The South African tax system is made up of several components, the three largest of which are personal income tax, value-added tax, and company tax. The collections from these and other taxes that the South African Revenue Service (SARS) administers are eroded in ways ranging from innocent ignorance of the law through to aggressive tax avoidance and on to outright fraud. Inevitably, where one taxpayer escapes tax, the shortfall has to be made up from other taxpayers. In addition less revenue is available to enable government to render essential services and to provide general tax relief in the form of lower tax rates.
In his Budget speech to Parliament on 21 February 2001, the Minister of Finance expressed his concern over the low effective tax rate prevailing in the financial services industry and, in particular, in the banking industry. The Minister indicated that Government would engage with the industry to address this matter to ensure that the industry pays its rightful share of taxation. Measures to address the concern would include steps such as:
The concerns raised by the Minister were based on the fact that while the industry is a profitable one, its tax base or the amount to which the tax rates are applied is substantially lower. As a result the actual company tax revenue collected from the industry is substantially lower than would be expected from a review of the industry's results. Conceptually, this could be the result of the use of tax allowances in an anticipated manner, expected differences between accounting and taxable income, aggressive tax structuring, or outright violations of the law in extreme cases.
INDUSTRY DISCUSSIONS AND INVESTIGATION
SARS and National Treasury have met with the Banking Council to discuss these issues on an industry basis. The Council has provided information at an industry level that will assist in identifying the main causes of the low effective tax rate in the industry.
In addition, SARS has, through its investigations, identified a number of structured finance transactions that contributed substantially to the minimisation of tax liabilities in the industry. Although it is not expected of any taxpayer to pay more tax than what is due in terms of the Act, it is clear from cases already identified that many of these transactions amount to aggressive tax structuring and are clearly in conflict with the intention of the legislature.
SARS has successfully challenged a number of these transactions and Media Release No. 30 was released on 4 July 2001 to bring the risks of structured finance transactions to the attention of the participants.
The question has subsequently arisen as to the nature of the transactions at risk of a SARS challenge so that participants will be better able to evaluate the tax risks associated with the transactions. While it is not possible to provide a detailed or comprehensive list of transactions, the selection of characteristics and transactions provided below serve as a guide to the transactions that are currently under review.
COMMON CHARACTERISTICS OF TAX SHELTER TRANSACTIONS
SARS regards a transaction as constituting a tax shelter if it exhibits one or more of the following characteristics:
TAX SHELTER TRANSACTIONS ALREADY INDENTIFIED IN THE MARKET
Although not an exhaustive list, the following are examples of tax shelter transactions available in the market that purport to reduce and defer the payment of taxes and which SARS is in the process of challenging.
These transactions include the use of conditional promissory notes, limited recourse deposits/advances and other arrangements whereby income accrues for accounting purposes but not for tax purposes due to an element of conditionality built into the terms and conditions of the transactions.
These transactions include advances made to clients in terms of which the loan capital is converted into equity on maturity date. The rights to the conversion shares (i.e. the capital element of the loan) are generally sold back to the client, or a connected person. The growth between the purchase consideration and maturity value of the share rights is generally treated as a growth of a capital nature, or unrealised growth, or not treated as growth at all.
Transactions of this nature include the use of structured leases and other transactions, although not defined as a lease transaction, whereby a party obtains the right to the use of an asset. In these transactions ownership of the asset, or control of the asset-owning company, generally passes to the client at the end of the period, or the client obtains the option to acquire the asset at a discounted value.
Included in this category are transactions whereby an asset is purchased from a client and then leased to another party. The asset, excluding the lease or lease rentals, is then generally sold to a connected party of the lessor and a tax loss is claimed on the disposal of the bare dominium.
These transactions include transactions where a liability is disposed of to a third party and an artificial interest deduction is created in the hands of the borrower.
These include transactions whereby assets, including shares, are purchased or sold forward. They can be categorised as:
These transactions include deep-in-the-money options, deferred premium options and at-the-money spots written/purchased for inter alia tax purposes.
Included in this category are put-call arrangements written/purchased which have the economic effect that a forward contract has been created.
The deep-in-the-money options result in the deferral of the taxpayer’s taxable income to the year in which the options are exercised or disposed of. The deferred premium options result in a permanent difference as the option writer includes the premium receivable in gross income at its present value while the option purchaser deducts the premium payable at its future value.
These transactions include transactions whereby money is lent to a South African resident via another tax jurisdiction. These loans may be funded by another South African resident by making the funds available through a preference share investment, an insurance growth policy or some other means.
Included in this category are transactions structured through low tax-rate jurisdictions, tax-exempt entities or entities subject to a preferential tax regime.
The negative effect that these transactions have on the corporate income tax base is substantial and is detrimental to taxpayers at large. It would therefore be against the national interest if transactions of this nature were allowed to continue. SARS has already successfully challenged a number of these transactions while others have been referred for hearing to the Income Tax Special Court and the Supreme Court of Appeal.
SARS will continue to challenge these transactions and wishes to alert recipients of financial assistance that depend on benefits generated by tax legislation for preferential terms, that they:
For further details, contact Fani Zulu (082 451 0457)
ISSUED BY THE COMMISSIONER FOR THE SOUTH AFRICAN REVENUE SERVICE