Head of Tax and Asia Practice
The impact of international developments
Law as a concept may be described as the normative order imposed upon specific communities and countries. It is a social contract that binds a particular country and its communities.
A nation guards the sovereign authority of the state to govern itself. So a country's law is directed both:
- internally to the state and its people, grounded on the supremacy of the government institutions; and
- externally towards the world on the basis that the state is supreme as a legal person.
The absolute nature of national sovereignty, however, is qualified by international legal principles like jus cogens that embed accepted norms and principles essential for the protection of the fundamental interests of the international community and which countries are compelled to follow because it is felt to be correct.
Furthermore, international agreements and treaties are commonly drafted between countries where they voluntarily undertake between themselves to amend their domestic law. Such agreements are measured against the respective interests of the participating states, which may have different agendas, moralities, normative orders and a multi polarity of interests.
Globalisation not only makes it harder for tax authorities to accurately determine the tax liabilities of their taxpayers: it also makes the collection of tax more difficult. Tax authorities are constrained by national borders and sharing information is not necessarily in a country’s own interests, as low-tax countries may make themselves less attractive to foreign investors.
A legal framework is required to allow information exchange and co-operation while respecting the rights of taxpayers to secrecy, enshrined in the domestic legislation and the sovereignty of countries. Besides bilateral tax treaties, there are also multilateral agreements and dedicated bilateral agreements outside of tax treaties, under which information may be exchanged.
There is an absence of enthusiasm for multilateralism in the area of tax administration as such arrangements are unsuitable for countries inexperienced in international taxation matters and require a comparable level of administrative development and structures between the countries.
Treaty states are not obliged to provide information if administrative measures contravene their legislation or administrative practices, the request should also be done in conformity with the terms of the agreement.
Information must be obtained under legislation or normal administrative procedures of the respective states. Information cannot violate trade, business or industry process secrets or provide information in conflict with public order. An exchange of information under an international agreement will depend on the domestic laws of the respective countries involved.
Domestic laws provide for a variety of procedural rights and safeguards for persons affected by information gathering measures or information exchange. Such rights and safeguards include notification rules, a right to challenge the exchange of information and information gathering measures utilised.
Article 26 of the OECD Model providing for the exchange of information between the revenue authorities of the two states concerned, includes taxpayer protections. This article does not provide for unlimited exchange of information and only information that falls within the scope of the article can be exchanged. An exchange of information outside the scope of the article is likely to breach domestic secrecy laws in the provider country.
Any information received should be treated as confidential. The Manual on the Implementation of Exchange of Information Provisions for Tax Purposes 2006 specifies that information received may be disclosed only to persons or authorities concerned with the assessment, collection and enforcement of the taxes covered by the agreement and the information may be used only for such purposes. Information may not be disclosed to any other person or third jurisdiction without the express written consent of the competent authority of the requested party.
Governments sometimes have conflicting interests with regard to exchange of information. Some governments in particular international financial centres, usually attract investments from foreigners by adopting a permissive regulatory environment. For many of the smaller nations this is really an issue of sovereignty. Some offshore jurisdictions view confidentiality as a vital ingredient for the success of their financial industry, and courts in offshore jurisdictions enforce the protection of confidentiality.
Offshore countries are aware that less confidentiality could adversely affect their competitiveness and lose clients to more secretive jurisdictions. This secrecy obviously poses problems to tax administrators. A common practice in international tax evasion schemes is to incorporate multiple layers of entities in jurisdictions with strict commercial secrecy provisions.
Tax secrecy under domestic law ensures that information relating to a taxpayer and his business remains confidential and is protected from unauthorised disclosure. It is, therefore, fundamental for the co-operation in matters of information exchange that such confidential information continues to enjoy a similar level of protection when it is exchanged with other countries. For this reason, any information supplied by a contracting party must be treated as confidential. In order to comply with the domestic secrecy rules of the supplier country, only if confidentiality is preserved by the exchange of information arrangement and the applicable domestic law in the receiving country, can the information be supplied.
Offshore financial centres (OFCs) operate in a highly successful industry attracting and servicing global corporations and individuals. These OFCs offer attractive tax and financial incentives usually in a low regulation regime with the added attraction of privacy and protection of identities.
The British Virgin Isles, house many of the world’s offshore companies, and its corporations outnumber its residents by an estimated 30 times with the financial industry contributing some 60% of its GDP. In my experience it is a favoured jurisdiction to route Chinese outbound investment. Information on beneficial ownership is held by agents who set up the offshore companies and not in a central registry.
The Federation of St Kitts and Nevis through the Confidential Relationships Act, the Banking Act, the Nevis Offshore Banking Ordinance and other regulations ensures that confidentiality is maintained within its financial services sector. These laws prohibit disclosure of any information obtained in the course of business by professional persons, including accountants, attorneys, brokers or other kind of commercial agents or advisers, banks or other financial institutions, public officers, government employees or other prescribed persons. Breaches of confidentiality are an offence and liable to sanctions varying from fines to imprisonment.
The Cayman Islands have the 1976 Confidential Relationships (Preservation) Law (CRPL), which makes it a criminal offence to divulge (or threaten, offer or attempt to divulge) or wilfully to obtain (or attempt to obtain) any confidential information with respect to business of a professional nature, which arises in or is brought into the Cayman Islands. The penalty for committing an offence under the CRPL is imprisonment and a fine.
Despite the perception that lending assistance in tax collection is a form of extraterritorial intrusion, several OFCs have entered into Tax Information Exchange Agreements (TIEAs) nevertheless the Organisation for Economic Cooperation and Development (OECD) believes not enough is been done to effectively implement them and progress is slow.
Automatic exchange of information has been undertaken by various countries within specified time schedules. For example, by 2017 the countries include The British Virgin Isles, Cayman Islands, Liechtenstein, Luxembourg, Mauritius and South Africa. By 2018 the countries include Saint Kitts and Nevis, China, Hong Kong and the Marshall Islands.
Some countries, such as Bahrain, Cook Islands and Panama have not committed to an exchange, but it is manifest that confidentiality provided by the domestic laws of sovereign states is gradually but inevitably been eroded. New tax reporting legislation, the United States Foreign Account Tax Compliance Act (FATCA) and recent case law in the United States and Australia provide a glimpse of the future.
In the United States a “John Doe” summons may be employed by the Internal Revenue Service (IRS) where it suspects a federal tax violation and the court will authorise the information-gathering summons where it relates to a particular person or ascertainable class of persons, and there is a reasonable basis for issuing the summons and there are no alternatives for obtaining the information.
In November 2013, Judge Berman, Southern District of New York authorised the IRS to issue "John Doe" summonses on the Bank of New York (Mellon), Citibank, JPMorgan Chase Bank NA, HSBC Bank USA NA and Bank of America to produce information about taxpayers with undisclosed accounts around the globe.
In MH Investments and JA Investments v The Cayman Islands Tax Information Authority (2013), an Australian court allowed the use of confidential documents in a tax case, despite the Caymans’ confidentiality legislation that applied to the documents because the documents pre-dated the TIEA between the two countries. The Australian court ignored a ruling by Justice Quin of the Cayman Islands’ Grand Court, which held that the release of the information was unlawful, in breach of the requirements provided for in the applicable TIEA and that the documents should be returned or destroyed.
Closer to home, in Commissioner for South African Revenue Service v van Kets, 74 SATC 9 (2011), the Commissioner sought orders in the Western Cape High Court declaring that sections 74A and 74B of the Income Tax Act (as they stood at that time) may be invoked for the purpose of obtaining information regarding an Australian taxpayer to comply with its obligations under a double taxation agreement, concluded between South Africa and Australia (the DTA) and which contained a provision for the exchange of information.
Sections 74A and 74B provided that the Commissioner may cause any taxpayer or any other person to furnish information as the Commissioner may require, to inspect, audit or examine. The definition of “taxpayer” in section 1 of the Income Tax Act means any person chargeable with any tax leviable under this Act and includes every person required by this Act to furnish any return.
The respondent contended that he was not obliged to furnish the information requested on the ground that the Australian taxpayer was not a “taxpayer” as envisaged in sections 74A and 74B. The crisp issue for determination was whether the words “any taxpayer”, employed in 74A and 74B could be interpreted to include a person who is not a taxpayer as defined. It was accepted that the Australian taxpayer in issue was not a “taxpayer” as defined.
The court held that:
- the South African legal system has followed a dualist approach to international law and for this reason section 231(2) of the Constitution provides that an international agreement binds the Republic after it has been approved by a resolution in both the National Assembly and the National Council of Provinces;
- section 231(4) of the Constitution provides that any international agreement becomes law in the Republic when it was enacted into law by national legislation, in terms of section 108 of the Income Tax Act, unless it was inconsistent with the Constitution or an Act of Parliament;
- section 108(1) of the Act provides that the national executive may enter into an agreement with the government of any other country for the prevention of or relief from double taxation. The effect of section 108 is to ensure that domestic statutory obligations are created;
- in terms of section 231 of the Constitution, the DTA must rank at least equally with domestic law, including the Act, and for this reason the provisions of the DTA and the Act, should be reconciled and read as one coherent whole;
- if tax is payable in respect of income, profits or gains under South African domestic law but in terms of the provisions of a treaty the relevant tax is not payable in South Africa, or only part of that tax is payable, then the treaty automatically takes precedence and overrides the relevant domestic law;
- in the Australian case of Lamesa Holdings BV 1997 35 ATR 239, 97 ATC 4229, it was held that tax treaties by their nature are unlike other international agreements because they also confer rights and obligations on parties other than those to the double tax agreement (that is, taxpayers). When enacted as part of domestic law they therefore automatically override domestic law;
- article 25 of the DTA clearly provided that the competent authority of either contracting state may request information from the other contracting state in order that it may impose any of the taxes “to which the agreement applies insofar as the taxation under that law is not contrary to the agreement”;
- the dispute was whether the provisions of the DTA in general and Article 25 in particular broaden the scope of 74A and 74B beyond the strict meaning of the definition of “taxpayer”’;
- the court must interpret 74A and 74B so as to render them compatible with the provisions of the DTA and, in particular Article 25;
- once the DTA is read together with the Act, it implied that the word “taxpayer” should include those taxpayers who do not fall within the scope of the Act but fall within the scope of the DTA, which would include an Australian resident;
- once the Australian resident is considered to be a taxpayer, “respondent” would be classified as “any other person” who would be able to furnish information regarding a taxpayer, in this case the Australian resident;
- accordingly the application must succeed.
- The provisions of the DTA and the Act should be reconciled and read as one coherent whole;
- A DTA takes precedence and overrides domestic law.
Unlike other jurisdictions, South African international treaties do not automatically become part of domestic law on the effective date of the treaty. Section 231 of South Africa’s Constitution governs international agreements, such as tax treaties, and section 231 (4) provides that “any international agreement becomes law in the Republic when it is enacted into law by national legislation…” that is, once published in the Gazette.
Section 108(2) of the Income Tax Act provides that Parliamentary approval is required per section 231 of the Constitution and only once notified by publication in the Gazette, will the tax treaty have effect as if enacted in the Act.
The South African court decisions over the years have, however, fuelled debate rather than provided clarity as to the status of international treaties should it conflict with domestic law.
In Commissioner for the South African Revenue Service v Tradehold Ltd  3 All SA 15(SCA), the Supreme Court of Appeal said “Double tax agreements effectively allocate taxing rights between the contracting states where broadly similar taxes are involved in both countries. … a double tax agreement thus modifies the domestic law and will apply in preference to the domestic law to the extent that there is any conflict”.
That view appeared to be consistent with the Van Kets case but at odds with an earlier judgment, Glenister v President of the Republic of South Africa  (3) SA 347 (CC), where the Constitutional Court minority view held that a treaty will not enjoy higher status than domestic law, holding “It is implicit, if not explicit, from … s 231 that an international agreement that becomes law in our country enjoys the same status as any other legislation. This is so because it is enacted into law by national legislation, and can only be elevated to a status superior to that of other national legislation if Parliament expressly indicates its intent that the enacting legislation should have such status…”.
In AM Moola Group Ltd v C: SARS  65 SATC 414, another Supreme Court of Appeal case, it was held that where difficulties of interpretation arise between domestic law and an international agreement, domestic law prevails as the international agreement, once promulgated, is by definition part of the domestic law.
Following the judgments in the most recent cases, it appears that our courts will follow the principle in Tradehold and Van Kets to afford international agreements precedence over domestic legislation.
The South Africa Revenue Service (SARS) has proposed new disclosure requirements for South African financial institutions, to simplify compliance with FATCA and also expand the nation's access to information relevant to its own domestic tax investigations. In February last year, the National Treasury and SARS announced the start of negotiations with the United States Department of the Treasury to enter into an inter-governmental agreement (IGA) with respect to FATCA.
Once the IGA has taken effect, financial institutions in South Africa will report the required information to SARS, which will then exchange information with the United States of America under the legal framework provided by the double taxation agreement that exists between the two countries. Under the current FATCA timetable, South African financial institutions will be required to obtain information on American taxpayers in accordance with the IGA from 1 July 2014, and report that information to SARS.
The first reporting period is 1 July 2014 to 28 February 2015, and the required information will have to be submitted to SARS by June 2015.
Thereafter, information will be submitted annually for every tax year ending February. In addition to South Africa's obligations under its existing network of bilateral double taxation agreements, SARS also noted that there have been other developments in the international arena to use the automatic exchange of information to identify non-compliance by taxpayers using foreign accounts, and to establish a global approach to combating offshore tax evasion. SARS noted that similar information could be valuable for domestic purposes. It has therefore proposed the establishment of a "business requirement specification" to cater for automatic periodical reporting of specified information by financial institutions, and its scope has been extended to require affected financial institutions to provide similar information regarding all non-residents, not just US citizens under FATCA.
Once the relevant information is available from financial institutions, SARS will be able to automatically share it, if required, with any of its treaty partners, on a reciprocal basis. Finally, it is emphasised that South Africa will continue to "play a leading role in the global movement towards greater transparency and exchange on information in tax matters to ensure greater trust and fairness in the international tax system. South African taxpayers who have not yet regularised their position with respect to their offshore holdings are reminded that SARS offers a voluntary disclosure programme.
On 23 December 2014, the Davis Committee released its interim report on Base Erosion and Profit Shifting in South Africa (BEPS). It referred to growing international concern at how aggressively multi-national companies (MNCs) seek to shift profits to other lower-tax countries and referred to the much publicised Google, Amazon, Starbucks, Vodafone and Cadbury examples, where legal arbitrage opportunities due to asymmetries in the tax laws of different countries, were exploited. Of note is the description "legal arbitrage opportunities". In other words, it is no longer sufficient that aggressive tax planning is done within the parameters of the law. MNCs must now carefully consider reputational risk when embarking on their tax planning.
The report recognises that domestic rules for international taxation and internationally agreed standards are still based on an economic environment characterised by a low degree of economic integration across borders. As modern businesses increasingly expand across borders, the tax rules often remain uncoordinated and businesses utilise structures that are technically legal but take advantage of asymmetries in domestic and international tax rules. Governments recognise this and that greater coordinated international co-operation is required.
Recognition is given to the fact that tax policy is an expression of national sovereignty and each country is free to devise its tax system in the way it considers most appropriate. States have the sovereignty to implement tax measures that raise revenues to pay for the expenditures they deem necessary. In addressing the BEPS concerns, the unique circumstances of South Africa must be considered. South Africa’s National Development Plan (NDP) cannot be ignored. The BEPS concerns and challenges that other countries face may not necessarily be shared by South Africa. Appropriate and customised solutions for South Africa are required.
Measures adopted must consider the need to encourage foreign direct investment in line with the NDP and preserve the competitiveness of South Africa’s economy. A balance is required. Countries increasingly compete to attract foreign direct investment and lower tax rates, particularly low corporate income tax rates are utilised. The report urges South Africa to set a clear tax policy on the use of tax incentives to attract much needed investment. In order for South Africa to remain globally competitive it must develop a balanced tax policy and not proceed too hastily with the OECD Action Plan when other countries take a “wait and see” approach, relaxing their laws to attract investment and changing their policies in order to remain competitive.
The report discusses various OECD action plans of which I will only discuss treaty abuse and transfer pricing.
Regarding tax treaty abuse, the report recommends that South Africa should:
- take steps to renegotiate its older treaties or sign proposals amending the preambles of its treaties to include, in their title and preamble, a clear statement that the contracting states, when entering into a treaty, do not intend to create opportunities for non-taxation or reduced taxation through tax evasion or avoidance, including through treaty shopping arrangements. All new treaties should have the above recommended preamble;
- endeavour to include a specific anti-abuse rule, based on the United States limitation-on-benefits provisions, in its new treaties and older treaties should be renegotiated to include such a provision;
- add to new tax treaties a general anti-abuse rule to make a factual determination as to whether the principle purpose, that is, main purpose of a structure or transaction was to access the benefits of a particular tax treaty. Older treaties should be renegotiated.
Regarding transfer pricing, the report recommends that:
- a binding general ruling should be enacted, including a set of principles reflecting the South African reality;
- SARS should ensure that the enforcement capacity of its transfer pricing unit is adequate;
- legislation to prevent transfer pricing of intangibles, may not currently require major legislative attention, since South Africa's exchange controls restrict the outbound movement of intangibles and royalty payments;
- SARS Practice Note 7 to be revised in line with the OECD Transfer Pricing Documentation Guidelines;
- transfer pricing documentation such as a master file, local file and country-by-country reporting should be compulsory for large multinational businesses with group turnover of ZAR1 billion;
- where a taxpayer has provided full details of the international agreements that it has entered into with connected parties, the absence of formal transfer pricing documentation will not be obligatory. Taxpayers choosing not to prepare documentation are however at risk and may find it more difficult to prove that connected party transactions are at an arm’s length price.
In conclusion, the world is changing rapidly and becoming a small market where enhanced communication and exchange of information through international agreements will inevitably cause reliance on secrecy and confidentiality to slowly disappear. Substance over form and commercial realism where the principle purpose of the transition or structure is not the avoidance of tax, must be the keystones of any structure. Transfer pricing disputes will become the new battle field and, more importantly, the reliance on strict legal compliance by overly aggressive tax planning may fail in the arena of public opinion, but that is a discussion for another day.
Head of Tax and Asia Practice