Tax treaty interpretation in South Africa – A sting in the tail?
The Tax Court handed down a judgment on 15 May 2015 in a matter dealing with the interpretation of the double tax treaty between South Africa and the United States of America (DTA). Briefly, the facts were that two companies came to South Africa in 2007 to perform strategic and financial advisory services to a client based in South Africa. The contract for rendering the services was concluded on the basis that:
- The services would be rendered for a fixed term in three phases ending in May 2008.
- 17 employees came to South Africa to render the services as and when required, with the employees being in South Africa during 2007 for a period exceeding 183 days.
- The client granted space in its boardroom with access only granted on weekdays and during office hours.
- The nature of the services required the employees to be present at the offices of the client.
- Income was derived from the services rendered both during the period that the services were rendered in South Africa and then subsequently in 2009 as part of a success fee when no services were physically rendered in South Africa. The total amount of the income earned was ZAR63 990 639.
The question that the court had to answer was whether the assessments levied against the taxpayer were correct, having regard to the relevant provisions of the DTA. In particular, the issue was whether the taxpayer had a "permanent establishment" in South Africa giving the basis for SARS to tax the taxpayer on the business profits earned in South Africa.
The taxpayer contended that for there to be a "permanent establishment", it is necessary to meet both the requirements of the specific inclusionary provisions contained in Article 5(2) of the DTA (that is, the furnishing of services, including consultancy services, through employees, but only if activities of that nature continue for a period or periods aggregating more than 183 days in any 12 month period), as well as the general requirements of Article 5(1) that there must be a fixed place of business through which the business of an enterprise is wholly or partly carried on.
The court considered the OECD Commentary together with the specific Technical Explanation relating to the DTA and held that:
"The Technical Explanation makes it unambiguously clear, that when considering the furnishing of services by an enterprise (article 5(2)(k)) the analysis or interpretation accorded to the place of work (articles 5(2)(a) – 5(2)(f)) is not applicable. It goes on to say that in the case of furnishing of services this does not have to occur within a 'a fixed place of business' (article 5(1)). Thus, once the provisions of article 5(2)(k) are met, there is no need to further examine whether the provisions of article 5(1) have also been met to determine whether the existence of a permanent establishment has been proved."
Based on this conclusion, the court held that during the 2008 year when the services had been physically rendered in South Africa, there was a "permanent establishment" both on the basis of the specific inclusion and in terms of the general requirements of Article 5. The use of the boardroom constituted a "fixed place of business".
The more contentious outcome of the case is that the court proceeded to conclude that after May 2008, when the taxpayer no longer was in South Africa, there was nevertheless a "permanent establishment" in South Africa giving rise to the right to tax the taxpayer in South Africa on the success fee earned after leaving South Africa. The reasoning of the court was that the 183 day requirement was still satisfied as the wording of the DTA refers to "any 12 month period", which effectively allows for double counting under the provisions of the DTA. The object of the DTA is to prevent opportunities to avoid tax and the OECD Commentary recognises the possibility of double counting.
The use of the words "any 12 month period" may therefore unwittingly catch foreign service providers in the South African tax net, notwithstanding that they are not actually present in South Africa at the time that the relevant assessment is raised. Foreigners should therefore be aware of the potential pitfalls in having a "permanent establishment" in South Africa and should carefully consider the time periods involved in rendering the services.