Legislation: Income Tax Act, Sections 80 and 103
Tax avoidance is a complex concept that creates uncertainty in the South African tax law system and results in revenue loss. Tax avoidance is a broad concept that constitutes permissible tax avoidance and impermissible tax avoidance. The main difference between impermissible tax avoidance and permissible tax avoidance is that the former is illegal and the latter is legal. To deal with, amongst other problems caused by impermissible tax avoidance and revenue loss, South Africa introduced GAAR (general anti-avoidance rule) to curb impermissible tax avoidance. In doing so, GAAR rejects tax avoidance arrangements that are found to be abusive and allows permissible tax avoidance.
The South African GAAR is aimed at curbing impermissible tax avoidance arrangements that, inter alia, result in tax benefits with the sole or main purpose to obtain that tax benefit. The problem with this GAAR is that it does not clearly differentiate between permissible tax avoidance and impermissible tax avoidance. A taxpayer who gets caught by the GAAR is subjected to the provisions of section 80B of the ITA. The consequences in section 80B are corrective measures and do not result in any disincentive to the taxpayer except that the taxpayer only pays the amount of tax that would have been due in the absence of the avoidance arrangement.
Section 103(1) contained the acts’ general anti-avoidance rule (GAAR) for a number of years. This provision did, however, contain certain inherent weaknesses, with the result that a new GAAR was incorporated within the Act. These new provisions were inserted in sections 80A to 80L and apply to any arrangement entered into on or after 2 November 2006.
Section 80A describes what an “impermissible avoidance arrangement” is. The powers that the Commissioner has with respect to an impermissible avoidance arrangement are set out in Section 80B.
Section 80L defines the terms “arrangement”, “avoidance arrangement”, “impermissible avoidance arrangement”, “party” and “tax benefit” for use in the GAAR.
The GAAR provisions empower SARS to impose a tax liability on a taxpayer where it has been party to an impermissible avoidance arrangement. Sections 80A, B and C are the provisions relevant to this case. The general anti-avoidance rule can be applied if an avoidance arrangement (in other words, an arrangement that results in a tax benefit) is an “impermissible avoidance arrangement”.
An impermissible avoidance arrangement arises if:
• The sole or main purpose of the avoidance arrangement was to obtain a tax benefit (it is always presumed that an avoidance arrangement was entered into with the sole or main purpose of obtaining a tax benefit (s 80G) and
• A tainted element is present. There are three tainted elements:
• Abnormality (ss 80A(a)(i), ss 80A(b) and 80A(c)(i); or
• Lack of commercial substance (s 80A(a)(ii)); or
• Misuse or abuse of the provisions of the Act (s 80A(a)(ii)). A “lack of commercial substance” (s 80C) Section 80C provides a general rule for determining whether an avoidance arrangement lacks commercial substance for the purposes of s 80A, as well as a non-exclusive set of characteristics that serve as indicators of a lack of commercial substance.The general rule is that an avoidance arrangement lacks commercial substance if it results in a significant tax benefit for a party but does not have a significant effect upon either the business risks or the net cash flow of that party (s 80C).
Examples of indicators of a lack of commercial substance, according to s 80C(2), include:
• Situations where the legal substance of a transaction differs from the legal form, or
• Round trip financing is present, as described in s 80D, or
• A tax-indifferent party, as described in s 80E, is introduced as part of the arrangement, or
• Elements are present that have the effect of offsetting or cancelling each other. These elements are typically present when one transaction creates a significant tax benefit while another transaction effectively neutralises the undesired consequences of the first transaction.
Section 80D provides a non-exclusive description of round trip financing. This essentially relates to a transfer of funds between parties that results in a tax benefit and a significant reduction, offset or elimination of business risk.
Accommodating or tax-indifferent party
A party to an avoidance arrangement is an accommodating or tax-indifferent party (accommodating party) if:
• Any amount derived by the accommodating party is not subject to normal tax in SA or is significantly offset by any expenditure or loss; and
• The participation of the accommodating party (directly or indirectly):
– has the result that an amount that would have been included in the gross income of another party now becomes capital in the accommodating party’s hands;
– has the result that an amount that would have been non-deductible in another party’s hands now becomes deductible in the accommodating party’s hands;
– has the result that an amount that would have been included in the gross income of another party now becomes exempt in the accommodating party’s hands; or
– involves a prepayment to another party.A person will qualify as an accommodating party whether or not that person is a connected person in relation to any party.
In order to ensure that normal business transactions do not fall within the net, the following exclusions to the definition of an accommodating party have been incorporated:
• The amounts derived by the accommodating party are cumulatively taxable in another country in an amount equal to at least two-thirds of the tax that would have been payable in SA; or
• If the accommodating party continues to engage directly in substantive active trading activities in connection with the avoidance arrangement for a period of at least 18 months and the activities are attributable to a proper place of business (which is equivalent to a foreign business establishment as defined in s 9D of the Act if it were located outside SA and the accommodating party were a CFC).
The Commissioner is empowered to treat connected persons as one and the same person, or to disregard any accommodating party, or to treat any accommodating party and another party as one and the same person.
Section 80A defines an impermissible avoidance arrangement:
“80A. Impermissible tax avoidance arrangements.—An avoidance arrangement is an impermissible avoidance arrangement if its sole or main purpose was to obtain a tax benefit and:
(a) in the context of business:
(i) it was entered into or carried out by means or in a manner which would not normally be employed for bona fide business purposes, other than obtaining a tax benefit; or
(ii) it lacks commercial substance, in whole or in part, taking into account the provisions of section 80C;(b) in a context other than business, it was entered into or carried out by means or in a manner which would not normally be employed for a bona fide purpose, other than obtaining a tax benefit; or
(c) in any context:
(i) it has created rights or obligations that would not normally be created between persons dealing at arm’s length; or
(ii) it would result directly or indirectly in the misuse or abuse of the provisions of this Act (including the provisions of this Part).”Section 80B sets out the tax consequences of impermissible tax avoidance as follows:
“80B. Tax consequences of impermissible tax avoidance.
(1) The Commissioner may determine the tax consequences under this Act of any impermissible avoidance arrangement for any party by:
(a) disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement;
(b) disregarding any accommodating or tax-indifferent party or treating any accommodating or tax-indifferent party and any other party as one and the same person;
(c) deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;
(d) reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;
(e) re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or
(f) treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit.
(2) Subject to the time limits imposed by sections 99, 100 and 104(5)(b) of the Tax Administration Act, the Commissioner must make compensating adjustments that he or she is satisfied are necessary and appropriate to ensure the consistent treatment of all parties to the impermissible avoidance arrangement.”
In determining the tax consequences commonly called “the remedy”, SARS may inter alia disregard parts of the impermissible avoidance arrangement.
The GAAR is different to most fiscal provisions in that SARS must call for the taxpayer to make representations before it may issue an assessment. This it does by way of the GAAR notice which must conform to the prescripts contained in section 80J:
“80J. Notice
(1) The Commissioner must, prior to determining any liability of a party for tax under section 80B, give the party notice that he or she believes that the provisions of this Part may apply in respect of an arrangement and must set out in the notice his or her reasons therefor.
(2) A party who receives notice in terms of subsection (1) may, within 60 days after the date of that notice or such longer period as the Commissioner may allow, submit reasons to the Commissioner why the provisions of this Part should not be applied.
(3) The Commissioner must within 180 days of receipt of the reasons or the expiry of the period contemplated in subsection (2):
(a) request additional information in order to determine whether or not this Part applies in respect of an arrangement;
(b) give notice to the party that the notice in terms of subsection (1) has been withdrawn; or
(c) determine the liability of that party for tax in terms of this Part.(4) If at any stage after giving notice to the party in terms of subsection (1), additional information comes to the knowledge of the Commissioner, he or she may revise or modify his or her reasons for applying this Part or, if the notice has been withdrawn, give notice in terms of subsection (1).”
In terms of section 80J(4), SARS, if additional information comes to its knowledge, may at any stage after it has issued a GAAR notice revise or modify its reasons for applying the GAAR or if it withdrew the GAAR notice, issue a new GAAR notice. There is thus a consequence should the taxpayer elect not to respond or be coy in his response to the GAAR notice or withhold material information as a residual uncertainty will remain.
Section 80J(4) must be read within its immediate statutory context, i.e. section 80J as a whole. Section 80J(1) makes giving of the GAAR notice peremptory and explains what the notice must contain. Section 80J(2) provides the taxpayer with an opportunity to answer the GAAR notice. Section 80J(3)(a) to (c) obliges SARS to do one of three things within 180 days of receipt of the response, i.e. request information, withdraw the GAAR notice, or assess the taxpayer in terms of the GAAR. Section 80J(4) permits SARS to do two things if additional information comes to its notice. It may revise or modify its reasons for applying the GAAR (i.e. revise or modify the underpinning of the assessment), or if it has withdrawn the GAAR notice, issue a new one. Those are the two options and in both cases the jurisdictional fact for the revision or modification for the reasons for applying the GAAR, or the giving of a new GAAR notice, is when additional information is brought to SARS’s notice.