Proposed new section 103
South Africa has a general anti-avoidance rule (GAAR) in the form of section 103(1) of the Income Tax Act No 58 of 1962. In essence, a transaction can be attacked if there are four elements present:
There must be a transaction, operation or scheme;
which has the effect of obtaining a tax benefit;
whose sole or main purpose was the obtaining of a tax benefit; and
which was entered into in an abnormal manner (as more fully set out below).
A discussion paper was released by the Treasury and the South African Revenue Service (SARS) in early November 2005 calling for comment by interested parties by January 31. The discussion paper is a comprehensive and well-researched document, looking at difficulties in legislating and enforcing a GAAR. A number of countries' rules were looked at and discussions held with counterparts of the SARS in other jurisdictions.
It cannot be argued but that the existing section 103(1) of the Act was dealt a severe blow in the Conhage case when the Supreme Court of Appeal made two important findings: First, within the bounds of anti-avoidance legislation, a taxpayer may minimize his or her tax liability by arranging his or her affairs in a suitable manner. Secondly, in determining whether the sole or main purpose of any transaction, operation or scheme was to obtain a tax benefit, one must look at the transaction or scheme as a whole and not merely at certain elements thereof. Thus as long as the scheme as a whole was undertaken for commercial purposes, individual steps therein could not be attacked even if the sole or main purpose of those individual steps was tax avoidance.
Another problem faced by SARS in enforcing the section is that there had to be abnormalities involved, depending on the circumstances. For example, in a business context, the scheme must have been entered into in a manner which would not normally be employed for bona fide business purposes other than the obtaining of a tax benefit. In any other context the transaction, operation or scheme must have been entered into by means or in a manner which would not normally be employed in such a transaction, operation or scheme. In the alternative to both of these, the scheme must have created rights or obligations which would not normally be created between persons dealing at arm's length.
The problem arose as to what was "normal". In many cases, a scheme was devised and became widespread, and the taxpayer argued that so many people were doing it that it must have been normal.
Accordingly, a new draft of section 103 has been published for comment. The proposed changes seek to deal with the shortcomings referred to above as well as to make the application of the tests more objective. The following are the main elements of the changes.
The section can be applied to any step in a transaction, operation or scheme or a part thereof, thereby overriding the Conhage decision.
The normality of the scheme must now be determined objectively with reference to the relevant facts and circumstances. In addition, certain factors have been set out which must be taken into account objectively to determine normality, and the legislation goes on to state that if any of those factors is present, its very presence creates a rebuttable presumption of abnormality. These factors include the form and economic substance of the scheme; its timing; the result that would, but for the application of the section, have been achieved; any circular flow of cash or assets; the participation of any "tax indifferent party"; self-cancelling steps or transactions which have no substantial effect on the economic position of the parties; a failure by parties to deal at arm's length; the lack of any change in the financial position of any person; the absence of a reasonable expectation of pre-tax profit; the fact that the tax benefit exceeds the pre-tax profit.
A "tax indifferent party" is a person who is not subject to tax under the Income Tax Act; or a person who participates in such a way that his income in connection with the scheme is substantially matched or offset by expenditure; or an SPV.
It is no longer the test that the sole or main purpose must be the obtaining a tax benefit, but rather now it is if the sole or one of the main purposes is the tax benefit (though it is grammatically impossible to have more than one main purpose). In addition, whether or not the sole or one of the main purposes of the scheme or any step therein is the obtaining of a tax benefit must be determined objectively by reference to the facts and circumstances, and if there is a tax benefit, there is a rebuttable presumption that the scheme was carried out with this benefit as the sole or one of the main purposes.
Now, if section 103 is successfully invoked, and there is interest payable on underpayment of provisional tax (that is, the instalments paid during the year on account of the final liability), the SARS' discretion to waive the interest has been removed. Not only will this provision be retained, but the discussion paper proposes that a penalty will be imposed in addition. Moreover, and very controversially, the discussion paper proposes that penalties should also be imposed on promoters of the scheme. Precisely what a "promoter" is, and what the dividing line between a promoter and an adviser is, remains uncertain.
It is intended that the new section 103 will not be retroactive, so it will apply to any transaction, operation or scheme or step therein or part thereof entered into or carried out on or after the date of promulgation of the amending legislation, or another specified date.
Ernest Mazansky (emazansky@werksmans.co.za), Johannesburg
