Corruption and tax avoidance were big topics in South Africa’s budget, which was delivered on February 21, and revealed a R48.2 billion ($4.1 billion) revenue shortfall. The day before, new President Cyril Ramaphosa had pledged his commitments to curb tax avoidance in his inaugural state of the nation address.

"South Africa will continue to play a leading role in international efforts, through structures like the OECD and G20, to tackle the various forms of tax avoidance," Ramaphosa said.

While staking out goals for international collaboration the government is also exploring measures that can be undertaken unilaterally – and soon.

In the budget speech, Finance Minister Malusi Gigaba said the government was “investigating options to further curb the practice of excessive interest deductions by companies in order to reduce their tax liability”.

Thin capitalisation

A report to assess the tax policy framework was released by the Davis Tax Committee in November 2017 said limiting base erosion and profit shifting from interest deductions was a “high priority for South Africa due to the potential risk of loss to the fiscus due to such avoidance strategies by multinationals”.

South Africa has thin capitalisation measures in place, but these are seen as unclear because they only refer to terms of debt that would need to be measured against what third-party lenders would make available to a company, Emil Brincker, national head of tax Cliffe Dekker Hofmeyr in Johannesburg, told TP Week.

“Previously a so-called safe-haven of 3:1 debt/equity [ratio] was accepted. Taxpayers have been waiting for a number of years to receive guidance how the arm’s-length test is to be applied.  Obviously a third-party lender would insist upon security and not necessarily make funding available if there is no real residual equity in a company,” Brincker said.

Guidance in this area is expected within the next few months. There are also two other ways to deal with excessive interest deductions in the MNE space, said Hylton Cameron, director at Grant Thornton in Johannesburg.

“[One] is an interest withholding tax at 15%, however a fair amount of double tax agreements with major trading partners reduce this to 0%. So this mechanism is not particularly effective,” he told TP Week.

There is also a specific provision which deals with interest paid offshore that is not subject to withholding tax. “This provision has the potential to disallow all or a portion of the interest expense for the South African company. The provision is based on a formula and is fairly complicated. We understand that SARS has previously said it may seek to adjust the provision as in their view it is still lenient compared to similar global provisions. From a tax perspective the provision is effective, although it could of course be more effective if one is to wear a SARS hat,” he said.

Uncompetitive corporate tax rate

South Africa is facing a paradox in regards to its corporate tax rate. While the government says the 28% corporate tax rate is uncompetitive, it cannot afford to decrease the rate to attract business. The budget confirmed that the rate will remain unchanged for now, but the government said South Africa was becoming an “outlier” and that the rate provided an incentive for companies to shift profits abroad and pay lower taxes elsewhere.

“Falling corporate income tax rates in advanced and middle-income countries affect South Africa’s global competitiveness. This trend limits the room to increase, or even maintain, the tax rate on business. Corporate income tax contributes more as a share of GDP in South Africa than in most other countries,” the government said in a document released with the budget.

According to the OECD’s latest report on revenue statistics in 16 African countries, corporate income tax accounted for 4.7% of GDP in South Africa in 2014. The OECD average for the same year was 2.8%, and the average of the 16 African countries examined in the report was 2.9%.

“Global investors look to invest their funds and the local tax rate is an easy starting point of what is attractive. For me the theory would be lower the rate, attract more investment, increase profits, and hopefully jobs with all the knock on effects, and therefore the same revenue, or more is collected,” Cameron of Grant Thornton said.

Tracy Brophy, head of tax risk management at FirstRand Bank, said the corporate tax rate was only one of many factors that influence foreign direct investment into South Africa.

"If South Africa manages to reduce its unemployment level, at 26%, stimulate economic growth to levels higher than the predicted 1.5% per annum, curtail government’s wasteful expenditure and reduce the unsatisfactorily high levels of crime, then foreign direct investment will be much easier to attract, irrespective of the corporate tax rate," Brophy said. 

“At this stage, it doesn’t appear that government can afford to lose any projected tax revenue, as a result of a decrease in the corporate tax rate, despite whatever uncertain future amounts of additional tax revenue may result from such a decision, and the related additional future investment by foreign and local investors.” 

Building resources

The budget also announced that the president would establish a commission of enquiry into the functioning of the country’s tax authority, South African Revenue Service (SARS) and take steps to improve governance and taxpayer relations.

“The government’s acknowledgement of its contribution to the cause of the tax morality debate in South Africa was encouraging, especially the measures which were outlined to address the issues at SARS and its ability to effectively collect taxes,” Brophy said.

In recent years, corruption and wasteful expenditure in the public sector have eroded taxpayer morality, undermining the social contract between taxpayers and the state, the budget document stated. 

“In the last few years, SARS has lost significant senior resources due to various issues. Hopefully this [commission of enquiry] will attract skilled resources back to SARS,” Cameron said.

Similarly, Brincker of Cliffe Dekker Hofmeyr noted, “a number of changes were effected to the administration and structure of SARS over the last few years and a perception has been created that it added to the shortfall in collections.”

“The commission of enquiry will address this issue and make recommendations in this regard.  Numbers have been mentioned that more than 500 individuals resigned from SARS over the last financial year, which obviously creates a significant hole in the ability to collect taxes.”

SARS did respond to TP Week’s request for comment.

“Taxpayers can therefore expect that SARS will become much more aggressive in auditing so as to restore itself to its ability to meet prior year collections,” he said.

This article was updated on 26.02.2018 with comments from Tracy Brophy.