Business Tax and Company Law Quarterly

Issue Number

Latest documents

• Unlocking the Beneficial Interest and Beneficial Ownership Quagmire

  The General Laws (Anti-Money Laundering and Combating Terrorism Financing) Amendment Act 22 of 2022 (GLAA) was introduced in 2022 and amends the Companies Act 71 of 2008 (Companies Act) by (i) providing for a comprehensive mechanism through which the Companies and Intellectual Property Commission can keep accurate and up-to-date beneficial ownership information; (ii) requiring a company, which is not an ‘affected company’ for purposes of the Companies Act, to keep, and file with CIPC, a record of the ’beneficial owners’ of a company, and by providing for specified time-lines within which a company must record any changes in this information; (iii) requiring a company, which is an ‘affected company’ for purposes of the Companies Act, to establish and maintain a register of the persons who hold beneficial interests equal to or in excess of 5% of the total number of securities of that class issued by the company, together with the extent of those beneficial interests; and (iv) specifying that persons who are convicted of offences relating to money laundering, terrorist financing, or proliferation financing activities or are subject to a resolution of the UN Security Council are prohibited from registering as company directors.Key to the amendments is the distinction between a company which falls within the definition of an ’affected company‘ for purposes of the Companies Act, on the one hand, and a company which does not fall within the definition of an ;affected company; for purposes of the Companies Act, on the other hand. Also key is the definition of ‘beneficial owner’ and the manner in which it will be interpreted — which remains to be seen. Time will tell as to how beneficial these provisions are and whether they can assist in having South Africa removed as a grey list country. Enforcement may be more effective if the sanction for non-compliance is a criminal sanction (in addition to a financial sanction) — as is the case in Mauritius, which managed to convince the Financial Action Task Force to remove it from the grey list.

• How Foreign is Your Business Establishment?

  The introduction of full residence-based taxation in 2001 brought with it the concept of a ‘Controlled Foreign Company’ (CFC), whose profits (calculated on SA income tax principles) would be attributed to qualifying South African shareholders (‘participants’) as taxable income. Exempted from attribution were those profits of a CFC which arose from a ‘business establishment’, a term which was tightly defined and relied in part upon the establishment displaying the hallmarks of a real operating business in the foreign country and not having been set up for the purpose of tax avoidance.Since those early days, the definition of what is now a ‘foreign business establishment’ (FBE) has undergone detail change. Today, and central to the definition, is the requirement that in order to qualify there must be a ‘fixed place of business’ located in the foreign country and ‘used for the carrying on of the business of the CFC, … where that fixed place of business is (inter alia) … suitably staffed with on-site managerial and operational employees … who conduct the primary operations of that business …’.Over the years there has been much comment in the tax specialist press dealing with the extent to which the operations of an FBE can be outsourced, before it is no longer ‘suitably staffed’ for conducting its primary operations. Silke and Income Tax South Africa took slightly different positions on this issue and now the SCA has handed down judgement in Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd 2023 JDR 0295 (SCA), which sets out that court’s view on the point.In Volume 14, Issue 1 of this journal Wally Horak criticised elements of this judgment and in this edition David Clegg raises some additional concerns. These are whether the court was correct in its identification of the ‘primary operations’, and in finding that a ‘primary operation’ cannot, in principle, be outsourced. Clegg also addresses what he sees as a fundamental mistake made by the taxpayer, in setting up his foreign business.

• Editorial

  The authors of the journal welcome the move to the Juta stable of tax literature and look forward to many years of expanding the readership of the journal to those interested in the commercial features of tax and corporate law.

• The Misuse and Abuse of Section 80J of the Income Tax Act

  Section 80J of the Income Tax Act was introduced in 2006 as part of the then new General Anti-Avoidance Rule (GAAR). This section requires the Commissioner to notify a taxpayer at the point in an audit when he/she first comes to believe that the GAAR may be applicable to an arrangement entered into or carried out by the taxpayer. It was enacted in response to concerns that the new GAAR might be automatically relied upon by SARS as a ‘catch-all’ section of last resort without due and proper consideration. Commentators also expressed concerns about conduct of audits under former s 103, particularly with respect to delays they encountered and the time and expensed they incurred.Section 80J attempted to address these concerns by providing a logical framework for the timeous conduct of audits under the new GAAR. Subsection (1) requires the Commissioner to notify the taxpayer if he/she believes the GAAR may be applicable to an arrangement and state his/her reasons therefor; sub-s (2) gives the taxpayer an opportunity to respond to that notice; sub-s (3) requires the Commissioner to take further action within a specific statutory time frame; and sub-s (4) permits the Commissioner to revise or modify his reasons for applying the GAAR in light of any additional information that may come to his knowledge.Two recent judgments have raised concerns about the current approach being taken to s 80J by taxpayers and, to a certain extent, SARS itself. In particular, taxpayers appear to be taking the position that section 80J(1), read together with the statutory definition of ‘arrangement’, have imposed a burden upon the Commissioner to identify and describe a transaction, operation or scheme with an exacting degree of precision never before required under the former s 103 or its predecessors. This approach cannot be support by a textual, contextual and purposive interpretation of the provisions involved, and, in fact, would severely frustrate both the overriding purpose of the current GAAR and the specific purposes of s 80J itself.

• Editorial

  There can be little argument that our tax laws are complex. Added to the complexity of our tax laws is a large measure of uncertainty in the application of these complex laws. Should anyone have any doubt regarding these two statements, this will be quickly dispelled after reading these three erudite articles.

• The Modified Section 23M

  Section 23M of the Income Tax Act 58 of 1962 seeks to limit the deduction of interest on debt arising between parties related to one another and in respect of which the interest is not subject to tax in the hands of the recipient of the interest.Section 23M was amended in 2021 by the Tax Laws Amendment Act 20 of 2021 and is effective from years of assessment ending on or after 31 March 2023. The key amendments to the section deal with: Interest partially subject to tax.The amendment to the definition of ‘interest’, being the subject matter of the limitation rules in the section.In respect of interest partially subject to tax, i e a tax rate say of 5% in terms of a double taxation agreement, the limitation rules will apply to that part which is not subject to tax, i e 10% in the example given (being the 15% withholding tax rate — 5% withholding tax limitation under the applicable double taxation agreement).The definition of ‘interest’ is expanded. The relevance of the definition’s expansion is that all ‘interest’ payable to a related party (a ‘controlling relationship’ as defined) which is not subject to tax, could be limited in terms of its deductibility.The amended interest definition includes: Interest as contemplated in s 24J of the Act: which includes common law interest and other charges of a similar nature;Amounts incurred or accrued in respect of ‘interest rate agreements as contemplated in section 24K of the Act;Any finance cost element recognised for purposes of IFRS in respect of any lease agreement that constitutes a finance lease as defined in IFRS16;Foreign exchange gains and losses; andAmounts deemed to be interest in terms of Sharia compliant financing arrangements.Accordingly, finance arrangements between related parties where the ‘interest’, as defined, is not subject to tax or is partially subject to tax may be limited in terms of its deductibility.

• Editorial

  The first article in this issue deals with a cross-border-related tax provision of the Income Tax Act of 1962, namely section 9I. This section provides relief for so-called ‘headquarter companies’ in respect of dividends tax, controlled foreign company rules and from the transfer pricing and thin capitalisation rules. In addition, paragraph 64B of the Eighth Schedule to the Act provides for a headquarter company to enjoy the participation exemption from capital gains tax in respect of the disposal of it shares in a foreign company.

• Whatever Happened to Hedge Funds?

  South African hedge funds were declared as ‘Collective Investment Schemes’ (‘CIS’), and accordingly regulated under the Collective Investment Schemes Control Act (‘CISCA’), in 2015. The inclusion of hedge funds in the regulatory sphere of CISCA was intended to provide protection to investors and the financial system, whilst affording greater access to hedge funds for retail investors, which were previously reserved for the most sophisticated, daring and well-connected investors.This article investigates the characteristics and methodologies of hedge funds and their typical structure in South Africa, as well as the evolution of the regulatory landscape of the South African hedge fund industry. This is followed by a summary of the relevant income tax and capital gains tax provisions that currently apply to hedge funds, and the importance of correctly classifying amounts as either capital or revenue in nature. The current state and climate of the South African hedge fund market is further explored in order to determine whether the regulation of hedge funds under CISCA has provided the intended protection to investors and South Africa’s financial system, whilst developing financial markets, without unreasonably or excessively constraining the business of hedge funds.Since 2015, the number of registered hedge fund CISs and portfolios has been declining, whilst the value of assets under management has been steadily increasing. The authors submit that this inverse relationship is indicative of the fact that despite the relative health of South Africa’s hedge fund industry, there are significant barriers to the establishment of new hedge fund CISs and portfolios. With onerous prescriptions, limitations and requirements, South African hedge funds are now among the most extensively regulated in the world and the protection afforded to investors, whilst effective, may be slowly strangling the sustainable growth of South Africa’s hedge fund industry.

• Holding-Company Deductions

  The deductibility of expenditure incurred by holding companies is often a contentious issue, particularly where expenditure, usually interest costs, exceeds taxable income, usually in the form of interest.The deduction of expenditure must meet the ‘carrying on of trade’ test with reference to either section 11(a) of the Income Tax Act or section 24J, the latter being applicable to interest.The article summarises relevant principles from older tax cases applicable to taxpayers carrying on money-lending activities to more recent case law, applying the older principles in order to argue the deduction of expenses, including interest, against interest income in the context of ‘trade’.The degree of risk attendant to particular ventures may go too far to constitute a ‘trade’, as defined. But the expectation of profit has often been regarded as a cornerstone in determining whether a trade is carried on. This assertion though is premised on the degree of commercial expediency in relation to the ultimate objective of the business of the taxpayer.In Solaglass Finance Company (Pty) Ltd v CIR 1991 (A), 53 SATC 1, the court summarised the key elements of a moneylenders’ activities. Albeit that the analysis was required to address the capital versus revenue nature of the taxpayer’s losses, it is submitted that the analysis forms an adequate assessment of whether or not a taxpayer carries on a trade. Some of the features in the analysis are: the level of activity of the taxpayer, a system or plan that displays a degree of continuity, including a continuous desire to earn a margin, and obtaining security.What is interesting in later court decisions in 2005 and in 2022, is that the principal guidelines set out in the earlier judgements relating to moneylenders, in summary: continuity, a system or plan and the generation of profit, were applied in assessing the deductibility of interest and in particular whether the interest was incurred as a deduction from income derived from the carrying on of a trade.So what must be considered is where holding companies engage as the source of funding, and the application thereof. In isolation, the company must be able to demonstrate a continuous system or plan in which money is borrowed and advanced, at profit, to group entities. Often experts are employed in holding companies in larger groups to manage the treasury function, or if such experts reside within the group, an appropriate charge is levied. The anticipation of profits is of paramount importance. The difficulty here often lies in underlying subsidiaries meeting cash flow or liquidity constraints thereby being unable to settle the debt plus interest costs. A system or plan should be agreed upon to deal with these issues. A mere reduction of the interest rate to affected subsidiaries will not, it is submitted, meet the trade test in section 24J nor in section 23(g) of the Act.

• Holding-Company Deductions

  The deductibility of expenditure incurred by holding companies is often a contentious issue, particularly where expenditure, usually interest costs, exceeds taxable income, usually in the form of interest.The deduction of expenditure must meet the ‘carrying on of trade’ test with reference to either section 11(a) of the Income Tax Act or section 24J, the latter being applicable to interest.The article summarises relevant principles from older tax cases applicable to taxpayers carrying on money-lending activities to more recent case law, applying the older principles in order to argue the deduction of expenses, including interest, against interest income in the context of ‘trade’.The degree of risk attendant to particular ventures may go too far to constitute a ‘trade’, as defined. But the expectation of profit has often been regarded as a cornerstone in determining whether a trade is carried on. This assertion though is premised on the degree of commercial expediency in relation to the ultimate objective of the business of the taxpayer.In Solaglass Finance Company (Pty) Ltd v CIR 1991 (A), 53 SATC 1, the court summarised the key elements of a moneylenders’ activities. Albeit that the analysis was required to address the capital versus revenue nature of the taxpayer’s losses, it is submitted that the analysis forms an adequate assessment of whether or not a taxpayer carries on a trade. Some of the features in the analysis are: the level of activity of the taxpayer, a system or plan that displays a degree of continuity, including a continuous desire to earn a margin, and obtaining security.What is interesting in later court decisions in 2005 and in 2022, is that the principal guidelines set out in the earlier judgements relating to moneylenders, in summary: continuity, a system or plan and the generation of profit, were applied in assessing the deductibility of interest and in particular whether the interest was incurred as a deduction from income derived from the carrying on of a trade.So what must be considered is where holding companies engage as the source of funding, and the application thereof. In isolation, the company must be able to demonstrate a continuous system or plan in which money is borrowed and advanced, at profit, to group entities. Often experts are employed in holding companies in larger groups to manage the treasury function, or if such experts reside within the group, an appropriate charge is levied. The anticipation of profits is of paramount importance. The difficulty here often lies in underlying subsidiaries meeting cash flow or liquidity constraints thereby being unable to settle the debt plus interest costs. A system or plan should be agreed upon to deal with these issues. A mere reduction of the interest rate to affected subsidiaries will not, it is submitted, meet the trade test in section 24J nor in section 23(g) of the Act.

Featured documents

• Interest-deduction limitation - Section 23M

  While recognising the need for debt capital, fiscal authorities throughout the world have been concerned for some time now that excessive debt funding could lead to tax avoidance. Such tax avoidance occurs where there is a mismatch between the tax treatment of interest incurred and interest...

• VAT and corporate transactions : the dragons slumber : part 2

  In the previous issue of this journal the provisions of section 11(1)(e) of the Value-Added Tax Act 89 of 1991 (the VAT Act), which applies where a vendor disposes of an enterprise or part thereof that is capable of separate operation as a going concern, were considered. This article...

• VAT and corporate transactions : the dragons slumber : part 2

  In the previous issue of this journal the provisions of section 11(1)(e) of the Value-Added Tax Act 89 of 1991 (the VAT Act), which applies where a vendor disposes of an enterprise or part thereof that is capable of separate operation as a going concern, were considered. This article...

• Leasehold improvements - the VAT implications

  The issue of how VAT must be accounted for under a leasehold-improvement arrangement remains topical. While SARS issued a Draft Interpretation Note in 2012 which was intended to bring very necessary clarity to this issue, it was never finalised. This article considers the VAT implications of such...

• The Tax Characterisation of 'Earn-Outs'

  Earn-out payments are a common feature of business acquisition transactions. An earn-out payment is a feature of the purchase price consideration for the acquisition of a business. The earn-out payment is dependent on the fulfillment of particular conditions, typically in the form of achieving...

• The retrospective operation of statutory amendments to taxation laws : interpreting the amendments to section 8EA of the TLAA, 2016

  Statutory amendments of the tax laws in the annual Taxation Law Amendment Acts (‘TLAA’) now often provide for an effective date for the coming into operation of the amendment that precedes the promulgation date of the TLAA. There is usually also a provision that the amendment is to apply in respect ...

• The infamous Section 8c : how the section may extend beyond an employment link

  The infamous section 8C was introduced to defer the employees’ tax obligation of an ‘equity instrument’ acquired by virtue of employment (as a direct cause of employment) until the instrument is disposed of or until the qualifying restrictions imposed thereon are lifted. The section will apply...

• The reduction of debt and taxation : some takeaways

  As most tax-orientated people will be aware, a new income-tax and capital gains tax (CGT) regime has been introduced that deals specifically with debt reduction, by whatever legal means the debt is reduced. Where any debt owed by a person is reduced and that debt was used to fund, whether directly...

• The minefield of debt restructuring

  A debtor that benefits from a concession or compromise in respect of a debt could trigger a tax liability. The tax will not only add to the debtor’s financial woes, but it could be extremely difficult to accurately determine the amount of tax, seeing that the tax implications of the debtor depend...

• VAT and the Issue and Redemption of Tokens, Stamps and Vouchers

  Where a token, stamp or voucher (collectively referred to as ‘voucher’) is issued by a vendor for consideration, the crisp issue is whether the supply of the voucher falls to be dealt with under section 10(18) or (19) of the Value-Added Tax Act 89 of 1991 (‘VAT Act’). Should the voucher fall to be...