Business Tax and Company Law Quarterly

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• Thistle and Coronation: Can a Taxpayer Place Reliance on a Legal Opinion to Avoid or Reduce Penalties while at the Same Time Withholding Disclosure of the Opinion from SARS?

  Understatement penalties1 featured in two tax cases recently argued in the Constitutional Court. In both cases, the taxpayer had sought to avoid or reduce liability for understatement penalties on the basis that the taxpayer’s contentious tax position had been based on a favourable legal opinion. In the one case, the opinion was disclosed to SARS. In the other, it was not. In the latter case, SARS contended that the taxpayer ought to have disclosed the opinion and adduced it in evidence. The SCA had disagreed, finding that ‘it was not incumbent on [the taxpayer] to disclose a tax opinion that it had obtained, any more than it would be on any other party which litigates on the basis of a procured legal opinion.’rnIt is, for various reasons, difficult to predict whether or not the Constitutional Court will engage with this finding. For the reasons explored below, however, taxpayers should proceed with caution before seeking to invoke the SCA-finding as authority for the proposition that they may rely on a legal opinion to avoid or reduce penalties, while at the same time withholding disclosure of the opinion from SARS.

• Understatement Penalties Through the Cases

  The understatement penalty (‘USP’) provisions were introduced in the Tax Administration Act in 2011 (‘the TAA’) with effect from 1 October 2012. These provisions stipulate, amongst other things, when the South African Revenue Service (‘SARS’) may impose understatement penalties, when no penalties may be imposed, how the penalty must be calculated and when penalties imposed must be remitted. In particular, the USP rules require there to be an ‘understatement’, as defined in section 221 of the TAA. However, where an understatement arises from a ‘bona fide inadvertent error’, no penalty may be imposed. This term is not defined and has accordingly been the subject of many disputes between taxpayers and SARS, resulting in the term being considered by the tax court, the Supreme Court of Appeal (‘SCA’) and currently the Constitution Court, as discussed in this article. While SARS adopts a narrow view of what constitutes a bona fide inadvertent error, the SCA held in CSARS v The Thistle Trust (Thistle)1 that SARS was not entitled to levy an understatement penalty because the taxpayer made an error, but did so in good faith and acted unintentionally. In Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd (Coronation),2 the SCA held that the understatement arose from a bona fide inadvertent error because it resulted from the taxpayer relying on a tax opinion from a tax practitioner.rnThe TAA also stipulates that the burden of proof is on SARS in respect of the facts on which SARS bases the imposition of an understatement penalty. The onus of proof has similarly been the subject of case law, resulting in a clearer understanding of the requirements that SARS has to meet in imposing understatement penalties. In terms of Purlish Holdings (Pty) Ltd v The Commissioner for the South African Revenue Service (Purlish Holdings)3 and Enviroserv Waste Management (Pty) Ltd v The Commissioner for the South African Revenue Service (Enviroserv),4 SARS must show not only that the taxpayer committed the conduct envisaged in the definition of ‘understatement’ (e g, an incorrect statement in a return), but also that such conduct resulted in prejudice suffered by SARS or the fiscus. Furthermore, it was held in Purlish Holdings that ‘prejudice’ is not limited to financial prejudice.

• Supreme Court of Appeal Refuses ‘Reverse’ Piercing of the Corporate Veil

  A company is a separate legal person in terms of South African law. That principle is also widely recognised in most countries. Sometimes, however, either through common law or statutory operation, the separate legal personality of a company may be ignored. Where a company’s separate legal personality is ignored for limited purposes, it is often referred to as a court ‘piercing the corporate veil’ of the company.rnIn South Africa, the piercing doctrine has historically been developed under the common law. More recently, however, that doctrine has now been incorporated into statute and, more specifically, section 20(9) of the Companies Act. The codification of the piercing doctrine is still rather new, and the recent case in The Butcher Shop and Grill is important because it reasserts the principles that have recently emerged in South African law in this regard.rnThat case is also important because it not only reasserts the interaction between section 20(9) and the common law but also because it deals with the interesting concept of so-called ‘reverse piercing’, that is, where a company’s shareholder approaches a court to have the separate legal personality of the company in which shares are owned disregarded. The Butcher Shop and Grill is important in this sense because it confirms the basic principle that a company is a legal person, the existence of which must at all times be acknowledged unless the separate identity of the legal person was the subject of abuse. This makes reverse piercing highly unlikely, if not impossible.

• Editorial

  The three articles in this edition analyse recent pronouncements of the courts relating to (i) the piercing of the corporate veil (the first article), and (ii) understatement penalties under Part A of Chapter 16 of the Tax Administration Act 28 of 2011 (‘the TAA’) (the second and third articles engaging with different facets of the understatement penalty regime).

• Foreign Pension Schemes: There Be Dragons, and Some Confusion: South African Members Qua Beneficiaries Have a Vested Right to the Income and Capital of the Foreign Pension Scheme (Trust) Ab Initio — Part 2

  Given South Africa’s present political and economic position, a significant number of wealthy taxpayers are either engaged in making contributions to foreign pension schemes or are contemplating doing so. As the heading to this article suggests, the South African tax implications that arise when a South African resident taxpayer embarks on this journey are complex and confusing.rnWhilst SARS has provided some guidance in terms of a binding class ruling, this guidance is limited to the position where the South African participants participate in the foreign pension scheme as vested beneficiaries — not the general position. The ruling nevertheless provides some indication of SARS’ views as regards the application of the law in these circumstances. However, SARS neatly side-stepped the real issue, namely that a strict application of the law res ults in double taxation in certain instances by declining to rule on the application of section 25B of, and paragraph 80 of the Eighth Schedule to, the Income Tax Act, 1962.rnThis article explores the South African tax implications that are triggered for South African residents in consequence of their participation as vested beneficiaries in these foreign pension schemes — the situation addressed in SARS’ binding class ruling.rnThe South African implications that arise are wholly dependent on the rights and obligations that are established under the foreign pension scheme rules. However, as a general proposition it may be said that under a vested scenario the South African participants are required to make regular contributions to the foreign pension scheme, although lump sum contributions are allowed in certain instances. The contributions are then accounted for in a bespoke account, as is any accretion in value. When the time comes for payment of the retirement benefits (the income capital will already have vested in the beneficiaries), the trustees generally have a discretion as to the nature and value of the payments — but the participant has a right to request the trustees to exercise their discretion in a specific manner.rnThe article concludes in the first instance that the contributions made by the South African participants to the foreign pension scheme do not constitute a donation that is subject to donations tax. As regards accretions in value in the bespoke account (e g interest, dividends, realised capital gains, the article argues that those amounts fall to be taxed in the hands of the residentrnOnce the trustees exercise their discretion to pay the South African participants either an annuity or a lump sum, South African income tax or capital gains tax is triggered again. A possible double taxation conundrum accordingly arises should any income or capital derived by the foreign pension scheme have previously been vested in the South African beneficiary.rnOn death, it is strongly arguable that the amount standing to the credit of the resident beneficiary in his or her bespoke account does not form part of the deceased South African beneficiary’s estate for estate duty purposes, or an asset for capital gains tax purposes.

• Editorial

  This issue features two articles by co-editors of the Business Tax and Company Law Quarterly on tax topics which raise issues of importance to investors, corporates and tax practitioners alike.

• ‘Dividend–stripping’ Complexities and the Interaction with the ‘Rollover’ Relief Provisions

  The legislative rules relating to ‘dividend-stripping’ are complex and ever-evolving. This article seeks to examine the more complex aspects of those rules, particularly as they relate to the anti-avoidance elements of the legislation. The simplest way to explain the application of these rules is to illustrate their application with concrete examples.rnPrior to the application of the dividend-stripping rules it was relatively easy to escape tax on share exits, whereby a purchaser subscribed for shares in a target company and the target company repurchased the sellers’ shares free of tax by way of a ‘return of capital’ and/or a dividend distribution.rnThe article deals with the rules as they apply in relation to (a) deferral transactions; and (b) ‘clawback’ transactions. The former transactions are excluded from the dividend-stripping rules and the latter are brought into the dividend-stripping rules.rnDeferral transactions escape the application of the dividend-stripping rules. These transactions include transactions covered by the roll-over relief provisions contained in sections 41 to 47 of the Income Tax Act, 1962 (‘the Act’).rn‘Extraordinary dividends’ are recharacterized in the Act for tax purposes. These are dividends that arise within 18 months of a sale of shares transaction, or arise in respect of a sale of shares and exceed 15% of the value of shares at the date of sale or 18 months prior thereto, whichever is the higher.rnA distribution of shares by a company in anticipation of the liquidation of the company (section 47 of the Act) will escape the dividend stripping rules.rnThe recipient company of distributions from the liquidating company will also escape the dividend-stripping rules, as distributions derived by section 47 (liquidation distributions) and section 46 (unbundling transactions) are excluded from ‘extraordinary dividends’. So too does section 47 of the Act exempt from tax the disposal by a company of shares in the liquidating company.rnThe ‘clawback’ rules work as follows:rnrnrnDividends derived by a company that disposes of shares to another company in terms of the rollover relief rules, other than a section 46 unbundling, will form part of the proceeds for capital gains tax (‘CGT’) purposes in the hands of the company disposing of these shares to third parties.rnrnA similar provision will apply to dividends declared by one company to another company (‘old shares’) where the shares in the declaring company are sold under section 42 of the Act (asset-for-share transactions) to a new company which issues shares to the disposing company (‘new shares’) and the disposing company sells such new shares to a third person. The dividends declared on the old shares will form part of the proceeds for CGT purposes in the hands of the company disposing of these shares to third parties.

• Protecting the Public Purse with Moral Tax Administration

  This article engages with the scourge of tax immorality, an unsavoury practice adversely affecting state resources which puts South Africa’s democracy and its social transformation programme at risk. This article argues that tax immorality must be combatted head-on. To this end, it is contended that the bilateral and multi-lateral co-operation agreements concluded by the government of South Africa with their counterparts in Africa and beyond are insufficient to effectively combat tax non-compliance in all their manifestations. This is because there is no single reason for taxpayers acting in breach of their duty to the fiscus.As a result, it is argued by the author that a multi-pronged approach is needed which demands of tax administrators that they be innovative in their thinking and creative in their strategies. The nub of the thesis advanced is that, in practice, there is a correlation between, on the one hand, failure by tax authorities to fulfil their tax administration obligations with integrity and, on the other, failure by some taxpayers to comply with their tax related duties.It is further argued that conduct un-associated with a dignified tax administrator, and which may well contribute to tax immorality, includes hostility towards taxpayers, disrespect for the law and the rule of law, abuse of power, coercion, partiality, bias, threats, unethical behaviour, maladministration, and corruption. Conduct of this nature is antithetical to the final Constitution, 1996 and its democratic values and principles, all of which apply in the realm of tax administration being a facet of public administration governed by the Constitution.Finally, the author concludes that the South African Revenue Service can promote tax compliance by ensuring that it operates efficiently as an institution and that its officials act in accordance with the law and without favour, and with fairness, honour, dignity, decency, responsiveness to taxpayers’ needs, and open-mindedness.

• South Africa’s Ambiguous Exchange Control Climate

  Although the South African Minister of Finance announced in the 2020 Budget speech that sweeping reforms would be enacted to relax the South African exchange control system, it is now three years later, and no meaningful relaxation of exchange control has occurred. Rather, investment into South Africa remains plagued by exchange control laws, which result in costly and time-consuming processes for foreign investors.In January 2021, a long-awaited change to the exchange control rules was enacted, with the relaxation of the so-called ‘loop structure’ rules. Many investors jumped at the opportunity to take advantage of this relaxation and restructured their existing South African assets so that they would be owned by approved foreign structures. The relevant parties then, in line with the prescribed rules, reported the transactions to the Financial Surveillance Department of the South African Reserve Bank (FinSurv), via their Authorised Dealers. The FinSurv did not simply acknowledge receipt of the reported information as expected under the law. Rather, the FinSurv elected to reject applications submitted under the respective circular, without withdrawing the circular, leading to much uncertainty in the market, especially for those investors who have already restructured their assets, triggered taxes on the restructure and paid the taxes.Further, it appears that South Africa’s negative rating and greylisting, by the Financial Action Task Force (FATF), has triggered a stricter application of the existing exchange control regime, with more frequent application of the penalty regime by the FinSurv to identified contraventions. In the past, South African corporates were able to regularise an exchange control contravention with the FinSurv without difficulty. The process was relatively straight forward. However, lately, the responses received from the FinSurv to requests for regularisation (including to standard commercial transactions) are vague with the result that the matter does not seem to reach finalisation. The responses provided suggest that the applicant may still be subject to further investigation and ultimately may be subject to financial penalties. This is only one of the challenges such applicants face.

• Purpose Requirement of the GAAR: Rethinking The ‘Subjective’ vs ‘Objective’ Debate

  The current general anti-avoidance rule (GAAR) was enacted in 2006. Its overriding goal was to provide a more consistent and effective determent to what the legislation termed ‘impermissible tax avoidance arrangements’. As the SARS Discussion Paper on Tax Avoidance and Section 103 made clear, a major problem facing the fiscus was the growth of a tax avoidance industry in which extremely complex tax shelter products were designed and marketed to taxpayers. This development reflected a shift from prior practice in which taxpayers approached advisors to obtain advice on specific problems to one in which promoters marketed carefully prearranged products to clients.These products were typically sold on a ‘black box’ basis, which hid the specific inner workings of those tax shelter products. Amongst other things, this approach enabled promoters the ability to protect their so-called intellectual property, while giving clients the opportunity to use ignorance or ‘plausible deniability’ as a defence against the GAAR.To counter this problem and to resolve inconsistent applications of former section 103, in which two taxpayers could enter into identical tax shelter products but obtain different results depending upon their subjective state of mind, Parliament introduced a hybrid test in which the subjective purpose of a taxpayer must be tested against all of the relevant facts and circumstances of the case, including the purpose of the avoidance arrangement in question. It is a hybrid approach, in which the relative weight of the objective and subjective components will depend upon the circumstances of the case.Tax shelter products are meticulously designed by their promoters for one purpose — to generate a tax benefit without having a significant impact upon a taxpayer’s business operations and to be as risk-free as humanly possible. It is in these situations that the objective purpose of an avoidance arrangement is of paramount importance, particularly where these tax shelter products have been added to otherwise straightforward commercial transactions. As a result, taxpayers should no longer be able to hide behind either their ignorance or the purpose of a larger arrangement into which a tax shelter product has been inserted, to defeat the GAAR.

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