Davis Commission Report on First Deliverables BEPS Release
13 April 2015
Posted by: Author: Keith Engel
Author: Keith Engel (SAIT Technical)
Commission Report on First Deliverables BEPS Release: A Good Effort Despite the Constraining
Engel argues that tax professionals should value the Davis Commission’s
thoughtful and open approach, although a Committee with a more South African
centric mandate may have proven more valuable in the long run.
23 December 2014, the Davis Commission released its first interim report on
Base Erosion and Profit Shifting ("BEPS”).
The report contains recommendations for the South African tax system relating
to the 2014 deliverables by the OECD on BEPS.
All-in-all, the 2014 report covers 7 of the 15 deliverables (with the
remainder due this year). Public
comments on the Davis Commission recommendations are due by 31 March 2015.
Davis Committee interim report falls into three parts: (1) an overall introduction, (2) a detailed
summary of the OECD action points as these points relate to South Africa, and
(3) a summary table of the same recommendations.
A. Introductory note
introductory note reiterates the overall global statements on BEPS and seeks to
contextualise these concerns within a developing country paradigm with emphasis
on South African in particular. In terms
of a developing country context, the Davis Committee indicates that protection
of the corporate tax base in a developing country context is more important
than for developed countries. Relative
corporate revenues for developing countries are typically more than 25 per cent
of total revenue; whereas, the OECD and other developed countries rely only on
corporate revenues to the extent of 3-10 per cent of the total tax-take. In justifying this differential, the Davis
Committee states that developing countries cannot fully rely on VAT as a source of revenue in large part due
to the regressive nature of VAT and raises concerns that a lack of corporate
taxation could favour capital over labour.
a South African level, the Davis Committee reveals some interesting statistics
on the non-goods outflow of service/intangible payments from 2008 to 2011,
which in aggregate increased from roughly 43.6 billion to 205 billion per
annum. The largest increase stems from the
subcategory of legal, accounting and management services. The Committee indicates that much of this
outflow is associated with the mining and manufacturing industries (which is
said to be "not surprising”.) The role
of State-Owned Enterprises in this outflow is also noted, but the Committee is
implicitly concerned about the post-2008 progression overall.
Davis Committee report contains a fairly exhaustive attempt at applying the
OECD recommendations to the South African context. Provided below are the more notable items of
- Action Plan 1: Addressing the Challenges of the Digital Economy
The Davis Commission is of the view that there
is no urgent need for general legislative action in the case of e-commerce
given the plethora of general South African tax rules already in place, but
some specific rules may be helpful. One key
recommendation is the enactment of specific source rules for the supply of
e-commerce goods and services. The Davis
Committee believes that these source rules should have a consumption focus and contain
an element of apportionment (as opposed to the all-or-nothing approach of the
current source rules). At an
administrative level, foreign residents should be required to file annual
income tax returns if these residents have any quantum of source income without
regard to the prerequisite existence of a South African permanent
The report also spent considerable focus on VAT
issues as they relate to e-commerce, in part re-examining the recent changes of
2013 and 2014. Amongst other recommendations,
the Davis Committee suggested that the definition of e-commerce be clarified
(with the specific inclusion of online advertising) as well as the distinction
between business-to-business transactions versus business-to-consumption
transactions. Other suggestions included
the clarification of the continued application of the reverse-charge mechanism,
relief from penalties for inadvertent errors in identifying the consumption
versus business status of payees, simplified VAT registration for foreign suppliers
of e-commerce and the desire for neutrality between foreign versus domestic
stakeholders. Of particular note is the
Committee’s suggestion that consideration be given to utilising the banks as an
improved (and immediate) withholding mechanism for VAT transactions.
- Action Plan 2: Neutralising the Effects of Hybrid Mismatch
The Davis Committee believes
that the issue of hybrid instruments should best be addressed conceptually
rather than via specific rules such as the hybrid debt provisions of sections
8F and 8FA. Under this approach,
deductions would presumably be denied if the cross-border payment fails to
qualify as income under the payee country’s system of taxation. The anti-avoidance ceiling of section 23M was
additionally questioned "as complex and its workings unclear” despite its
anti-avoidance intent. Pre-existing
foreign tax credit schemes (such as those associated with the Brazilian tax
treaty) were said to be on the decline.
However, the Committee suggested that foreign credits should not be legislatively
available where global tax was effectively neutralised in terms of underlying net
income (through deductions or other offsets).
- Action Plan 5: Countering Harmful Tax Practices More
Effectively, Taking into Account Transparency and Substance
The Davis Committee
identified the South African Headquarter regime as the main preferential regime
that could be subject to the new substantial activity requirement of the OECD. The Committee suggested that the regime be
retained for the sake of enhancing South Africa’s gateway status and that the
regime be enhanced so as to promote headquarter services (as opposed to the
current regime which merely favours holding company status). Special economic zones are additionally
slated as a preferential incentive that need to be similarly examined for
- Action Plan 6: Preventing Treaty Abuse
The Davis Committee favours the introduction of
a "main business purpose” requirement for the application of tax treaties as
well as a possible limitations of benefits article. A domestic general anti-avoidance override
for tax treaties is said to exist implicitly but should be made legally
The Davis Committee strongly favours the
renegotiation of older treaties with outdated provisions (such as the lack of
source taxation for immovable property companies in the case of the Netherlands
tax treaty and the pro-source bias of the interest provision within the Zambian
tax treaty). The revised Mauritius tax treaty is strongly
supported, including the revised tie-breaker clause in the case of dual
residence companies. Pre-existing tax
sparing clauses within certain older treaties should be revised in line with
newly announced OECD pronouncements.
As a side note, the Davis Committee calls into
question the tax credit of section 6quin.
The Committee states that the credit effectively relinquishes taxing
authority to its fellow Africa neighbours even though this relinquishment is
unwarranted under international tax principles.
- Action Plan 8: Assuring that Transfer Pricing Outcomes are
in Line with Value Creation/Intangibles
The Davis Committee focuses on two aspects of
this Action Plan. Firstly, the Davis
Committee takes cognizance of schemes where intangibles are developed locally,
but only finalised abroad so that payments are made to the new (low-taxed) foreign
location. However, these schemes are of
little concern given the anti-avoidance measures (such as section 31 transfer
pricing, the anti-intangible migration provisions of section 23I and Exchange Control
provisions prohibiting the outbound transfer of certain intangibles) with the
possible exception of some potentially remaining schemes involving local
deductions followed by foreign income.
The second category of concern deals with payments to a foreign location with little value
addition (for example, people presence), but the Committee is unsure how these
schemes can appropriately be rectified.
- Action Plan 13: Re-Examining Transfer Pricing Documentation
The Davis Committee mainly suggests that any
revisions in this area be updated in line with the OECD recommendations. The SARS interpretation guidelines (including,
Practice note 7) should be updated in line with recent OECD principles. The Davis Committee fully supports the notion
that multinationals should be prepared to have a master global file, a local
file and country-by-country reporting but suggest a R1 billion group turnover
threshold and other requirements of materiality to reduce administration that
outweighs the business economics.
- Action Plan 15: Developing a Multi-Lateral Instrument
As expected, the Davis Committee fully supports
the OECD plan for multi-lateral agreements to facilitate the globalisation of
the BEPS proposals. The outcome of these
OECD efforts is still pending.
Davis Committee is to be commended for performing the herculean task of fully
reviewing the OECD BEPS reports despite the short-time frame and lack of
extensive staff support. The scale of
the project is massive, and one can see that the Committee made an exhaustive
attempt to cover all aspects of the OECD work.
The Committee is also to be commended for seeking local economic data.
the Committee worked hard to contextualise the BEPS debate so that the debate
had a South African flavour, the real problem for the Committee was the mandate
itself. The Action points of the OECD
clearly have a strong European flavour.
For instance, the Committee rightfully points out that management and
technical fees pose a greater threat to the South African tax base than the
OECD focus on intellectual property fees.
As a result, the Committee was wrongfully forced into an OECD
straight-jacket to find base erosion through an OECD lens. This is not to say that South Africa does not
have base erosion – just that South African base erosion is probably occurring
from a different source. Indeed, the
Committee’s information on management and related service fees highlights this
fact, but the OECD action points unfortunately do not specifically address
these concerns beyond improved general documentation associated with transfer
Committee’s focus on tax treaties was rightfully identified as a probable
concern. However, the actual avoidance
at stake within South Africa needs to be clarified. For instance, treaty shopping in terms of
dividend payments via countries such as Mauritius are not really an issue
because the Mauritian treaty dividend rates match the rates found in most
treaties (and dividends do not cause base erosion in the OECD sense because
dividend payments by a South African company are not deductible). The bigger concern is interest, service and
royalty payments when applied in the case of tax treaties involving low-tax
jurisdictions. If revenue is to be
protected, a more comprehensive policy strategy needs to be considered focusing
specifically on low-tax jurisdictions that adversely impact the South African
tax base, and specific information relating to these outflows would have been
helpful. Unfortunately again, the format
of the OECD action points do not facilitate this approach – instead seeking a generic
response for all tax treaties. That
said, the Committee’s overall emphasis on adding clarification on the application
of the domestic GAAR and support of subjective anti-avoidance rules within
treaties themselves probably can be supported as a reasonable generic response.
the introductory note, the Committee strongly raises the point that
anti-avoidance must be measured against South Africa’s need for
competitiveness. Most practitioners will
undoubtedly take comfort that the Committee recognises the need for this
balance and, indeed, the overall tone of the report takes a very measured
response. Nonetheless, this author
expects some commentators to criticise the report for its failure to discuss
the issue of tax and competitiveness (other than a brief discussion of the
headquarter company issue). To be fair
to the Committee, the issue of competitiveness is outside the core mandate of
the OECD report, meaning that the issue of tax and competitiveness has to be an
item of discussion reserved for another day.
This author for one believes that the line between anti-avoidance and
competitiveness can be preserved as long as anti-avoidance measures do not
inadvertently impact non-tax motivated commercial transactions (easier said
terms of transfer pricing, the Committee again took a balanced approach. While South Africa will clearly follow
international trends in this regard, many businesses will undoubtedly support
an approach that provides documentation relief in terms of materiality. The international "paper/systems burden” of
compliance in the tax and regulatory arena is quickly becoming a heavy expense
for many companies, and company resources dedicated to these efforts are
quickly falling short of international demand.
The question is how to simplify information requests while enhancing
government access to useful information.
This clearly requires an enhanced dialogue between government and
practitioners should welcome the Committee’s thoughtful and open approach in the
debate even if certain points may be of concern. One would hope that practitioners will
respond constructively with additional information and that Government will properly
take into account the measured nature of the Committee’s approach when
formalising proposals (without one-sided cherry-picking). From a larger perspective though, one does
wonder whether the BEPS report was the best use of Committee resources in a
time-period when Government is seeking to raise significant revenues via
closing loopholes. Although the closure
of some loopholes raised by the Committee using the OECD lens may raise small
pockets of revenue, a Committee mandate starting with a more South African
"centric” factual/legal paradigm would probably have been more fruitful.
This article first appeared on the March/April 2015 edition on Tax Talk.
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