Permanent Establishment and ITC 13276
20 October 2015
Posted by: Author: Nico Theron
Author: Nico Theron (Tax Consulting South Africa)
Theron looks at the recent judgement of ITC 13276 and its wider implications for
Permanent Establishment in relation to the double tax treaty between South
African and the United States of America.
In the recent seminal judgement
of ITC 13276, the Tax Court was faced with the daunting task of interpreting the
definition of "Permanent Establishment” as contained in the double tax treaty
concluded between South Africa and the United States of America ("the treaty”).
Briefly, the facts of
the case are that employees of a non-resident advisory company ("the
appellant”) came to South Africa during 2007 on a rotational basis to provide
certain strategic and financial advisory services to a South African-based
company. During the 2007 calendar year, employees of the appellant were in
South Africa for a period exceeding 183 days while rendering services to the
South African based company.
The South African
Revenue Service (SARS) assessed the appellant to tax it for each of its 2007-to-2009
years of assessment on the basis that the appellant had a permanent
establishment in South Africa as envisaged in the treaty.
In arriving at its
conclusion that the appellant had a permanent establishment in South Africa,
SARS contended that the appellant had satisfied the requirements of paragraph
2(k) of article 5 of the treaty, and that this fact automatically resulted in
the appellant having a permanent establishment in South Africa. SARS further
contended that, even if the application of article 5(2)(k) alone could not
create a permanent establishment, it was the SARS’ view that a permanent
establishment will in any event also exist under article 5(1) of the treaty.
On the other hand, the
appellant contended that article 5(2)(k)
of the treaty alone cannot create a permanent establishment. Rather, the
appellant contended that article 5(2)(k) of the treaty can only create a
permanent establishment if the requirements of article 5(1) of the treaty are
also satisfied. In this case the appellant submitted that the requirements
thereof were not satisfied.
The appellant sought to support
its arguments by placing reliance on, inter
alia, the Organisation For Economic Cooperation and Development’s (OECD)
Commentary ("the Commentary”) on the OECD model tax treaty.
The appellant argued that, in
terms of the Commentary, article 5(2)(k) of the treaty cannot operate independently
from article 5(1) of the treaty as the Commentary quite clearly states that
items listed under paragraph 2 of article 5 will only create a permanent
establishment if these items "… meet the requirements of paragraph 1.”
The question before the court
The binary issue that formed the
subject matter of the appeal was (a) whether or not sub-paragraph 2(k) of
article 5 of the treaty should be interpreted in line with the Commentary, or
if some other interpretation should be afforded thereto,; and (b) if
sub-paragraph 2(k) does not operate independently from article 5(1), whether a
permanent establishment will exist under article 5(1).
We shall only deal with the
court’s decision to question (a) -
whether or not sub-paragraph 2(k) of article 5 of the treaty should be
interpreted in line with the Commentary on the model tax treaty, or if some
other interpretation should be afforded thereto.
The court’s conclusion
Vally J, in delivering
the judgment of the Tax Court, plainly disagreed with the interpretation
proffered by the Commentary stating that:"This interpretation, in my view, takes no account of the phrase ‘includes especially’.” Vally J then went
on to analyse the term "includes especially” with reference to various
authorities and concluded that:
"It therefore has to be interpreted that the
contents of article 5(2)(k) must be read to mean that they are an integral part of article 5(1). On this
analysis, as soon as an enterprise’s activities fall within the ambit of
article 5(2)(k) it becomes liable for taxation in the non-resident country. There
is no need for a further or separate enquiry as to whether the requirements of
article 5(1) have been met. The two articles cannot be read disjunctively. The
definition, by virtue of the bridging phrase "includes especially”, is a composite one. This clearly
expresses the purpose of the treaty. To break it up and treat the two articles
separately would be to ignore the natural and ordinary meaning of the phrase "includes especially”. (Our emphasis).
interpretation stands in direct contrast to the Commentary, Vally J made quick
work of finding support for the court’s controversial conclusion. Vally J stated
that firstly, there is no counterpart of article 5(2)(k) in the model tax
treaty on which the Commentary is based and secondly, the nature of article
5(2)(k) of the treaty is of a different specie to those contained in
sub-paragraphs (a) to (f) of paragraph 2 in the model tax treaty. For these
reasons, the court found that it cannot simply accept the interpretation
proffered by the Commentary in relation to how article 5(2)(k) of the treaty in
question should be interpreted.
interpretation favoured by the court in
casu is that paragraph 5(2)(k) operates independently from article 5(1) of
the treaty. Since the appellant satisfied the requirements of article 5(2)(k)
in this case, the court found that the appellant had a permanent establishment
in South Africa and was therefore indeed
subject to tax on its business profits, attributable to such South African
based permanent establishment.
It would be interesting to know
whether or not the SARS, at any point in this dispute, placed reliance on the
requirements under section 23 of the Companies Act to register an external
company where certain activities are conducted in South Africa for more than 6
The take away
Arguably, the judgement casts the
permanent establishment net wider from a South African tax perspective than
what the Commentary may have led some to believe. Where article 5(2) of a
treaty between South Africa and another country contains examples not listed in
article 5(2) of the model tax treaty and which is of different specie to those
listed in the model tax treaty, the impact of ITC13276 should be considered.
Example of treaties where this
may be the case are those concluded between South Africa, and, amongst others:
- Mauritius (the treaty with effect from 28 May
- Canada; and
There may very well be various
non-resident companies operating in South Africa in such a manner so as to
avoid creation of a fixed place of business as required under article 5(1) of
the relevant treaty. Following ITC13276, these efforts may have turned out to be
Depending on how business
structures have been set up, non-resident and resident taxpayers will be well
advised to reconsider whether or not a permanent establishment may be said to
exist following the judgment in ITC 13276.
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This article first appeared on the September/October 2015 edition on Tax Talk.