Double Taxation Agreements: Germany and Mexico; Preliminary Briefings: Qatar, Kenya, Chile, Lesotho, Sri Lanka

Meeting report

Ratification of Tax Treaties with Germany and Mexico
Ms Yanga Mputa, Director of the Tax Policy Unit, National Treasury, explained the ratification process of the tax treaties with both Germany and Mexico along with the reasons for the treaties.

Ms Mputa noted that before a tax treaty could come into force it needed to be ratified by Parliament, and this was done in accordance of Section 231 of the Constitution and Section 108(2) of the Income Tax Act. The treaties that were to be ratified with Mexico and Germany were in the best interest of South Africa.

Germany Tax Treaty
Ms Mputa outlined the reasons for the need to have this treaty ratified. This was a renegotiation of an old treaty which was originally signed in 1975, and at that time South Africa was still on a source based system of taxation and did not have capital gains tax. The revised treaty would included missing aspects in the old treaty and would render it ineffectual.

The investment flows which were discussed showed that Germany had been investing significantly more into South Africa since 2005 than South Africa had into Germany. In 2005 Germany invested R75.2 billion, while South Africa invested R19.3 billion, in 2006 this was R82.2 billion compared with R22.6 billion, and in 2007 this was R98.2 billion compared with R27.4 billion. German companies operating in South Africa included BMW, Puma, Siemens and Volkswagen, while South African companies operating in Germany included Dimension Data, Sasol and Sappi.

The trade flows between South Africa and Germany showed that South Africa was importing almost twice as much from Germany than it was exporting.

Mexico Tax Treaty
Ms Mputa outlined the reasons for the tax treaty with Mexico. These included the growing economic ties between the two countries, the fat that South Africa was the fifth largest investor in Mexico, increasing relations with the Latin America Region, and the expressed interest by Mexico to have a treaty with South Africa.

The South African companies that operated in Mexico included Dimension Data, Gencor, Standard Bank and Sasol amongst others.

The trade flows between the countries showed that South Africa imported more from Mexico than it exported, were in 2007 this amounted to R1.2 billion for exports and R2.1 billion for imports.

Double Taxation Conventions/Agreements, Formal Ratification
Mr Ron Van Der Merwe, Senior Manager, South African Revenue Service (SARS), said that the purpose of the agreements was to remove barriers to cross border trade and investment. The way in which these were removed, were through the elimination of Double taxation, the certainty of tax treatment and the resolution of tax disputes.

Germany Tax Treaty
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 5: Permanent Establishment
Article 8: Shipping and Transport
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 13: Capital Gains
Article 14: Income from Employment
Article 16: Entertainers and Sportspersons
Article 17: Pensions, Annuities and Similar Payments
Article 26: Limitation of Benefits

The protocol of the treaty was discussed briefly. This explained that rules of interpretation had been agreed to ensuring a consistent approach to the Agreement. It noted that paragraph two dealt with the taxation of local recruits of embassies, and noted that these would only be taxed in the source State after a period of two years from the entry into force of the Agreement. This applied only to recruits already employed by Embassies on 31 March 2000.

Discussion
Mr E Mthethwa (ANC) noted on page three of Treasury’s presentation that imports to South Africa in 2005 were twice that of exports and the same tendency occurred in 2006, 2007 and 2008. He asked what the reasons for these discrepancies were.

Ms Mputa said that the treaty did not regulate trade flows, but as soon as a treaty was in place, these tended to increase. The reason for the discrepancy between exports and imports was that South Africa imported cars from Germany, which were more expensive than anything that South Africa exported.

Ms Z Dlamini-Dubazana (ANC) said that the content of the treaty needed to be provided as the Committee did not have an idea of this.

Ms Mputa said that the main aim of the tax treaty was to provide certainty between the two countries, as it set out the manner in which taxes were to be regulated. By doing so, it increased cross boarder investment flows. The content of the treaty was what Mr van der Merwe was discussing in terms of the provisions in the treaties.

Mr van der Merwe said that the content of the treaty was set out in a structured manner which followed the same pattern of treaties throughout the world. This set out who was covered, and what was covered. The residents of the two contracting States were covered, and all taxes related to income were covered.

He said that the treaty dealt with all different types of income, from “immovable income” in Article 6 to Article 21 which dealt with “other income”, which was anything that had not previously been dealt with. In relation to those items of income, it assigned taxing rights to the States. Article 22 then spoke of how countries would eliminate double taxation, which was decided by the domestic law of each state. In South Africa’s case, this would say that ‘we would allow credit within certain limits set forth in our domestic law in relation to the elimination of double taxation’. In these agreements there would then be general Articles dealing with, the exchange of information, assistance in collection, and the mutual agreement procedure. There was also an Article on non-discrimination where the two countries stated that they would not treat each others nationals any worse than their own people, which were guaranteed by the two states. This was the basic content of the treaties. The certainty that Ms Mputa was talking about was created because the treaties had a longer life-span than domestic law, which enabled investors to find opportunities abroad, knowing that the tax implications would be a, b and c.

Ms Dlamini-Dubazana asked for further clarity on Article 5, which talked about the taxation of permanent establishments, but the examples that were used appeared to be temporary fixtures, such as construction projects. She asked how South Africa benefited from this.

Mr van der Merwe said that when talking about business profits, one talked about a permanent establishment. In the context of treaties, the word ‘permanent’ did not mean ‘forever’, rather it referred to business that existed within the other country. For example if a resident of Germany was conducting business in South Africa, then they would be liable for South African tax once they had a permanent establishment. If a German company was selling cars in South Africa, they would find a fixed place of business in South Africa before they could be taxed. In that case it would take the form of the showroom where the cars would be sold. If business was conducted there for a 6-12 month period, then it would be regarded as a fixed place of business and would become liable for tax in South Africa. The situation would be applicable in both countries. A commentary was set up for such treaties and this clarified the criteria which determined what a permanent establishment was. Paragraph one of Article 5, clearly sated that a permanent establishment was any “fixed place of business through which the business of an enterprise [was] wholly or partly carried on”. Here the question needed to be asked of what a fixed place of business was, and the normal interpretation was that it needed to be in place for a period of 6-12 months. Construction was a temporary business and therefore special time rules applied because of this. In the treaty this was a twelve month period.

Ms Dlamini-Dubazana said that clarity was needed on what ‘that’ meant in paragraph one of Article 8, which said that “traffic shall only be taxable in that State”. This, she felt, ought to rather be ‘the resident sate’, as it was not clear which State was being referred to.

Mr van der Merwe said that the wording in Article 8 was standard, and earlier in the sentence it was stated “Profits of an enterprise of a contracting state”, where “contracting state” was defined as a resident of a contracting state. This was made clear in sub-paragraph (g) of paragraph one in Article 3, which stated that “the terms ‘enterprise of a Contracting State’ and ‘enterprise of the other Contracting State’ mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State”. 

Ms Dlamini-Dubazana asked how aware the Department of Trade and Industry was of this Agreement because Article 2, paragraph three, spoke about the existing taxes in each country. In Germany this covered the income tax, the corporation tax, the capital tax, and the trade tax, while in South Africa it only covered the normal tax, the secondary tax on companies and the withholding tax on royalties with no reference made to either corporation or trade taxes. 

Mr V.D. Merwe said that the trade tax in Germany was merely a tax on income, and what was covered on the German side was all of their taxes on income, and the same was true for the South African side. The treaty did not deal with consumption taxes, such as vat and so on, and there were not many cases of double taxation occurring in relation to these types of taxes.

Ms Dlamini-Dubazana noted that Article 13 spoke about Capital Gains, and asked what percentage was going to be used by “indirectly principally of the immovable property” because the capital gains should be accrued. Was the 50 percent in the resident state or in the “indirect principally”, where we would have the right to tax.

Mr van der Merwe said that the term “principally of” in paragraph two of Article 13 meant amounting to more than 50 percent. As soon as the 50 percent limit was crossed over, any profit on the sale of the shares was taxable in the State where the property was situated.

Ms Dlamini-Dubazana noted that Article 16 spoke of ‘Entertainers’ and asked how this was linked with SARS because filmed production had in the past been put to one side.

Mr van der Merwe said that Article 16 only dealt with entertainers and sports persons. The making of films was not covered by this Article.

Mr D Van Rooyen (ANC) said that the repercussions of not having treaties with other countries were huge given the current economic situation. He asked where South Africa was in terms of a backlog of these treaties.

Mr van der Merwe said that he did not think that South Africa had a backlog of treaties for the most part, although he admitted that there were a few instances in Africa where struggles in beginning negotiations had stalled the process. South Africa had an extensive treaty network that covered all its major trading partners, and the countries that had the potential for investment in South Africa.

Ms Mputa added that since 1994 Mr van der Merwe had done much work to try to negotiate the tax treaties. There was no backlog because all of the treaties had been done with the countries major trading partners. There was only a backlog with African countries, and a few SADC partner countries, such as Angola and Madagascar. Currently there was concern primarily about these SADC countries because there was a provision in the SADC protocol that required member countries to have treaties with one another. Although South Africa would like to have treaties with African countries this was difficult to achieve, and the problem lay with the Parliamentary process, specifically in the ratification and preliminary hearings.

Mr van der Merwe added that progress had been made with Senegal and Cameroon, which had long been on the list of the National Treasuries priorities. Overall there was no backlog.

Mr Van Rooyen wondered if, in Article 5, there were provisions for preferential procurement systems, or if they were sensitive to local preferential procurement practices. He asked for more information to be given on Article 26 (b), specifically what its implications were.

Mr van der Merwe said that Article 26 was only saying that every country had anti-abuse provisions in their domestic laws, such as section 103 in the South African Income Tax Act. There were also, in South Africa’s domestic law, provisions dealing with controlled foreign corporations and the fact that these could be taxed in South Africa. Article 26 merely said that nothing in the treaty would prevent South Africa from using those anti-abuse provisions or controlled foreign corporation rules.

Mr M Motimele (ANC) noted that there was an important statement made that was said very casually that “all treaties were done in the interest of South Africa”. Mr Motimele felt that this statement was an important point of political departure and said that this would test a common understanding of the agreements as this should be evident in their content. In that context, he asked what the criteria were being used for “the interest of South Africa”, so that a common understanding could be gained.

Ms Mputa said that the criteria could be discussed using the example of the South Africa and United States (US) tax treaty. Before a tax treaty was entered into with the US, the investment flows and trade flows between the two countries were low. Due to the treaty, it became easier for business to be conducted with the US. The treaty could be looked at beyond domestic law, as it did not change when domestic law changed. Essentially the treaties set out the manner in which countries could tax each other.

Mr D George (DA) noted that the previous Parliament had been concerned about the sequencing and the timing of the processes. Currently the Committee was busy with the ratification of the treaty, and before this could be done the treaty needed to be signed. He asked if the treaties had already been signed.

The Chairperson said that the treaties were there to be ratified because they had already been signed. The legislative process might be problematic in the cases of African countries. He asked if the Parliamentary process was simultaneously occurring in both Germany and South Africa.

Mr van der Merwe said that as soon as signing had happened the process of ratification would begin, and preparation for ratification was underway in both Germany and Mexico. There would be a later protocol to the German treaty, which would deal with the new exchange of information Article, which had become acknowledged as a world standard. This would be a protocol where the language would still need to be finalised, and that would have to come back to the Committee for ratification. This was a good step forward, as in the past the exchange of information had been limited between South Africa and Germany.

Mr George asked what the process would be if the Committee was not happy with a provision in the agreement, given that both parties had already signed.

Mr van der Merwe said that in a situation such as that, a negotiation of the protocol could be done to take account of serious issues.

The Chairperson noted that Parliament needed to be brought on board much earlier in the process.

Ms Mputa said that all the treaties were brought before Parliament as preliminary hearings, so if there were changes that needed to be made, these could be done before the treaties were signed.

The Chairperson noted that this matter had been cleared up. The ratification was a continuation of the process that was started by the previous Committee. It had been noted that many of the members of the Committee were relatively new, but nevertheless the continuation of the process needed to be undertaken.

Mexico Tax Treaty
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 4: Resident
Article 5: Permanent Establishment
Article 7: Business Profits
Article 9: Associated Enterprises
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 21: Limitation of Benefits
Article 26: Assistance in the Collection of Taxes

The protocol was discussed, and this explained that rules of interpretation had been agreed to ensuring a consistent approach to the Agreement.

Discussion
Ms Dlamini-Dubazana said that the NT needed to ensure that proper monitoring tools existed. The treaty itself might be functional, but if monitoring did not occur, then it was possible that the sense of what was happening could be lost.

Mr van der Merwe said that ensuring compliance was very important and the point was taken.

The Chairperson said that the Committee would move onto the preliminary agreement presentations as Mr Koornhof (COPE), had requested a break for another Committee meeting and would return later.

Preliminary Hearings: Tax Treaties with Chile, Kenya, Lesotho, Sri Lanka and Qatar
Ms Mputa explained the general purposes of tax treaties and the reasons for having these with the countries mentioned in the title of the document. 

Tax Treaty with Qatar
Preliminary Hearings: Tax Treaty with Qatar
Ms Mputa stated that the reasons for this treaty were to advance economic relations between South Africa and Qatar, the fact that Qatar was of huge strategic importance to South Africa due to its oil reserves and natural gas reserves and the establishment of the South Africa Social Committee in Qatar which showed the ever-increasing numbers of South Africans in the country.

Generally Qatar had invested more into South Africa than South Africa had into Qatar. Major investments by South Africa included a $900 million agreement between Sasol and Qatar Petroleum, and the involvement of Murray and Roberts in the building of a stadium in Qatar.

Overall South Africa imported more from Qatar than it exported. The main exports included chemical products, base metals and animal products. The main imports included plastic products, transport equipment and paper products

Preliminary Hearing: Double Taxation Conventions/Agreement with Qatar
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 5: Permanent Establishment
Article 8: Shipping and Air Transport
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 15: Directors Fees

Discussion
The Chairperson asked if there were any questions from Members. There were none.

Tax Treaty with Sri Lanka
Preliminary Hearings: Tax Treaty with Sri Lanka
Ms Mputa said that the reasons for this Agreement were to strengthen economic ties between the two countries and that South Africa was the most important trading partner for Sri Lanka in the Southern African Region.

The investment flows indicated that Sri Lanka had invested far more into South Africa than South Africa had into Sri Lanka.

The trade flows showed that South Africa exported more to Sri Lanka than it imported. The main exports included containers, citrus fruit and soya beans, while the main imports included tea, natural rubber and live fish. 

Preliminary Hearing: Double Taxation Conventions/Agreement with Sri Lanka
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 5: Permanent Establishment
Article 7: Business Profits
Article 8: Shipping and Air Transport
Article 9: Associated Enterprises
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 17: Pensions and Annuities
Article 19: Teachers and Researchers
Article 21: Other Income

The protocol for this Agreement clarified that independent personal services income fell under Article 7 and tax sparing was not debated.

Discussion
Ms Dlamini-Dubazana asked Treasury what the domestic policy of shared risk was in terms of shipping in Article 8 because of the 50 percent tax deduction.

Mr V.D. Merwe said that that what was being spoken about was an income tax, imposed by the Income Tax Act on the shipping company. This was an issue for SARS because if a ship came in and loaded goods, what was being taxed was transport and not the goods themselves. The income that was earned from transporting the goods and passengers was taxable under the Income Tax Act, and there was no sharing with other parties.

Ms Mputa said that in previous treaties, income of shipping would have been taxable in the country of residence. In the case of Sri Lanka, they wanted a shared right of taxation on the income of shipping of the company involved and not of the transportation of goods. Because Sri Lanka was an entirely coastal country, they derived a significant portion of their income from shipping.

Mr Van Rooyen said that the provision for the collection of taxes on behalf of other States had only appeared in this agreement, and asked why that was as he felt that this was a very acceptable arrangement for all countries.

Mr V.D. Merwe said that he agreed that as a matter of policy this was very important. The problem was that there needed to be a base for this in domestic law which in turn enabled the country to enter into provisions for this in international agreements. South Africa had this in Section 93 of the Income Tax Act, but not all countries had this at that stage. This provision was only included for the first time in an international model in the OECD in 2005, and the United Nations Committee only approved this for inclusion in their model in 2008. South Africa proposed this provision in every single negotiation that it entered into, but the other State could not always agree to this.

Tax Treaty with Kenya
Preliminary Hearings: Tax Treaty with Kenya
Ms Mputa stated that the reasons for this treaty were to enhance economic ties, to expand South Africa’s tax treaty network in Africa, to promote South Africa as a regional centre for Africa and because Kenya was one of the most advanced economies in the East Africa Region.

The investment flows showed that in 2005 and 2006 Kenya was investing far more into South Africa than South Africa was in Kenya. In 2007 this changed and investments were roughly equal in both countries. Local companies operating in Kenya included Afrox, Dimension Data, Santam, Shoprite and Engen amongst others.

The trade flows were heavily in South Africa’s favour, and exports to Kenya greatly outweighed imports.

Preliminary Hearing: Double Taxation Conventions/Agreement with Kenya
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 5: Permanent Establishment
Article 8: Shipping and Air Transport
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 18: Pensions and Annuities
Article 20: Professors and Teachers
Article 27: Assistance in the Collection of Taxes

Discussion
The Chairperson asked if there were any questions from Members. There were none.

Tax Treaty with Chile
Preliminary Hearings: Tax Treaty with Chile
Ms Mputa said that the reasons for the Chile tax treaty were to strengthen economic relations with the country and to increase South Africa’s tax treaty network in the Latin American Region.

Tax investment flows indicated that overall South Africa had invested near ten times the amount in Chile than Chile had invested in South Africa. The companies that operated in Chile included, Dimension Data, SABMiller and Tiger Brands amongst others.

Exports to Chile amounted to R403million in 2006, R426 million in 2007 and R530 million in 2008, the main exports included fruit juices, lamps and chemical fertilizers. Imports amounted to R1 billion in 2008 and included chemical fertilizers, maize and insecticides.

Preliminary Hearing: Double Taxation Conventions/Agreement with Chile
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 4: Resident
Article 5: Permanent Establishment
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 13: Capital Gains
Article 17: Pensions
Article 25: Exchange of Information
Article 27: Miscellaneous Rules

Discussion
Mr Van Rooyen said that the provisions for Miscellaneous Rules were needed in treaties with other countries, as they demonstrated the differences between the countries, and how the environment there may result in the formulation of different treaties.

Tax Treaty with Lesotho
Preliminary Hearings: Tax Treaty with Lesotho
Ms Mputa said that the reasons for the tax treaty with Lesotho were that this was a renegotiation of an old treaty with the first coming into effect in 1997. South Africa was still on the source based system of taxation at that time and certain aspects were not covered in the original treaty. Lesotho was also a member of SADC.

The investment flows showed that Lesotho had invested approximately three times as much into South Africa than South Africa had invested in Lesotho between 2005 and 2007. South African companies that operated in Lesotho included Afrox, Edgars, Nedbank, Telkom and SABMiller amongst others.

The trade flows indicated that exports to Lesotho far outweighed imports from Lesotho.

Included in this treaty were the cross-border movement of individual since there was a shared border. It included the exchange of tourists between the countries and the exchange of students studying at universities.

Preliminary Hearing: Double Taxation Conventions/Agreement with Lesotho
Mr van der Merwe noted that this treaty closely followed the OECD Model Convention, although there were a number of Articles that differed from the normal South African Approach. These were

Article 4: Resident
Article 5: Permanent Establishment
Article 7: Business Profits
Article 8: International Transport
Article 10: Dividends
Article 11: Interest
Article 12: Royalties
Article 13: Fees for Technical Services
Article 17: Entertainers and Sportspersons
Article 18: Pensions
Article 21: Professors and Teachers
Article 23: Elimination of Double Taxation
Article 27: Assistance in the Collection of Taxes

The protocol for this Agreement clarified that if Lesotho entered into an Agreement with another State that gave lower rates in respect to Articles 11, 12 or 13, then those lower rates would apply to this Agreement. It also clarified that paragraph three of Article 23 was understood that benefits would not apply in respect of financial intermediation activities, the licensing of intellectual property, shell businesses which were not engaged in substantive business operations, and passive income.

Discussion
The Chairperson said that the Committee was at one in terms of the strategic objectives, but more was still needed on the technical level for the Committee to get closer to the process.

The Chairperson noted that the Committee needed to oversee large, complex departments such as SARS and the National Treasury. The Committee needed to make a decision on the first two agreements.

The Chairperson said that the second set of issues were with the preliminary agreements. It was noted that documentation had been provided in time, but often the Committee itself did not have sufficient time to devote to this because of the heavy schedule that they often had. He asked what the timeframes were for the preliminary agreements to be ratified, as that would determine what the Committee should do. In the previous committee, full engagement with the subject matter did not occur and therefore an idea of the timeframe available was necessary in order to ensure that engagement did occur on the Committee’s side.

The Chairperson said that before the negotiations were completed, and the Agreements signed, the Committee should be engaged once more.

Mr van der Merwe said that in terms of timeframes, in practice (at their level) as soon as a consensus was reached on a text it would be taken to the law advisors at the Department of  Justice and the Department of Foreign Affairs, after which it would go straight to this committee for the preliminary hearings. There were no definite timeframes, unless there was a pressing issue where there was the possibility of signature on State visits, but generally there would be enough time for full engagement to occur. The signing of treaties could also take a long time because it could only be done by ministers, who were not always available.

Mr van der Merwe thought that no problems would arise in giving the Committee the time that they needed, except in isolated cases where their indulgence would be requested.

The Chairperson asked the Committee if this arrangement was agreeable with them.

The Committee indicated that it was.

The Chairperson said that he did not expect the negotiations between the different countries to happen simultaneously and the reason that the timeframe was requested was because he felt that the preliminary briefing should not be constituted as input from the Committee. The technical aspect of the agreements had not been dealt with as deeply as it could have. If further comments were made, these would be passed on to the relevant bodies. 

Ratification of Agreements between South Africa and Germany, and South Africa and Mexico
The Chairperson said that the formal process of ratification could continue, he read the report for the ratification of the Agreement with Germany, which stated:

“The Standing Committee for Finance, having considered the request for approval by Parliament of the Agreement between the Republic of South Africa and the Federal Republic of Germany for the Avoidance of Double Taxation with respect to taxes on income and on capital recommends that the House, in terms of Section 231, subsection 2 of the Constitution approve the said Agreement”.

The Committee indicated its agreement. And it was noted that this was unanimous.

The Chairperson then read the report for the ratification of the Agreement with Mexico, which stated:

“The Standing Committee for Finance, having considered the request for approval by Parliament of the Agreement between the Republic of South Africa and the United Mexican States for the Avoidance of Double Taxation and the prevention of Fiscal Evasion with respect to taxes on income recommends that the House, in terms of Section 231, subsection 2 of the Constitution approve the said Agreement”.

The Committee indicated its agreement, with the suggestion that National Treasury must put in proper monitoring mechanisms to ensure compliance.

The Chairperson noted this.

The meeting was adjourned.