Reportable arrangements – significant changes in the pipeline
27 January 2015
Posted by: Author: Kyle Mandy
The Tax Administration Laws Amendment Bill 14 of 2014 (TALAB) proposes a number of important changes to the reportable arrangement provisions contained in Chapter 4 of the Tax Administration Act (TAA). However, it is important to also consider the proposed changes to the listed reportable arrangements contained in a draft notice published in June. These proposals are discussed in this article.
The purpose of the reportable arrangement provisions is to provide SARS with an early warning system of potentially aggressive arrangements that may lead to undue tax benefits. Originally, the provisions were primarily aimed at the structured finance industry and were designed to identify tax-based financing arrangements. However, as will become apparent, the provisions are being adapted for a broader purpose of identifying other avoidance arrangements that are perceived to be aggressive.
Chapter 4 of the TAA contains, in sections 34 to 39, the reportable arrangement provisions. These provisions compel a participant in certain arrangements to report information in relation to such arrangements to SARS within a stipulated period. In terms of the provisions, an arrangement is a reportable arrangement if:
- a tax benefit is assumed to be derived by a party to the arrangement and it contains certain specified characteristics; or
- it is listed by the Commissioner as a reportable arrangement.
The specified characteristics of an arrangement are any of the following:
- it contains provisions to the effect that any finance costs, fees or other charges are dependent on the tax treatment;
- it contains round trip financing, an accommodating or tax-indifferent party, elements that have the effect of offsetting or cancelling each other or substantially similar characteristics;
- it results in a deduction for income tax purposes but not an expense for accounting purposes;
- it results in revenue for accounting purposes but not gross income for income tax purposes; or
- it does not result in a reasonable expectation of a pre-tax profit for any person deriving a tax benefit or the pre-tax profit is less than the tax benefit in present value terms.
The important changes that are proposed to the reportable arrangement provisions in the TALAB are set out below.
Firstly, the definition of a ‘participant’ is extended to include a natural person. The definition will now encompass the promoter of the arrangement and any person who will derive, or who assumes that they will derive, a tax benefit or financial benefit from the arrangement. Previously, only a promoter, company or trust could be a participant. In this regard, it is worth noting the proposed listed reportable arrangement relating to contributions to foreign trusts referred to below.
Secondly, the concept of a tax benefit is now extended to encompass tax evasion insofar as it relates to reportable arrangements. What this is intended to achieve is unclear. What it would mean is that any person who is party to an arrangement and assumes that the arrangement will result in them evading tax will now have an obligation to report if the arrangement is a listed reportable arrangement or if it contains any of the specified characteristics referred to above. Similarly, the promoter of any such tax evasion arrangement would also have an obligation to report. Why SARS believes that a tax evader or any promoter of a tax evasion scheme is going to report this to SARS defies comprehension.
The final significant amendments are in relation to the reporting obligations. Previously, the promoter had the primary reporting obligation. Now both the promoter and any other participants will be equally responsible for reporting the arrangement, although it is necessary only for one person to report provided that any other participants obtain a written statement that the arrangement has been reported. The timing of the reporting obligation is also changed in a subtle manner.
Previously, the reporting obligation was required to be complied with within 45 business days after an amount is first received or accrued to or paid or incurred by a participant in terms of the arrangement. This is now amended to within 45 business days of the arrangement qualifying as a reportable arrangement or within 45 business days of a person becoming a participant in an arrangement after the date on which it qualified as a reportable arrangement. The result is that the reporting obligation now arises with reference to the time that the arrangement is entered into rather than with reference to cash flows associated with the reportable arrangement. In addition, a new participant in a reportable arrangement will now incur an obligation to report unless it has previously been reported.
The proposed changes to the listed reportable arrangements and excluded arrangements provide context for some of the proposed amendments to the legislation. Section 35(2) of the TAA currently provides the Commissioner with the power to list an arrangement as a reportable arrangement if satisfied that it may lead to an undue tax benefit. At this stage, the only listed reportable arrangements are those related to hybrid equity instruments as contemplated in section 8E of the Income Tax Act (ITA) and hybrid debt instruments as contemplated in section 8F of the ITA. These existing arrangements are proposed to be excluded from the new list of reportable arrangements. This is to be welcomed for two reasons. Firstly, sections 8E and 8F have recently undergone significant changes. In particular, the latter section has been completely rewritten and bears little resemblance to its predecessor. In addition significant new hybrid rules have been introduced insofar as third party backed shares and hybrid interest are concerned. Secondly, precisely what the perceived mischief of concern to SARS in relation to these arrangements was is unclear. The vast majority of arrangements reported in respect of these listed arrangements related to purely vanilla preference share funding arrangements which present little risk to the fiscus.
The draft notice lists six new reportable arrangements. These relate to South African-sourced service fees that are paid to a non-resident, subscription and buyback arrangements in relation to the shares in a company, arrangements that are expected to give rise to foreign tax rebates, contributions to foreign trusts, acquisition of shares in assessed loss companies and payments to foreign insurers in terms of captive arrangements. The nature of these proposed listed reportable arrangements clearly illustrates the shift in focus from tax structured financing to other forms of perceived avoidance, although funding clearly remains a key concern to SARS. A number of the proposed listed reportable arrangements have a distinct base erosion and profit shifting (BEPS) feel to them and this is a trend that is likely to continue. The final form of the notice remains to be seen and we may well see significant changes to the listed reportable arrangements, including possible additions or expansions.
The draft notice also proposes to replace the existing excluded arrangements. Currently, the listed excluded arrangements are those where the tax benefit does not exceed R1 million or where the tax benefit is not the main or one of the main benefits of the arrangement. In terms of the draft notice, it is proposed that the main benefit exclusion will be removed and that the de minimis exclusion be increased to R5 million. The proposed removal of the main benefit exclusion is problematic and will result in many wholly commercial arrangements being reportable purely on the basis that they result in a tax benefit for a party. There are many examples that can be used to illustrate this, but one will suffice to demonstrate the absurdity involved.
Take the example of a taxpayer who conducts research and development and who qualifies for the 150 percent deduction provided for in section 11D of the ITA. The super deduction will clearly result in a tax benefit for the taxpayer and, because it will give rise to a deduction for income tax purposes but not an expense for accounting purposes, it will constitute a reportable arrangement as defined. As it would not be an excluded arrangement if the tax benefit is in excess of R5 million it will have to be reported to SARS. The resultant administrative burden for both taxpayers and SARS will be significant if this proposal is pursued.
Further consideration of the implications of two of the proposed listed reportable arrangements is appropriate.
The proposed service fee reportable arrangement reads as follows:
“Any arrangement in terms of which fees that are payable or may become payable … by a person that is a resident to a person that is not a resident with regard to services rendered to that resident in the Republic, exceed or are reasonably expected to exceed R5 million”.
This reportable arrangement must be considered in light of the withholding tax on service fees to come into effect on 1 January 2016 and the new requirement for foreign companies earning South African sourced service fees to submit income tax returns, regardless of whether or not they are entitled to treaty relief in respect thereof. The understanding is that SARS is concerned that such service fees are not being subjected to tax in South Africa notwithstanding that South Africa may be entitled to tax these fees. What SARS seeks to achieve with introducing a reportable arrangement in this regard is not entirely clear. It is unlikely that the foreign company is going to report these arrangements to SARS if they are not already registered for income tax. Presumably, SARS is then expecting that the recipient of the services should then report the arrangement. Whether the recipient will have an obligation to report will, however, depend, firstly, on whether they derive a tax benefit from the arrangement. In effect, this would mean that they obtain a deduction or allowance in relation to the service fees paid. Secondly, if a main benefit excluded arrangement is to be retained or a similar exclusion for commercial arrangements is to be introduced, it is difficult to envision the situation where a reporting obligation will actually arise for the recipient of the service. It is understood that SARS is currently considering other avenues of obtaining the information that it requires in relation to service fees and it is therefore possible that this reportable arrangement will ultimately not materialize.
Foreign tax credits
The proposed reportable arrangement reads:
“Any arrangement that is expected to give rise … to any rebate in respect of foreign taxes if the amount of the rebates to be taken or that have been taken into account in determining normal tax payable by any person or persons that is or are party to that arrangement, exceeds or is reasonably expected to exceed an aggregate amount of R5 million”.
It is not entirely clear what arrangements are of concern to SARS in this regard. However, the proposed reportable arrangement is couched in such broad terms that it will inevitably apply to most legitimate arrangements in respect of which foreign withholding taxes are levied, for example, interest and royalties. Presumably, SARS is interested in arrangements that are designed to generate foreign tax credits in situations where there is no underlying substance or where they are used to shelter tax more than once. This is one of the issues being addressed in the BEPS project as part of the hybrids action point. It is hoped that SARS will design this reportable arrangement to more closely target those schemes that are of concern. In its current form, it is likely to impose a significant administrative burden on both taxpayers and SARS.
As a final point, the proposed changes to the reportable arrangement provisions is a symptom of increasing concerns on the part of SARS in relation to tax avoidance and its desire for information in respect thereof. In some respects, it is surprising that it has taken SARS so long to make greater use of this powerful information gathering mechanism. It is expected that we will see significantly greater use being made of reportable arrangements over time and further reforms are likely once the OECD finalises its recommendations under the BEPS project.