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FINANCE PORTFOLIO COMMITTEE
22 March 2006
TAX AVOIDANCE DISCUSSION PAPER: HEARINGS
Chairperson: Mr N Nene (ANC)
Documents handed out:
Presentation by Brian J. Arnold
Business Unity South Africa Presentation
Joint Submission: FPI and SAFSIA
South African Institute of Chartered Accountants Presentation
Law Society of South Africa
Gobodo Chartered Accountants (SA)
Financial Planning Institute of Southern Africa
Banking Association South Africa
Association For the Advancement of Black Accountants of Southern Africa
Judge Denis Davis said that the tax laws in South Africa were too complicated and this made tax law difficult to understand. The problem was that all of the new factors that SARS wanted to bring in were potentially problematic. The ‘purpose’ requirement was to be assessed objectively. He did not know what that meant. The approach SARS wanted to take made no sense and created an impossibility. It was not a jurisprudentially sound process.
Mr Arnold said that in response to the prevalence of tax avoidance schemes, better, coherent legislation was drafted, with better enforcement. Specific and general statutory anti-avoidance rules were drafted, and judicial anti-avoidance doctrines were developed. In South Africa, what form should the General Anti-avoidance Rules take was the question that had to be answered as it was generally acknowledged that Section 103 of the Income Tax Act was deficient. SARS’ proposed amendments were based on a sound analysis as evidence by their discussion paper. The paper considered the General Anti-avoidance Rules of other countries and borrowed judiciously from them. In general, Section 103 would be improved significantly.
Business Unity South Africa said that in practice, the ‘abnormality’ requirement was hard for SARS to apply, and hard for taxpayers to understand fully. Objectively assessing such transactions was a positive move, but transactions that were normal business activities should not be included in the factors. Another problem with the proposals was the shifting of the onus to the taxpayer. The problem was exacerbated by the general lack of clarity in the wording of the section.
The Financial Planning Institute and the South African Financial Services Intermediaries Association said that the ‘abnormality’ requirement had to be retained, but the creation of a list of "non-exclusive" factors was not ideal. On the contrary, it would lead to further abuse and finding of loopholes within the factors by clever planners. They agreed in principle that the move from a subjective purpose to an objective one was a wise move as it would set the parameters clearly with little or no ambiguity.
The South African Institute of Chartered Accountants said that the current Section 103 had not been the subject of a lot of litigation so it was unwise to conclude that it was not an effective deterrent. The real success of Section 103 was in the number of transactions that taxpayers did not go into because of the existence of the provision. The proposed ‘purpose’ test was too far reaching and had the real risk of bringing the majority of unintended transactions within the ambit of the General Anti-avoidance Rules. The objective test should not be applied in isolation without regard to the purpose as evidenced by the actions of the taxpayer amongst other factors.
Presentation by Judge Dennis Davis
Judge Davis began by saying that the tax laws in South Africa were too complicated. The Revenue Laws Amendment Act was amended every year. This made tax law difficult to understand. During the Katz Commission, Adv E Broomberg SC proposed the simplification of the law but the call had been ignored. The main problem with Section 103 of the Income Tax Act was that in order for it to be applied, all four requirements had to be met. SARS had struggled to prove the ‘abnormality’ requirement, especially since the Conhage case in 1999, which was a correct decision in his opinion. SARS were trying to undo the decision in this case by bringing in their proposed amendment. The problem was that all of the new factors that SARS wanted to bring in were potentially problematic.
One of the factors was ‘a failure by any party to deal at arms length without regard to whether the parties are connected in relation to one another.’ That meant that the arms length assessment would be made on the basis that the parties were independent of each other. This factor would include certain transactions within the ambit of an automatic shift of onus to the taxpayer. But interest free loans in a group of companies that were specifically exempt from the secondary tax on companies, could trigger a transfer of an onus on the taxpayer, which was wrong. Each of the factors was problematic and would bring a whole of factors that were ordinary business transactions at present. Also, what weight could the courts give to the factors in relation to the onus? He did not know.
The ‘purpose’ requirement was to be assessed objectively. He did not know what that meant. At present it was assessed subjectively. ‘Purpose’ was that of the taxpayer, not that of a reasonable person. The role of the judge was to test the taxpayer’s ipse dixit (unsupported assertion) against the facts. The approach SARS wanted to take made no sense and created an impossibility. It was not a jurisprudentially sound process.
He did see the need for a Section 103 and it did have to be refined. However, the amendments before the Committee seemed to be a very poorly drafted. SARS had to re-examine them to see if they really did address the mischief they sought to. The new sections were vague in their guidance to courts; it created undesirable presumptions and created a jurisprudentially poor structure of the ‘purpose’ requirement.
Presentation by Brian J. Arnold
Mr B Arnold, from Goodmans LLP, said that the discussion on tax avoidance began in the Duke of Westminster case. The House of Lords held that taxpayers were entitled to arrange their affairs to minimise tax. The consequences of this were that tax avoidance systems flourished. This was helped by globalisation, deregulation and the introduction of new financial products. This only benefited those who could afford tax planning expertise and increased the burden on those who could not. The idea should be that everyone must pay their share, and the legislature could not have intended that some taxpayers be able to escape their tax obligations.
In response to the prevalence of tax avoidance schemes, better, coherent legislation was drafted, with better enforcement. Specific and general statutory anti-avoidance rules were drafted, and judicial anti-avoidance doctrines were developed. However, it has been proved that better enforcement was not necessarily an adequate response, specific anti-avoidance rules did not work and the limited judicial doctrines were ineffective. Thus, tax avoidance required a multi-faceted response and every tax system required a general anti-avoidance rule (judicial or statutory) to deter unacceptable tax avoidance before it occurred. Australia, New Zealand and South Africa decided to adopt General Anti-avoidance Rules (GAARs), while countries such as the US and the UK developed judicial doctrines. In South Africa, what form should the GAAR take was the question that had to be answered as it was generally acknowledged that Section 103 was deficient.
The key principles were that the GAAR had to apply if one of the taxpayer’s main purposes, objectively determined, was to avoid tax. The GAAR had to apply to a series of transactions as a whole, and to each transaction in a series. The relationship between the GAAR and other statutory provisions had to be determined on a case-to-case basis. The GAAR had to distinguish between legitimate tax planning and unacceptable tax avoidance on some principled basis. The economic substance of the transactions had to be taken into account and the GAAR had to minimise uncertainty for taxpayers. If the GAAR was applicable, the taxpayer had to be subject to a financial penalty.
He said that SARS’ proposed amendments were based on a sound analysis as evidence by their discussion paper. The paper considered the GAARs of other countries and borrowed judiciously from them. In general, section 103 would be improved significantly. Minor concerns were that there was no definition of a multi-step arrangement, does the presumption in section 103(4)(b) apply only to business transactions, and how did the presumption affect the application of the GAAR?
In conclusion, the proposals to amend Section 103 should send a strong signal to the courts, taxpayers and their advisors that abusive tax avoidance would not be tolerated.
Dr Van Dyk (DA) asked Judge Davis that since he considered tax law to be complicated; did this keep many people out of the tax system?
Davis J replied that every country had complicated legislation, but the problem was that South Africa had borrowed too much from complicated jurisdictions, in a way that was out of context. The difficulty was finding the simplest, most effective rules for South Africa. There were people outside of the system, but SARS had done a splendid job to get more people into the system and pay their share.
Mr Y Bhamjee (ANC) lamented the fact that the Committee lacked the expertise too fully appreciate the arguments of the two presenters. Historically, taxation in South Africa was driven by the elite. To fix the problems, a lot of legislating had to occur, so to ask for simple legislation all of the time was a serious battle.
Mr M Johnson (ANC) said that Judge Davis’ comments worried him. Taxes had to be paid for the country to work. How could the laws be made less complicated?
The answer to the question was applying the correct methodology. Such legislation was aimed at the rich. It was valuable to borrow from other countries, but things that were relevant to South Africa and that lawyers and judges had to be taken. Things like the ‘objective purpose’ test blurred the lines. There had been no litigation on the current purpose requirement.
Mr I Davidson (DA) asked Mr Arnold what his thoughts were on Judge Davis’ comments that some of the requirements were jurisprudentially unsound. He asked Judge Davis how he would tighten up the section.
Mr Arnold replied that there were some problems with the factors. There was duplication in some cases, and there were some uncertainties, so they could be made simpler. Judge Davis said that the requirements had to be tightened up, rather than going the radical route of amending the section. The normality requirement could be tightened. There were cases that dealt with economic substance. The approach should be to use the tools that were there, such as using the cases and applying the normality section tighter.
Adv Meiring, from the Business Parliamentary Office Advisory Board, said that it was the duty of the taxpayer to fulfil his/her obligations within the requirements of the law. But within the ambit of the law, it was equally legitimate for the taxpayer to minimise those obligations. It can be argued that although the effectiveness of the section might not be measurable in terms of the successful cases won by SARS, its existence had served to discourage attempts to circumvent legitimate tax obligations.
In practice, the ‘abnormality’ requirement was hard for SARS to apply, and hard for taxpayers to understand fully. Objectively assessing such transactions was a positive move, but transactions that were normal business activities should not be included in the factors. A solution may be for the Minister to publish a list of transactions that were absolved from application of the ‘abnormality’ requirement. This would provide more certainty and clarity.
Another problem with the proposals was the shifting of the onus to the taxpayer. The problem is exacerbated by the general lack of clarity in the wording of the section. The question may be raised whether it was possible to have more than one main purpose of an arrangement or step. It was not necessary to change the current requirement that tax avoidance must be the predominant purpose.
The Advanced Tax Ruling (ATR) system was not yet in force, and BUSA proposed the postponement of the implementation of section 103 until after the revised ATR legislation had been brought into effect and the ATR unit at SARS was fully operational.
Financial Planning Institute (FPI) and the South African Financial Services Intermediaries Association (SAFSIA)
Ms P Govender, FPI Vice-Chairperson, said that their members’ main problems were the ambiguity of the wording of Section 103 and the lack of simplicity. The ‘abnormality’ requirement had to be retained, but the creation of a list of "non-exclusive" factors was not ideal. On the contrary, it would lead to further abuse and finding of loopholes within the factors by clever planners.
They agreed in principle that the move from a subjective purpose to an objective one was a wise move as it would set the parameters clearly with little or no ambiguity. That the section be applied to steps in a larger scheme was in the best interests of the taxpayer and SARS. This was almost necessary in the complicated global business environment. It was necessary that Section 103 be applied in the alternative as the technicalities surrounding Section 24J were often used as a loophole. Penalties were necessary and could act as deterrents in themselves.
In conclusion, any move towards engendering a culture of tax compliance was received by them in a positive light.
South African Institute of Chartered Accountants Presentation
Ms J Arendse, the Tax Project Director, said that the current Section 103 had not been the subject of a lot of litigation so it was unwise to conclude that it was not an effective deterrent. The real success of Section 103 was in the number of transactions that taxpayers did not go into because of the existence of the provision.
There were deficiencies in the legislation though. Taxpayers often structured their transactions because of perceived anomalies in tax legislation. For example, interest incurred on loans utilised to purchase assets as opposed to shares/equity was allowed as a deduction. In this regard, the principles outlined in the Drakensburg Gardens case should be codified. Consideration also had to be given to the introduction of ‘group’ taxation which would eliminate the many transactions and schemes developed to artificially create group taxation.
The Reportable Arrangements legislation had not been widely used which was unfortunate. They could be used to identify suspicious transactions at their root. The ATR rules were in legislation but were not yet in force. The system should be introduced prior or simultaneously with the new GAAR. There was still a significant tax gap in South Africa that had to be closed. SARS had done a lot to close the gap but much more could be done.
Mr N Nalliah, the Chairman of the National Tax Committee, said that the proposed ‘purpose’ test was too far reaching and had the real risk of bringing the majority of unintended transactions within the ambit of the GAAR. They suggested their own amendment where the phrase "other than that expressly provided for in the Income Tax Act" could be added to the provision. The danger of having a list of factors was that they could lead to a mechanical approach in their application by an assessor especially as the Commissioner had no discretion. The objective test should not be applied in isolation without regard to the purpose as evidenced by the actions of the taxpayer amongst other factors.
Mr K Moloto (ANC) asked BUSA how the new section would affect Black Economic Empowerment (BEE) Transactions.
Adv Meiring replied that yes, there were aspects in BEE transactions that could be regarded as being ‘abnormal.’
Ms J Fubbs (ANC) said that the presenters gave the impression that they saw section 103 as a "scare tactic." It seemed like they did not want to develop a culture of compliance and share.
Adv Meiring said that they did not mean anything sinister by saying that the section was seen as a "scare tactic." There was a place for an anti-avoidance provision in the law. Its existence had served to limit the number of abusive schemes entered into.
The meeting was adjourned.