Fiscal residence – new Mauritius DTA provision modifies the test for companies
10 June 2013
Posted by: Author: PwC
Author: PwC (Synopsis, Tax Today, May 2013)
Recent news articles on international tax have focused heavily on the use by multinational companies of tax-friendly regimes through which to hold investments and to transact business. Heads of industry have been summoned to appear before legislators to explain their companies’ tax structures and transactions. Much has been made in the course of these discussions of the use of benefits afforded under tax treaties to mitigate exposure to tax. It is perhaps significant that these issues did not raise their head when economies were booming, and one may be forgiven for observing that there is an air of desperation in economies whose tax revenues have suffered from the economic downturn of the past few years and which now cast about for scapegoats.
News that South Africa has just concluded a new agreement for the avoidance of double taxation and prevention of fiscal evasion with respect to taxes on income with Mauritius bears examination in the present tax environment.
It is no secret that the fiscus views the tax treaty with Mauritius as a potential source of tax leakage. This view is well summarised in a Parliamentary report summarising a briefing by SARS to the Parliamentary Committee on Finance on 9 February 2011 on the tax treaty programme, of which the renegotiation of the Mauritian treaty formed part.
After alluding to "abuse and erosion of the South African tax base” the briefing explained the "problem of dual residence”. Applying the domestic rules of tax residence in South Africa and Mauritius it was possible that a company could be a resident of both countries, the Committee was informed. In order to make the treaty work, one had to assign residence to one of the two only. This had to be done by mutual agreement between the two countries concerned. If mutual agreement could not be reached then such companies would be excluded from benefit of the treaty. The report on the briefing states:
"The message to companies was that if they caused confusion as to their place of residence, then they could not expect to benefit from these treaties.”
If one examines the current treaty, it is evident that dual residence is not an issue. The treaty provision that deals with fiscal residence contains a provision that is designed to ensure that a company can never be regarded as a resident of both countries. It states that:
"Where … a person other than an individual is a resident of both Contracting States, then it shall be deemed to be a resident of the State in which its place of effective management is situated.”
In other words, a person will always be resident under the tax treaty in the country in which its place of effective management is located. So, for example, if a company is incorporated in Mauritius, but regarded as tax resident in South Africa on the basis that its place of effective management is located in South Africa, the existing treaty is clear that it will be regarded as resident in South Africa for purposes of the treaty and not in Mauritius.
Place of effective management
International jurisprudence on the meaning of place of effective management and the OECD interpretation thereof for treaty purposes is now relatively well established as the place where the key decisions affecting the company as a whole are in substance made and that there can only be one place of effective management at any point in time. There should therefore be little confusion except in marginal cases.
The new treaty with Mauritius provides that, where there is a conflict relating to the residence of a person other than an individual, the competent authorities of the two states shall endeavour to settle the issue by mutual agreement; in the event that agreement cannot be reached, the person shall be considered outside the scope of the agreement except for purposes of Article 25 (relating to the exchange of information).
This gives rise to the interesting potential outcome that a company may be regarded by the respective tax administrations as having its place of effective management in both jurisdictions, and, if the jurisdictions cannot agree on the appropriate criteria for determining its place of residence or on the application of the facts and circumstances to those criteria, the treaty will simply not apply to that company and it will face the risk of double tax.
Under the Income Tax Act, a company is a resident of the Republic if it is incorporated or has its place of effective management in the Republic. Thus, if a company is incorporated in Mauritius, it can only be regarded as a resident of the Republic if it has its place of effective management in the Republic. In the event that South Africa should seek to tax a Mauritian incorporated company on the basis that it is regarded as having its place of effective management in the Republic, the company would be in a position under the current dispensation to exercise its rights to object and appeal against the assessment. The courts would be compelled to determine the dispute by establishing the jurisdiction in which the company has its place of effective management. There is therefore synergy between South Africa’s domestic legislation and the tie-breaker clause of the current treaty.
Under the new treaty, a Mauritian incorporated company will still have the right to contest a decision of SARS to impose tax on the basis that it is considered a resident of the Republic by way of objection to an assessment and subsequent appeal. In the event that it should be found that the company does not have its place of effective management in the Republic, it will not be a resident and will not subject to tax in South Africa in respect of its worldwide income. If that place of effective management is found to be in Mauritius (or in any other country), it will be entitled to invoke treaty relief in relation to any of its income that is derived from a source within the Republic. There will be no necessity to invoke the mutual agreement process as the domestic judicial determination will preclude SARS from persisting with its interpretation.
On the other hand, South African incorporated companies that claim to have their place of effective management in Mauritius will have no ground for contesting an assessment to tax in the Republic on the basis of fiscal residence if they are assessed to tax in South Africa. By reason of their incorporation, they are, by default, resident in the Republic unless they are found to be exclusively a resident of Mauritius under the treaty. Their sole avenue for relief will be to invoke the mutual agreement procedure and seek a mutual declaration that they are exclusively resident in Mauritius.
Unless there is a single agreed hierarchy of criteria to be applied by the competent authorities to identify the county of residence for treaty purposes, there is potential for disagreement. Although the commentary on the OECD Model Tax Convention lists the factors that should be taken into account in such a tie-breaker clause and invites contracting states to include these in the clause, this has not been done in the new treaty. The result is significant uncertainty of the factors and the weightings thereof to be considered by the competent authorities, which leaves taxpayers in an invidious position given that the factors listed by the OECD range from where meetings of directors are held to where accounting records are kept and even to whether determining that the company is a resident of one of the contracting states but not of the other for the purpose of the treaty would carry the risk of an improper use of the provisions of the treaty (whatever that may mean).
The anomalous position can therefore arise that a Mauritian incorporated company may effectively invoke the assistance of the South African courts to resolve a dual residence dispute with SARS, whereas a South African incorporated company will be unable to do so.
South African companies with Mauritian incorporated subsidiaries may find that the residence status of their subsidiaries will be more closely examined by SARS once the new treaty comes into existence. However, they should not be pressed into a hasty decision on the future of the subsidiaries. Instead they should examine the management of their Mauritian incorporated subsidiaries and establish where the key decisions affecting these subsidiaries are in substance taken. If they are able to conclude with confidence that the subsidiaries have their place of effective management in Mauritius, they should not be adversely affected by the proposed new treaty provision.
South African incorporated companies that presently enjoy exclusive Mauritian residence status based on effective management being in Mauritius under the existing treaty should carefully examine their status taking into consideration the factors listed by the OECD. In marginal cases, they may consider a change to the company’s management structures and procedures to weigh these more in favour of Mauritius as the country of residence, changing residence to another treaty jurisdiction or otherwise restructuring to avoid any risk that they may be denied treaty protection when the new treaty comes into operation.