Proposed changes to the Income Tax Act, contained in the 2019 draft Taxation Laws Amendment Bill, were released for comment by the National Treasury on July 21 2019. This update focuses on some of the international tax-related proposals.
Permanent establishment definition
The current definition of a permanent establishment (PE) in the Income Tax Act is linked to the definition of a PE in Article 5 of the OECD's Model Tax Conventional (OECD MTC). The effect is that the domestic definition of a PE, which is used to determine when certain types of income are treated as South African sourced, changes as and when Article 5 changes. The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, to which South Africa is a signatory, resulted in certain changes being made to Article 5 of the OECD MTC with effect from March 2018. While this automatically also changed the South African domestic law concept of a PE, South Africa reserved its rights not to include the relevant changes to Article 5(5) in its existing bilateral tax treaties.
To resolve the inconsistency between the definition of a PE, which has automatically incorporated Article 5(5) of the OECD MTC as it now stands, and existing treaties, which specifically exclude the 2018 amendments, the National Treasury proposes to amend the PE definition in the Income Tax Act retrospectively to align with the pre-March 2018 version of Article 5.
Controlled foreign companies
South Africa's controlled foreign corporation (CFC) legislation contains a general exclusion from imputation to South Africa of a CFC's net income, referred to as the so-called 'high tax exemption'. This applies where the CFC suffers effective foreign tax that is equal to at least 75% of the tax it would have suffered under SA tax law had it been SA tax resident. In recognition of the downward trend in global corporate tax rates, the National Treasury proposes to reduce the 75% threshold to 67.5% with effect from years of assessment ending on or after January 1 2020.
The CFC legislation contains certain rules which are aimed at supplementing South African transfer pricing rules. These anti-diversionary rules require net income of CFCs derived from, or linked to, certain transactions involving SA resident taxpayers to be imputed to SA for tax purposes even where the CFCs concerned have significant business substance. These rules already hinder the competitiveness of South African headquartered groups and are controversial. In a move that will make them even more so, National Treasury has proposed that the rules be extended with effect from years of assessment beginning on or after January 1 2020 to include not only net income derived from direct transactions between a South African connected person and a CFC, but also net income of other CFCs which are indirectly involved in a supply chain between a South African connected person in relation to the CFC and an independent non-resident customer or supplier.
The wording of the proposed amendments is confusing and it is uncertain exactly when and how they should be applied. Since South Africa has sophisticated transfer pricing rules which are actively enforced, it is also unclear why they are required.
South African transfer pricing rules require transactions between 'connected persons' as defined to be concluded at arm's length. The 'connected person' definition is well-established and broad in its scope. It is now proposed that transactions between 'associated enterprises' as contemplated in Article 9(1) of the MTC also be brought within the scope of the transfer pricing rules.
The concept of an 'associated enterprise' is foreign to South African legislation and the OECD MTC has deliberately not provided detailed guidance on its interpretation. There is consequently significant concern that the National Treasury's inclusion of the words "associated enterprise" in the relevant legislation, without further definition, will lead to significant uncertainty and disputes between taxpayers and the South African Revenue Service.
Following lobbying from taxpayers, however, the National Treasury has now stated that it may delay the introduction of this proposal to give Treasury time to consider it further.
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