16 July 2015 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: http://www.ey.com/gl/en/ Services/Tax/International- Tax/Tax-alert-library#date South African inbound services update Executive summary A Foreign Service Provider (FSP) 1 carrying on business in South Africa (SA) is potentially exposed to a full array of taxes and accompanying administrative compliance burden. Deriving service income from SA may however, also expose an FSP to some measure of compliance with minimal cash flow impact in certain circumstances. The South African Revenue Service (SARS) is taking action to close the information gap, intensifying audits and litigating issues on inbound services. This Alert summarizes recent case law and developments impacting inbound services. Detailed discussion Recent permanent establishment win for SARS The SARS recently won a permanent establishment (PE) case against a US multinational in the case of ABC Co and XXZ Co (Appellant) v SARS, (not yet reported), heard on 15 May 2015. The Appellant in this case rendered consulting services to a SA entity and was present in SA for more than 183 days during the period February 2007 to May 2008. In 2011, the Appellant was assessed income tax in SA plus interest and 200% penalties (later reduced to 100%). The Appellant appealed against the assessment, interest and penalties. The court dismissed all of the Appellant s arguments. The court s findings included: While the guidance provided by the Organisation for Economic Co-operation and Development (OECD) Commentary is of immense value in interpreting tax treaties, the possibility that tax treaties may be interpreted differently by contracting states is real, given the diverse interests of contracting states. A treaty must be interpreted in a manner that gives effect to its purpose and that is congruent with the words employed.
Once a person meets the service PE threshold in Article 5(2)(k) of the US/SA tax treaty (i.e., service or consulting activities in SA for an aggregate period of more than 183 days in any 12 months period commencing or ending in a taxable year), a PE is created and it is not necessary to consider the fixed place PE requirements in Article 5(1) (i.e., whether the FSP has a fixed place of business through which it carries on business in SA). Disregarding the general OECD approach, the court regarded the use of the words includes especially in the opening phrase to Article 5(2) as an extension of the fixed place PE requirement rather than a mere illustration of a fixed place PE. The application of the 183 days rule in the service PE article allows for double counting of days, where the period of presence overlaps over two years of assessment. Exercising judicial caution, the court further held that even if the aforementioned conclusion is wrong, the facts clearly indicate that the Appellant had a fixed place PE in terms of Article 5(1). In the main, this conclusion was influenced by the fact that the Appellant had several rotating employees working at the client s premises for more than 183 days, exclusive use of the boardroom with four tables and one phone. The court dismissed the argument that the Appellant does not have a PE on the basis that it could only use the premises during working hours and was not allowed to use it for other purposes except execution of the service contract with the client. Dismissing the appeal against interest and penalties, the court was harsher in its pronouncements. It emphasized that: It is a fundamental principle of international business that a business enterprise operating in multiple jurisdictions (such as Appellant) should familiarize itself with taxation principles applicable in the countries in which it operates. Failure to do so is grossly negligent and unreasonable. This was a case of misinterpretation and not a case of ignorance of the law, and thus, the Appellant must accept responsibility for its own error, irrespective of whether it was bona fide or not. The Appellant s failure to clarify its tax status with anyone, least of all SARS, was held to fall short of what is expected of a reasonable international corporation operating on the scale that it does. Perceived BEPS through inbound services The approach adopted by SARS on PEs comes as no surprise given the recent observations by the Davis Tax Committee (DTC), 2 appointed on 17 July 2013 to formulate, among other issues, SA s response to the base erosion and profit shifting (BEPS) concerns and the general trend for developing countries to secure source taxing rights. While the DTC could not make a direct correlation between the declining corporate income tax (as a percentage of GDP) to the existence of BEPS, it noted with concern statistical data collected from the Reserve Bank which indicates substantial outbound payments for non-goods transactions since the end of the global financial crisis. From the sampled data, on aggregate, for the period between 2008 to 2011, the data shows that nearly 50% of all payments flowing out of the country relate to legal, accounting and management consulting services. In the words of the DTC, it seems peculiar that [after the financial crises in 2008] legal, accounting and management consulting services increased by nearly 32.6%... and engineering and technical services by 39.5%. Consumption increases during the aftermath of a global financial crisis seem odd in the wake of sluggish economic activity The magnitude and prevalence of cross border non-goods transactions are clear. It poses a serious threat to the fiscus insofar as tax revenue, and is an indication that illicit tax base migration through avoidance schemes and practices could be taking place. The approach to inbound services is in line with the general position among developing countries that profits should be taxed where services are consumed rather than where the head office is located. 2
A push for legislative reform is also expected to extend the net to digital services, accede to country by country reporting and transfer pricing documentation, in addition to intensive enforcement and the revenue friendly court decisions. Revised reportable arrangements list On 19 June 2015, SARS issued another draft Public Notice on Reportable Arrangements on inbound services. 3 It is proposed that the following inbound technical, managerial or consultancy services (the terms are not defined) must be reported to SARS: The nonresident, its employees, agents, or representatives were or will be physically present in SA rendering such services The expenditure in relation to the rendering of those services will exceed or exceeds R10m (approximately US$823,557) in the aggregate. The reporting must take place within 45 business days after becoming a reportable arrangement. Failure to report may lead to penalties imposed for each month of the failure to report. Penalties may range from R600,000 to R3.6m (approximately US$49,414 to US$296,487), depending on whether the person is a participant or the promoter to the arrangement as well as the quantum of the tax benefit. Reported information is generally used as a forewarning to assess whether the foreign service provider (FSP) has a tax presence in SA (PE), and to gather information on Pay As You Earn (PAYE) compliance. Considering that the test to register as a vendor for value-added tax (VAT) purposes is easier to meet than the PE threshold, the information should readily be able to indicate VAT non-compliance. Withholding tax on services begins 1 January 2016 On 1 January 2016, SA will introduce withholding tax on service fees sourced from SA at a domestic rate of 15%. Service fees are defined as fees for services of a technical, managerial and consulting nature. The withholding tax will be imposed despite the existence of a number of tax treaties that effectively take away SA s right to tax in the absence of a PE. The withholding tax is thus likely to be used mainly as an information gathering tool to assess possible exposure to PE, VAT and PAYE. In a worst case scenario, the withholding tax might also lead to conflicting interpretations on whether certain fees constitute royalties or service fee. Notice to file tax return when deriving SA sourced service income On 12 June 2015, SARS issued a notice which requires every nonresident company, trust or other juristic person which derives income from a source in SA to file income tax returns. Unlike the 2014 notice which specified service income, the 2015 notice refers to income broadly, which would include service income. Income is however specifically defined; thus arguably, service fees that are not taxable in SA as a result of the application of a tax treaty will not constitute income. There is however a position in some circles that taxpayers should file an income tax return irrespective of whether or not SA ultimately imposes a tax on the income. In that case, the filling is likely to only yield information that may be used in other areas. Collaborative audits with Value Added Tax and Personal Income Tax An FSP rendering services through employees in SA is likely to create a VAT presence in SA before it establishes a PE (income tax presence). This is on the basis that the test for a VAT presence (i.e., carrying on an enterprise), is lower than the PE threshold. SARS is known to raise PE questions to FSPs that register for VAT but not income tax. Similarly, employees are likely to attract personal tax liability even in cases where a PE is not created. In this case, the information gathered through the PAYE system would generally feed into questions on whether the entity also has an income tax presence in SA. Implications If not properly considered, the above discussed issues are likely, not only to catch the unaware, but also put to test some legitimate global intra-group service business models. A regular review of existing models is therefore necessary to ensure that the practical aspects are aligned with existing documentation and available risk management tools. 3
Endnotes 1. The phrase FSP is used broadly to refer to any person that is not a South African tax resident that renders services to a resident. 2. See EY, South Africa s Davis Tax Review Committee issues report on BEPS, dated 16 January 2015. 3. See EY, South Africa issues draft notice on reportable arrangements, dated 22 June 2015. For additional information with respect to this Alert, please contact the following: Ernst & Young Advisory Services (Pty) Ltd., Johannesburg Justin Liebenberg +27 11 772 3907 justin.liebenberg@za.ey.com Charles Makola +27 11 722 3146 charles.makola@za.ey.com Rendani Neluvhalani +27 11 772 3948 rendani.neluvhalani@za.ey.com Ide Louw +27 11 502 0438 ide.louw@za.ey.com Mohamed Hassam +27 11 772 5035 mohamed.hassam@za.ey.com Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London Leon Steenkamp +44 20 7951 1976 lsteenkamp@uk.ey.com Gonçalo Dorotea Cevada +44 20 7951 2162 gcevada@uk.ey.com Ernst & Young LLP, Pan African Tax Desk, New York Dele A. Olaogun +1 212 773 2546 dele.olaogun@ey.com Mzukisi Ndzipo +1 212 773 9917 mzukisi.ndzipo@ey.com 4
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