged to supply fellow members with information on their nationals interest income, but Austria, Belgium and Luxembourg were exempted from this obligation. Liechtenstein has said that it wants to conclude a comprehensive tax fraud agreement with the European Union.

3 No such thing as a tax-free holiday Taxpayer tried to pass off free holidays for its employees as a staff-training exercise The recent decision of the Cape Tax Court in XYZ (Pty) Ltd v CSARS (case 12244; judgment delivered on 21 January 2008; not yet reported) is yet another example of failed tax-planning stratagems based on the premise that SARS assessors are too naïve to recognise a tax-dodge when they see it. In this instance the taxpayer, in a nutshell, tried to dress up free holidays for its employees as a staff-training exercise, to save their being taxed on the perk as a fringe benefit. The taxpayer was in the business of timeshare holiday exchange. Property developers sold timeshare in their holiday resorts to purchasers who thereby acquired three-year membership in the taxpayer s plan, after which they could renew their membership for an annual fee. Timeshare resorts are usually structured as shareblock companies. The purchasers of timeshare become shareholders in the shareblock company, which entitles them to occupy a particular unit in a particular timeshare resort for a particular week of the year. Members of the taxpayer s timeshare scheme were entitled to space-bank their occupation rights with the taxpayer, in return for which they were credited with points. Having accumulated points, a member had three years within 3

4 which to trade-up for a higher grade resort, or use the points to take holidays of less than a week. The taxpayer earned its revenue by charging an exchange fee for each exchange in which a member utilised his points to reserve accommodation held in the taxpayer s stock of space-banked rights of occupation. Knowledgeable sales staff were vital to the business Holiday timeshare exchanges were usually made telephonically between a member of the timeshare scheme and one of the taxpayer s call-centre staff, known as guides. Members were often unable to secure a booking at their first choice of timeshare resort and the role of the guide was to cross-sell and if necessary up-sell alternative accommodation that matched the member s needs and aspirations. The taxpayer believed that well-educated and experienced telesales guides were key to the success of its business. To this end, the taxpayer gave its staff the opportunity to visit the various resorts on its books by allocating each employee points annually for the purpose of resort education, so that they could visit several of the taxpayer s resorts each year and gain first-hand knowledge. This would assist them in advising clients and implementing successful exchanges. The taxpayer s employees were not obliged to use all or any of the points allotted to them, and they were permitted to use the points at resorts of their own choosing. But they were not allowed to cash in any unused points. The taxpayer s attitude was that it was in the interests of its commission-remunerated guides to acquire product knowledge through personal experience of the resorts in which they were selling rights of occupation. 4

5 SARS issued the taxpayer with an assessment to some R11 million in tax for the tax years, plus a R1 million penalty. In addition, it levied a charge for interest on the overdue tax of some R2.8 million. Staff took up resort accommodation that would otherwise have been vacant Because members of the taxpayer s timeshare scheme were given precedence, the rights of occupation that were in practice most often exercised by employees were those that were about to burn, in other words those accommodation rights that would otherwise not be exercised at all. In argument to the court, the taxpayer likened an unexercised right of occupation to an empty seat on an aircraft, and took the view that it would prefer an employee to exercise a right of occupation, rather than have it not exercised at all. This was because low occupancy was bad for the resorts, and it would cost the taxpayer nothing to allow employees to exercise rights of occupation that were about to burn. In terms of the taxpayer s scheme, its employees had to pay for their own transport to the resorts, and pay for meals and amenities they used. After their visit to a resort, employees were required to complete a resort evaluation form. They were only permitted to book two weeks per annum at a standard resort, and not more than one unit at a resort with a higher grading. They could not make bookings during peak times, nor could they sell or otherwise dispose of their points, or give them out privately to friends or family. The taxpayer regarded the allocation of points to its staff as an integral element in the training of employees and not as a form of remuneration for services rendered. The taxpayer s standard letter of appointment for its employees obliged the latter to participate in on-going learning, which could take place outside of normal working hours and over weekend in the interests of performance improvement. The taxpayer s self-assessment to fringe benefits tax and SARS s response In terms of para 3(1) of the Seventh Schedule to the Income Tax Act 58 of 1962 (a statutory code for the taxation of fringe benefits granted by an employer to an employee) a taxpayer is required to determine and enter in its tax return the cash equivalent of a taxable benefit given to its employees. Such cash equivalent is then taxable in the hands of the employee as part of his or her gross income. Acting in terms of the Seventh Schedule, and in the light of the way in which it operated its points system, the taxpayer in this case assessed the cash equivalent of the taxable benefit granted to its employees by way of exchangeable points to be nil. SARS became aware of the facts of the matter in the course of a routine audit, and responded by issuing an assessment for the PAYE that (according to SARS) the taxpayer should have deducted and paid over to the fiscus. The assessment was made in terms of para 2(d), or alternatively para 2(h) of the Seventh Schedule. These two subsections govern, respectively, the provision by an employer of residential accommodation free of charge or for less than the rental value, and amounts owing by an employee to a third person, which the employer has paid without requiring reimbursement. In its computation of tax liability, SARS adopted the current market value of accommodation at the timeshare resorts in question and issued the taxpayer with an assessment to some R11 million in tax for the tax years, plus a R1 million penalty for failing to deduct and remit PAYE on the taxable value of the benefits in question. In addition, SARS levied a charge for interest on the overdue tax of some R2.8 million. 5

6 Also damaging to the taxpayer s argument was that its employees would repeatedly visit the same resort, often within a short period of time. Did the employees receive a taxable benefit? The taxpayer argued that it had not provided its employees with accommodation as envisaged in the Seventh Schedule, but had merely provided employees, via its points system, with a right to exchange those points for rights of occupation at the resorts in question. That right, contended the taxpayer, was an asset, that is to say, a non-monetary item of property. In terms of the Seventh Schedule, assets provided by an employer to an employee as a fringe benefit are taxable in the latter s hands at their market value. The taxpayer company argued that, in all the circumstances, the value of these assets (in other words, the rights of occupation at resorts which had not been taken up by customers) had a nil market value because their employees were not permitted to cash in their right to stay at the resort, and take the money instead. In arguing that the cash equivalent of the fringe benefit in question was the amount of money into which the employee could convert the benefit in this case nil the taxpayer invoked the decision of the High Court in Stander v CIR 1997 (3) SA 617 (C). In this case, a certain Mr Stander had received, as a prize, an overseas trip. In terms of the conditions attaching to the prize, he could not sell or otherwise cash in the prize he had to take the free holiday or nothing at all. The court in Stander s case held that, for income tax purposes, the value of the prize in Stander s hands was the amount of money into which he could convert it. Since the conditions attaching to the prize were that he could not exchange it for cash, nor could he transfer it to anyone else, its value in his hands was nil. Unfortunately for the taxpayer in the present case, the Supreme Court of Appeal had just given its judgment in the muchpublicised case of CSARS v Brummeria Renaissance (Pty) Ltd 2007 (6) SA 601 (SCA) which held that Stander s case had been wrongly decided, and that the criterion of value for income tax purposes, was its objective monetary value, and not the amount of money into which the taxpayer could convert it. In the current case, the court held that the principle laid down in Brummeria Renaissance was applicable in the matter at hand. Hence, said the court The right to accommodation is a benefit for which an employee would have had to pay if he or she had not been given it for nothing. That right had a money value and the fact that it cannot be alienated does not negate the value. Was the accommodation a holiday or a training exercise? In the current case, the taxpayer s second argument was that the purpose of providing its employees with accommodation at its timeshare resorts was not to give them a free holiday, but to equip them to give improved service to clients through their personal knowledge of the resorts. Unfortunately for the taxpayer, SARS shot down this argument by laying before the court a document the taxpayer provided to its staff, which said You ve worked hard all year. You ve been part of an international team that s dedicated to arranging great Holiday experiences for [our] members. Now it s your turn to enjoy a Resort Educational... The court also pointed out that if the taxpayer had intended to accommodate its employees at resorts for training purposes, one would have expected a structured plan in this regard, rather than a points system that allowed the employees a wide choice. The fact that points were allocated, said the court is indicative of the fact that this privilege... is not only a management tool, but also a privilege given to staff in order to retain the services, to reward them for services rendered and further their morale. The fact that employees have to report back to the [taxpayer] on conditions at resorts is clearly but a convenient by-product of what is mostly an enjoyable experience for most employees. Also damaging to the taxpayer s argument was evidence laid before the court that its employees would repeatedly visit the same resort, often within a short period of time. All in all, the allocation of points to employees, said the court, was in the nature of a free holiday, given by way of a fringe benefit as a reward for services rendered or to be rendered by them. 6

7 A good idea, badly executed The tragedy from the taxpayer s perspective (apart from its eventual multimillion rand tax bill) was that the germ of the idea was sound. The decision of the Supreme Court of Appeal in the Brummeria Case that Stander s case was wrongly decided was clearly an unforeseen factor, given that the concept of money s worth had hitherto relied on the capacity of the recipient to turn the benefit to money. Notwithstanding this unfortunate turn of legal precedent, coming as it did just before the decision in this matter, it might have been possible to have saved a large tax bill. After all, many genuine business expenses involve an element of personal enjoyment for the employees involved. A business trip, with accommodation at a classy hotel, is not unrelieved drudgery. A business lunch with a client at a good restaurant, with fine food and wine, has an enjoyable dimension, and there is no principle of tax law that says that only the client s bill is tax-deductible. It is implicit in the Seventh Schedule that a benefit falls outside of its scope and is thus not a benefit taxable in the hands of the employee if the benefit in question enures to the advantage of the employer, not the employee. Thus, in the hypothetical scenarios just outlined, the business trip and the business lunch, were (in their purpose and effect) for the benefit of the employer, and any enjoyment or cost-saving by the employee was merely incidental and, for tax purposes, irrelevant. Thus, if the timeshare company in the present matter had genuinely intended (and if it were able, when push came to shove, to persuade the tax court that it genuinely believed) that it would be good for its business if its consultants had personal knowledge of the timeshare resorts in question, then a well-structured system of enabling those consultants to gain that knowledge at company expense, as one element in a genuine staff-training programme, would not (it is submitted) have constituted a taxable fringe benefit in the employees hands. The flaw in the taxpayer s case was not in the underlying idea, but in its ill-considered and flawed execution, including the damaging policy document which in effect, admitted that the intention was to reward employees. If the employees had received free accommodation at the timeshare resorts in the course of a genuine and reasonable staff-training programme in which the employer decided on the when and where, and ensured that the employees stayed at a variety of resorts and did not simply frequent their favourite one, the outcome of the case may well have been favourable to the taxpayer. 7

8 Amounts paid in terms of a settlement agreement: income or capital? Caution: be specific or pay the price Taxpayer could not give a clear and coherent account of what the money was paid for The judgment of the High Court in WJ Fourie Beleggings CC v CSARS (case A264/2006; judgment given on 6 August 2007; not yet reported) starts by saying that the issue in the case was whether an amount of R which was paid to the appellant during the year of assessment ending 28 February 2002 pursuant to a settlement agreement, was a capital receipt and therefore non-taxable or a revenue receipt which is taxable. 8

9 The taxpayer was the lessee of a hotel in Potchefstroom. In 2001, Naschem, a division of Denel (Pty) Ltd, requested the taxpayer to provide accommodation and meals for a delegation of thirty-eight students from the United Arab Emirates who were to be trained by Naschem in South Africa. The taxpayer agreed to do so for a consideration of just under R9 million. The students duly took up accommodation in the taxpayer s hotel, but following the attack on the Twin Towers in New York on 11 September 2001, they abruptly departed without notice, after wrecking their hotel rooms by burning carpets, making holes in the mattresses and damaging the furniture. The taxpayer threatened to sue Naschem and, after some negotiation, these two parties reached an out-of-court settlement whereby Naschem would pay the taxpayer R in full and final settlement. A sensible settlement, except in relation to tax It was of course sensible to avoid the expense and unpredictability of litigation by reaching a settlement. Less astute was that neither party (nor their professional advisers) seems to have given a moment s thought to the tax consequences of the settlement. Naschem s legal adviser later testified that she did not know how the settlement figure was computed, and that her brief was simply to get [the hotel] off their backs and to settle the matter out of court by keeping the settlement amount as low as possible. Tax law is clear The tax principle at stake is clear. Compensation accruing to a taxpayer for damages is of a revenue nature (and thus subject to income tax) when the hole in the taxpayer s pocket that the compensation fills is of a revenue nature, for example, compensation for the loss of profits. Compensation is capital (and usually subject to capital gains tax) when the hole which it fills is of a capital nature, such as loss of or damage to the taxpayer s capital assets. (See Burmah Steam Ship Co Ltd v CIR (1930) 16 TC 67; Bourkes Estate v CIR 1991 (1) SA 661 (A).) But since the settlement agreement in question merely recorded the monetary amount of the settlement and not what it was for, the question of precisely what the taxpayer was being compensated for remained mysterious. Indeed, the two contracting parties may have had different views on what the compensation was for. In the result, the lessee of the hotel became embroiled in litigation after all but with SARS, rather than with its client, Naschem. SARS contended that the compensation was of a revenue nature, and thus subject to income tax, and issued an assessment accordingly, which the taxpayer contested. In court, the taxpayer (through the sole member of the cc) put forward several conflicting versions of what the compensation was for. He first said that he did not know how the settlement figure had been computed, then later testified that he now remembered that it was R1.1 million plus VAT for damages, and R for legal fees. Later, he said the settlement figure included the costs of repairing the students vandalisation of hotel property. Still later he said that the compensation was to alleviate his cash flow. Thereafter, he admitted that he had used about R1 million of the settlement to repay a loan, and R to repay trade debts. In summary the court said that, in his testimony, Fourie, the sole member of the close corporation could not give a clear and coherent account of what the money was paid for. Nor could he give an acceptable explanation as to how the 9

10 The court said that the hotel itself was the taxpayer s capital asset its income-producing structure. That structure had not been crippled or destroyed by the cancellation of the agreement. The hotel had continued as a profit-earning asset. money was computed.... Fourie vacillated to such an extent that the true purpose and effect of the compensation, on his evidence, defies delineation. SARS argued that the settlement payment was compensation for loss of the taxpayer s future profits, and was therefore of a revenue nature and subject to income tax. The onus was on the taxpayer to prove the assessment was wrong The court pointed out that, in terms of the Income Tax Act, the taxpayer bore the onus of proving, on a balance of probabilities, that the assessment was wrong and that the compensation in question was in fact of a capital nature. On a conspectus of the evidence placed before it, the court said that the hotel itself was the taxpayer s capital asset its income-producing structure. That structure had not been crippled or destroyed by the cancellation of the Naschem agreement. The hotel had continued as a profit-earning asset. The contract with Naschem was thus not an essential part of the taxpayer s income-earning structure, but was merely a normal contract incidental to its business. The compensation paid to the taxpayer was for the loss of profit that it would have made if the students had not moved out prematurely. The actual amount of the compensation agreed upon, said the court, was a thumb-suck. Even if it had been paid to enable the taxpayer to effect repairs, it would still have been of a revenue nature. In the result, said the court, the taxpayer had not succeeded in proving that the compensation was of a capital nature, and its appeal against the assessment must be dismissed. The result of the judgment was that the amount of the compensation would have to be included in the taxpayer s gross income in the determination of its taxable income on which income tax was payable. 10

11 A failure of tax planning In hindsight, it was an elementary failure in tax planning for the parties not to have ensured that the settlement agreement specified what the compensation was for. This was no less important to Naschem as to the taxpayer, for Naschem s legal advisers ought to have drafted the settlement agreement in a manner that made it a taxdeductible expense. There was also a logical inconsistency in the taxpayer s argument. If as its sole member, Fourie contended the compensation payable by Naschem had been to cover the cost of repairs for the damage done by the students, then the taxpayer (the close corporation) ought simply to have conceded that the compensation was of a revenue nature, and thus to be included in its gross income, and should have claimed the cost of repairs as a tax deduction. The compensation and the cost of repairs would then have cancelled each other out, with a tax-neutral result. It was silly for the taxpayer to have used the compensation to pay off trade debts. This was inconsistent with the taxpayer s claim that that the compensation was in respect of the cost of repairs. The taxpayer should rather have used the compensation to pay for the repairs, and then borrowed whatever was necessary to pay its trade debts, for the interest on this loan would have been tax-deductible. Tax in Africa Survey This is the first Tax in Africa survey of its kind and it originates from a growing need among foreign investors who are considering Africa as a viable investment destination. The survey focuses on key tax, business and regulatory challenges faced by companies operating in Africa. The main findings of the survey confirm the view that tax systems across the African continent are extremely divergent and most require modern tax reforms to make the region more attractive to doing business. Other trends emerging, which are consistent with global trends, are the focus on managing tax risk and compliance, the need for tax function effectiveness within companies and the growing demand for tax skills. If you would like to receive an electronic copy of the survey please Manusha Pillay manusha.pillay@za.pwc.com. 11

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