SARS' Draft Interpretation note on "Place of Effective Management"
30 April 2015
Posted by: Author: Wilco Froneman
Author: Wilco Froneman (BDO South Africa)
The South African Income Tax Act does not define the term "place of effective management", although many double tax agreements (DTA's) deal with the term as a tie-breaker clause. The term has been commented on often, for example, by the Organisation for Economic Co-operation and (OECD).
The OECD interprets "place of effective management" to be where key management and commercial decisions necessary for the conduct of its business as a whole are made. This has been the subject of many international court decisions. In Wensleydale's Settlement Trustees v Inland Revenue Commissioners , Special Commissioner David Shirley commented on the ordinary meaning of place of effective management:
I emphasise the adjective ‘effective'. In my opinion it is not sufficient that some sort of management was carried on in the Republic of Ireland such as operating a bank account in the name of the trustees. ‘Effective' implies realistic, positive management. The place of effective management is where the shots are called, to adopt a vivid transatlantic colloquialism.
This view contrasts with SARS' view in Interpretation Note 6 (26 March 2002) (IN6), which determines that the place of effective management is where a company is managed on a regular or day-to-day basis by the directors or senior managers of the company, irrespective of where overriding control is exercised, or where the board meets.
SARS' second revised draft IN6 ("draft IN6") aligns more closely to the principles and guidelines established by International Case Law, such as the decision reached in Smallwood. In Smallwood the court held that the place of effective management should de facto be determined with reference to where the real top level of management or realistic, positive management of the taxpayer is exercised. Draft IN6 elaborates on the principles and guidelines surrounding "place of effective management" as in the term "resident" in section 1(1) of the Income Tax Act, 1962. The adoption of draft IN6 would represent a major shift from the view expressed in IN6.
In terms of draft IN6, substance over form will prevail and will require the identification of those persons in a company who actually "call the shots" and who exercise "realistic positive management". Or, in other words, a company's place of effective management must be determined by ascertaining who makes the key management and commercial decisions in respect of the company's business as a whole. It then needs to be determined where these decisions are substantively made. Draft IN6 outlines certain elements that will be considered to determine substance, summarised as follows:
- ¹ Paragraph 24 of the Commentaries on the Articles of the Model Tax Convention on Income and on Capital, condensed version, dated 15 July 2014 at 90.
- ² 1996] STC (SCD) 241 at 252.
- ³ Trevor Smallwood Trust v Revenue and Customs  UKSPC SPC00669 in 112 & 114 at 30 and in 130 at 35 and the subsequent appeal in the Court of Appeal, Her Majesty's Revenue & Customs v Smallwood & Another  EWCA Civ 778 in 48.
- Head office – A company's head office is often the predominant location of senior management and support staff, and is indicative of the place of effective management. Decentralised companies could suggest that the head office's location is less important. This needs to be analysed on a case-by-case basis.
- Delegation of authority – Where companies delegate authority across committees (consisting of key members and senior management), the location where these committees develop and formulate their key strategies for approval by the board, will be considered to be the company's place of effective management.
- Board – If a company does not delegate authority, its board will often exercise the authority required to govern the company. If the board, in substance, makes the key management and commercial decisions necessary to conduct the business, the place of effective management could be where they meet. However, the impact on the place of effective management arising from the holding of board meetings in different locations is another aspect SARS considers to be important. The facts of each case have to be considered, as well as aspects such as whether the directors have the necessary knowledge and experience to make strategic decisions for the company; their impact on decisions; and whether they simply ratify decisions made by others.
- Modernisation and global travel – Changes in global telecommunications, information technology and travel can impact a company's place of effective management. Physical meetings of the board are often not required or implemented. Alternatively, even when physical board meetings are held, often a majority of the directors or key directors with overriding decision-making powers do not physically attend the meeting. Draft IN6 propagates that undue focus should not be placed on the location of board meetings without considering surrounding facts and circumstances.
- Shareholders – Decisions that can only be approved by shareholders often do not affect a company's place of effective management. However, shareholder involvement can cross the line into effective management. For example, a shareholder may effectively assume the powers of the directors of the company. This situation typically (but not necessarily) arises where the company is owned by a single person (whether a company, juristic person or individual) or where it has multiple shareholders (either connected persons or acting in concert). This is of particular concern with passive holding companies located in low tax jurisdictions.
- Operational management versus broader top-level management - Operational management decisions are generally of limited importance in determining a company's place of effective management and must be distinguished from key management and commercial decisions. Key management and commercial decisions, concerned with broader strategic and policy decisions, are more important in determining the place of effective management.
- Legal factors – Legal factors, such as the place of incorporation, formation and establishment, are generally not relevant in determining the place of effective management.
- Economic nexus – A company's economic nexus with a country is generally not relevant in determining its place of effective management, but could add some weight where other factors are inconclusive.
- Support functions - Large multinational companies often make use of support centres to centralise various services. The location of these support services generally has a limited influence on the company's place of effective management.
In terms of draft IN6 a company's place of effective management is the place where key management and commercial decisions necessary for the conduct of the business are made. This is consistent with the OECD's commentary on place of effective management. Draft IN6 states that SARS does not anticipate that the application of draft IN6 will result in many companies, previously held to have their place of effective management outside South Africa, now being held to have it in South Africa, and vice versa. SARS extends an invitation in draft IN6 to companies to discuss the facts of each case.
Since Interpretation Note 6 is currently in draft form it does not represent "practice generally prevailing" for purposes of section 1 of the Tax Administration Act. The shift in SARS' interpretation on place of effective management is welcomed, as it would remove some of the uncertainty that currently exists.
This article first appeared on bdo.co.za.