The pitfalls of cross-border service arrangements - what you need to know
22 April 2015
Posted by: Author: Lavina Daya
Author: Lavina Daya (ENSafrica)
Part 1: recent developments
With the increasing focus on cross-border payments in the context of profit shifting, management services in general, have recently become a main focus area of the South African Revenue Service ("SARS”) due to the substantial amounts of money flowing from South Africa on an annual basis as payments for management and related fees. In this regard, the Davis Tax Committee, in analysing the impact of Base Erosion and Profit Shifting ("BEPS”) on South Africa, reviewed data obtained from the South African Reserve Bank ("SARB”) which shows that for the calendar years 2008 to 2011 nearly 50% of all non-goods payments flowing out of South African related to legal, accounting and management consulting fees.
This article sets out a brief summary of the various issues which need to be considered in the context of management services which have been relevant for many of our multi-national clients. This article has been split in two parts. Part 1 will deal with the recent developments in the context of cross border service arrangements, including the requirement for non-residents to register for income tax in South Africa, as well as the withholding tax on service fees which comes into effect on 1 January 2016. Part 2 will deal with transfer pricing and exchange control considerations in relation to cross border service arrangements.
Requirements for a non-resident service provider to register and submit income tax returns
In terms of the notice issued by the Commissioner in relation to the 2014 year of assessment ("2014 Notice”), non-resident companies are required to submit an income tax return if, inter alia, they derive service income from a source in South Africa.
It is important to understand that the ultimate objective of the registration requirement is for SARS to be able to identify non-resident service providers that earn service income from a South African source that is either not protected from South African tax as a result of a double tax agreement or where such income may be attributed to a permanent establishment ("PE”) of such non-resident service provider in South Africa.
Although the Income Tax Act No 58 of 1962 ("Act”) contains a definition of "source” in respect of certain forms of income, it does not specifically address the source of service income and therefore it is necessary to consider the common law source principles as distilled from case law.
South African case law indicates that the source (originating cause) of income received for services rendered are the services themselves. The source of such income is located at the place where these services are provided. In the context of services, the "activities test” is generally applied to determine the source of the income, i.e. the place where the services are rendered prima facie constitutes the source of the income.
Should a non-resident group entity render services to the local entity from outside of South Africa, the service income derived therefrom should not be regarded as being sourced in South Africa and accordingly there should be no obligation for such non-resident entity to register and submit an income tax return. However, the position may be different if, for example these services are rendered in South Africa or partly in South Africa. Should this be the case, it may then give rise to South African sourced income, triggering an obligation for such non-resident group entity to register for income tax in South Africa.
Withholding tax on service fees
The withholding tax on service fees comes into effect on 1 January 2016 and will be levied at a rate of 15 per cent in respect of the amount of any service fee that is paid by any person to or for the benefit of any foreign person to the extent that the amount is regarded as having been received or accrued to that foreign person from a source within South Africa.
Should a local company receive, inter alia, management services from a non-resident group entity, the withholding tax on service fees may apply to payments to the non-resident group entity for such management services to the extent that the amount is regarded as having been received or accrued to the non-resident entity from a source within South Africa. This would be the case where, for example, the non-resident group entity sends individuals to South Africa to render management or consulting services to the local entity. This would result in the local entity having an obligation to withhold the withholding tax and to pay such amounts over to SARS. In addition it will have a compliance obligation in terms of rendering a return to SARS in respect thereof. It is noted that failure to withhold or pay these taxes to SARS could result in the person that is required to withhold the tax (i.e. the local entity receiving the management services) being personally liable for the tax. In addition penalties may be levied in certain instances for the failure to withhold or correctly withhold.
The position, may be different in a scenario, where the non-resident entity provides the management services from outside of South Africa. In this case, the source of such income should not be regarded as being in South Africa and accordingly the withholding tax provisions should therefore not apply. As such no withholding obligations would be placed on the local entity receiving the management services.
At this stage it is unclear how the withholding tax on service fees would apply to service income from multiple sources (for example in a scenario where management services may be partly rendered from South Africa and partly from outside of South Africa). Furthermore, the definition of services fees currently refers to amounts received or accrued in respect of technical services, managerial services and consultancy services, but no guidance has been provided by SARS on what type of services would fall under these sub-categories, e.g. what would constitute services of a technical nature?
It is noted in the 2015 Budget Speech read by the Minister of Finance on 25 February 2015 that it is proposed that the provisions dealing with the withholding tax on services be reviewed to clarify definitions and remove any anomalies. Given the above statements in the Budget Speech and also the fact that no specific guidance or declarations has been released by SARS on the withholding tax on service fees to date, we expect to see amendments to the these provisions which are already contained in the Act in sections 51A to 51H of the Act.
A further issue to consider, is whether service arrangements constitute a "reportable arrangement” in terms of the Tax Administration Act No 28 of 2011 ("TAA”).
The TAA provides that an arrangement may constitute a "reportable arrangement” in two scenarios, one of which is if the arrangement is listed in section 35(2).
Section 35(2) provides that an "arrangement” is a "reportable arrangement” if the Commissioner has listed the "arrangement” in a public notice.
It is noted that in the context of services fees, SARS issued a Draft Notice on Reportable Arrangements ("Draft Notice”), in 2014. The Draft Notice set out certain arrangements which SARS identified to have certain characteristics that may lead to an undue tax benefit and therefore will be regarded as a "reportable arrangement”, triggering a duty to disclose such arrangement to SARS. Most relevantly the following was set out in the Draft Notice to be a reportable arrangement:
"any arrangement in terms of which fees that are payable or may become payable, on or after the date of publication on this notice, 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”.
Further to the Draft Notice, a public notice ("the Notice”) was issued in the Government Gazette on 16 March 2015 in terms of which the Commissioner for the South African Revenue Service ("SARS”) lists various arrangements as "reportable arrangements” in terms of section 35(2) of the TAA.
We note that the Notice no longer list arrangements in terms of which fees are payable by a person that is resident for services rendered to a non-resident which exceeds R5 million as set out above. Accordingly, at this stage the abovementioned service arrangements should not be regarded as a reportable arrangement in terms of section 35(2) of the TAA.
It is important that taxpayers be aware of the above mentioned considerations in respect of cross-border service arrangements. We note that the requirements for non-residents to register for income tax in South Africa as well as the applicability of the withholding tax on service fees is only relevant to the extent that the service income, derived by such non-resident, is regarded as being from a South African source. Should the non-resident service provider derive service income which is not from a source in South Africa, then the requirement to register for income tax in South Africa, as well as any withholding tax on service fees, should not be applicable.
We recommend that taxpayers who pay, inter alia, service fees to non resident service providers, perform a detailed analysis regarding the source as such service income in order to, inter alia, establish their obligations in respect of the withholding tax on service fees. Similarly the non resident service provider should analyse the source of any service income derived in respect of the provision of services to a South African taxpayer in order to consider its obligations to register for income tax in South Africa as set out above.
This article first appeared on ensafrica.com.