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FINANCE PORTFOLIO COMMITTEE
16 March 2006
TAX AVOIDANCE DISCUSSION PAPER: BRIEFING BY SARS AND NATIONAL TREASURY
Chairperson: Mr N Nene (ANC)
Documents handed out:
Discussion Paper on Tax Avoidance
SARS Presentation on Tax Avoidance and Section 103 of the Income Tax Act, 1962
National Treasury Perspective on the General Anti-Avoidance Rule (GAAR) Proposal
SARS presented the Committee with its views on tax avoidance, as well as its proposed amendments to Section 103 of the Income Tax Act. Section 103 was an essential part of tax law. Good fiscal citizenship and a growing tax base was vital for a developmental state. The general criteria for any tax system were certainty, simplicity, fairness and efficiency. Impermissible tax avoidance had been staggering in its scope and size. Up to 11.5 trillion in assets was now held in tax havens, equating to $435 billion in lost taxes.
To work towards a culture of compliance, there had to be a realisation that tax was no longer just an issue between a company and the taxman. In this new environment, taxpayers and SARS had to work together to achieve a culture of compliance. Section 103 was inconsistent, and at times an ineffective deterrent to impermissible tax avoidance and abusive avoidance schemes. The ‘abnormality’ requirement has long been considered to be the ‘Achilles Heel’ of the Act as promoters typically hijacked components of legitimate business transactions which gave their schemes an undeserved semblance of normality and business purpose. The ‘Purpose’ requirement was problematic as its application resulted in inconsistent results. In drafting the proposed amendments, the four-pronged test was retained with changes made to the abnormality and purpose requirements.
Treasury noted that it fully supported SARS’ efforts to upgrade the General Anti-Avoidance Rule (GAAR). The GAAR debate had to be viewed as a central part of the long-standing ‘cat and mouse’ game of tax non-compliance. Classic tax avoidance was about the age-old legal distinction between the ‘letter’ versus the ‘spirit.’ As wordsmiths, good tax lawyers could elevate the ‘letter’ of the law to a fine art. Taxpayers did not have an obligation to pay the maximum tax, but the dividing line was hard to draw when the decision to undertake a transaction would occur regardless of tax, but the manner of the transaction was heavily infected by tax considerations. It was important to stop the avoidance addiction but because of the huge sums involved, it was hard for the ‘sinners’ to stop. Should Treasury and SARS be successful at targeting the ‘sinning’ few, Treasury could consider providing further relief for all.
SARS Presentation on Tax Avoidance and Section 103 of the Income Tax Act, 1962
Mr Kosie Louw, General Manager, said that their key message was that Section 103 was an essential part of the tax law and good fiscal citizenship and a growing tax base was vital for a developmental state. The challenge was for all the role-players to embrace this ideal, but for this to happen, the law had to be clear, with distinct boundaries and an effective administration.
All over the world there had been a noticeable collapse of basic standards with an unprecedented number of corporate scandals involving companies such as Enron, Worldcom, Tyco, Parmalat and LeisureNet. In many of these cases, ‘tax planning’ was used to justify or disguise schemes to manipulate earnings or to enrich outsiders. For example, in the Enron scandal, more than 800 special purpose entities (SPEs) were set up in tax haven jurisdictions.
The general criteria for any tax system were certainty; simplicity; fairness and efficiency. Impermissible tax avoidance had been staggering in its scope and size. Up to 11.5 trillion in assets was now held in tax havens, equating to $435 billion in lost taxes. Some of the results would be short-term revenue loss especially for developing countries. The long-term problems were more serious however, including disrespect for the tax system and the law, increased complexity and an unfair shifting of the tax burden. For developing countries, the constant pressure and erosion of the tax base denied them fiscal independence and forced them to borrow or cut vital programmes.
The causes of these problems were found at many levels, from corporate leadership to the activities of professional accounting and law firms and banks. In many cases there involved a disintegration of fundamental values. The people adversely affected were shareholders, employees and whole communities. This led to a loss in confidence in the financial markets and business leaders and professionals.
Fortunately, the scandals had promoted a global response. New laws and regulations governing corporate behaviour were developed to enhance transparency and accountability, with an increased emphasis on corporate governance and social responsibility. Efforts were being made worldwide to stop impermissible tax avoidance and abusive avoidance schemes. The corporate sector had to commit to contribute to sustainable economic development, with tax compliance a key component of this.
To work towards a culture of compliance, there had to be a realisation that tax was no longer just an issue between a company and the taxman. There was reputational risk for the company itself, its executives and its advisors. In this new environment, taxpayers and SARS had to work together to achieve a culture of compliance. Compliance by existing taxpayers was improving in South Africa. Practitioners had played a major role in helping taxpayers to understand and comply with often complex rules. SARS had a fundamental duty to ensure a level playing field for these taxpayers and practitioners who were playing by the rules. SARS was also committed to providing taxpayers and practitioners with greater certainty about their obligations to ease their compliance burden and to help them avoid reputational risk by making the boundaries between permissible and impermissible behaviour more clear.
The goals SARS was trying to achieve were to clarify those boundaries through a stronger, better Section 103. They wanted to make Section 103 a consistent and effective deterrent to impermissible tax avoidance and abusive avoidance schemes in today’s economy. They wanted to protect the tax base and help provide a foundation for possible reform, simplification and relief.
Some of the lessons learned from the rest of the world were that it had been a serious problem internationally during the past decade. One reason was the collapse of standards and the impact of specific driving forces such as globalisation, financial deregulation and advances in information technology. Other factors were the growing complexity of tax laws and increasingly aggressive tax avoidance schemes. There was an erosion of leadership and a decline in values and a marked relaxation of enforcement of tax legislation in good times, for example where Government’s had budget surpluses.
At the multilateral and bilateral levels, South Africa had been involved in the Joint International Tax Shelter Information Centre (JITSIC) and other information exchange projects. At the national level, there had been increased enforcement with Australia, the United Kingdom and America announcing plans to beef up enforcement and close their tax gaps in the past few weeks.
Mr F Tomasek, the Assistant General Manager: Legislation, then explained the problems of the current law. Where taxpayers made use of a potential ‘loophole,’ which may have arisen from inevitable practical compromises, inconsistencies or discontinuities, the first step was to analyse their reliance on specific provisions and then consider applying Section 103. If something was lacking from the specific provisions, attention had to be given to improving their clarity and effectiveness. Section 103’s ‘wicket keeper’ role must be maintained.
Under the current section, there must be a transaction, operation or scheme that has the effect of avoiding tax, is not abnormal and has tax avoidance as its purpose before the Commissioner of SARS can invoke Section 103. In practice, Section 103 was inconsistent, and at times an ineffective deterrent to impermissible tax avoidance and abusive avoidance schemes.
The ‘abnormality’ requirement has long been considered to be the ‘Achilles Heel’ of the Act as promoters typically hijacked components of legitimate business transactions which gave their schemes an undeserved semblance of normality and business purpose. Consequently the Commissioner was forced to proceed on a case-by-case basis, which was a burden.
The ‘Purpose’ requirement was problematic as its application resulted in inconsistent results. Experience here and abroad showed that promoters manufactured plausible business purposes. In general, engagement in an avoidance scheme encouraged taxpayers to be economical with the truth. Other deficiencies were that the present section cannot be applied to steps in a larger transaction, cannot be used in the alternative and there were no penalties for promoters of abusive schemes. However, the countervailing concerns were that there was a potential for increased uncertainty, interference with legitimate or innovative business transactions. There could also be tension between a General Anti-avoidance Rule (GAAR) and the rule of law.
In drafting the proposed amendments, international experience was used as a guide; some of the current provisions were retained as far as possible, taking countervailing concerns into account while developing a South African solution. The four-pronged test was retained with changes made to the abnormality and purpose requirements. To determine abnormality, objective factors were added that could create a presumption of abnormality. The purpose test was made objective and the "sole or one of the main purposes" test was restored. The section could now be applicable to steps within a larger transaction, can be used in the alternative and penalties for promoters were introduced. The addition of the factors in determining abnormality reflected common elements in impermissible tax avoidance. These elements were often necessary to circumvent inherent fail-safes in the tax system itself as well as in financial accounting.
SARS had already received comments from interested parties. There was general acceptance of the notion of ‘impermissible tax avoidance’ and of a need for a stronger, more effective Section 103. There was general agreement that the Commissioner must be able to apply Section 103 to steps within a larger transaction. SARS had issued an interim response to these comments and appreciated many of the issues and concerns raised. Additional comments were encouraged with the legislation to be proposed later in 2006.
National Treasury Perspective on the General Anti-Avoidance Rule (GAAR) Proposal
Prof Keith Engel, the Treasury’s Chief Director of Tax Legislation, began by saying that the Treasury fully supported SARS’ efforts to upgrade the GAAR. With the assistance of Parliament, the Minister of Finance (via the Treasury) set tax policy through tax legislation. As the administrator, SARS had the task of maintaining that policy through legislative enforcement. Clever tax planning undermined SARS’ enforcement which accordingly nullified Treasury policy.
The GAAR debate had to be viewed as a central part of the long-standing ‘cat and mouse’ game of tax non-compliance. Borderline evasion took the form of aggressive or frivolous one-sided interpretations of legal ‘grey’ areas, endless paper trails and administrative tactics such as stalling on providing information or flooding SARS with too much information to ‘drown’ them with it. Classic tax avoidance was about the age-old legal distinction between the ‘letter’ versus the ‘spirit.’ As wordsmiths, good tax lawyers could elevate the ‘letter’ of the law into a fine art.
Since there was general agreement that tax avoidance was a problem, why was there all the fuss he asked? In terms of UK tax jurisprudence, impermissible tax avoidance was "a course of action designed to conflict or defeat the evident intention of Parliament;" whereas, permissible tax minimisation was acceptable as a course of action aimed at tax reduction. Taxpayers did not have an obligation to pay the maximum tax, but the dividing line was hard to draw when the decision to undertake a transaction would occur regardless of tax, but the manner of the transaction was heavily infected by tax considerations.
SARS had the power to charge people and organisations and disrupt cash-flows and reputations. It had many resources to draw from including international contacts and access to the media. Large corporations had power over the facts, also had a large pool of resources, contacts and access to the media. Thus, the battle could be described as one of ‘goliath versus goliath.’ A question that would arise from the results of this battle was: would the revised GAAR result in the unfair taxation of smaller businesses? On the other hand, could the revised GAAR be trusted in the hands of a rogue auditor who sought to achieve ever-increasing targets? SARS had no political interest in abusing its new-found powers as extreme enforcement would only lead to legislative curtailment of those powers in the future.
Not all tax planners engaged in sophisticated tax avoidance. Many lacked the risk appetite while others lacked the specialised skill. The ‘saints’ of the business actually resented the ‘sinners’ who generated deals that unfairly seduced clients and created undue layers of legislative complexity, as well as an undue climate of suspicion in the industry.
It was important to stop the avoidance addiction but because of the huge sums involved, it was hard for the ‘sinners’ to stop: tax professionals needed to maintain fees, company directors had to maintain profits and new deals had to be made to offset older ones that did not work.
In terms of the way forward, the revised GAAR provided a helpful set of factors to operate as indicators, that is, telltale signs of tax avoidance. Should Treasury and SARS be successful at targeting the ‘sinning’ few, Treasury could consider providing further relief for all, and given the history of the last five years, the Minister of Finance had been consistently generous in this regard.
Mr B Mnguni (ANC) asked how much tax income the country had lost through the relaxation of foreign exchange controls. He asked for clarification on the issue of "harmful tax practices."
Prof Engel replied that this was difficult to answer as they simply did not know. Guilty parties did not show them all of their deals and all of the amounts involved. Tax avoidance usually contained a fair measure of non-disclosure of facts. "Harmful tax practices" were usually conducted in tax havens, but they were only part of the problem. Mr Tomasek added that the tax system had to take up some of the slack when the foreign exchange controls were relaxed, hence the emergence of transfer pricing rules and control company rules.
Mr K Moloto (ANC) asked SARS what effect their new provisions would have on Black Economic Empowerment transactions since many of them involved SPEs.
Mr Louw replied that it was important to understand that the existence of an SPE in a transaction did not automatically make it fall foul of the provision. It was merely one of the factors to consider in the abnormality test. The other three main requirements would also still have to be met. In some cases, SARS had approved transactions that required there to be SPEs in obtaining finance for example.
Mr L Zita (ANC) asked if was not preferable to increase taxes in ‘good times’ and keep the money until it was needed when the economy was on a downward slope. SARS was bringing in a lot of money but in many provinces and municipalities there was a lack of capacity to spend the money. Why not put that money aside for ‘bad times?’
Mr Engel replied that Government did not want to increase the budget surplus, it could always re-route the money to help increase the skills base, for example,
which is what Treasury was doing. In the 80s and 90s, the system was so riddled with loopholes that it was the salaried workers that were disadvantaged. This led to high tax rates. Treasury had been gradually relieving workers of this burden. Also, there was a certain debt to equity ratio that the Government had to maintain and it was within those limits presently.
The meeting was adjourned.
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