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SARS is stemming the flow of outbound service fees

20 January 2016   (0 Comments)
Posted by: Author: Mohamed Hassam
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Author: Mohamed Hassam (EY)

The increase in non-goods transactions have not gone unnoticed. SARS has new tools to monitor this.

A key priority for the Davis Tax Committee, appointed by former Finance Minister Pravin Gordhan in 2013, was to formulate South Africa’s response to Base Erosions and Profit Shifting (BEPS). 

Among the myriad of issues considered by the committee, perhaps the most startling was the substantial outbound payments for non-goods transactions. It accounted for nearly 50 per cent of all payments since the end of the global financial crisis. In noting its concern the Committee stated state:

"…it seems peculiar that [after the financial crises in 2008] legal, accounting and management consulting services increased by nearly …32.6 per cent... and engineering and technical services by … 39.5 per cent. … Consumption increases during the aftermath of a global financial crisis seem odd in the wake of sluggish economic activity…”.  

"The magnitude and prevalence of cross-border non-goods transactions are clear. It poses a serious threat to the fiscus insofar as tax revenue, and is an indication that illicit tax base migration through avoidance schemes and practices could be taking place.” 

Considering this outflow of cash, it is not surprising that there has been a concerted effort on the part of the South African Revenue Service (SARS) to close the gap between base erosion and profits shifting practices and legitimate intra-group services. 

This article takes a look at the various measures introduced over the past three years to stem the tide of outbound service fees from South Africa.

Services withholding tax: 

The services withholding tax was introduced in the Taxation Laws Amendment Act of 2013 and is due to come into effect on 1 January 2017. The withholding tax will be applicable to service fees sourced in South Africa at a rate of 15 per cent.

Service fees are defined as fees for services of a technical, managerial and consulting nature and will be regarded as being from a South African source when the services are rendered in South Africa. 

Curiously, this means that the withholding tax will be imposed despite the existence of a number of Double Tax Agreements (DTAs) that effectively take away South Africa’s right to tax in the absence of a permanent establishment. Accordingly on the face of it, it would seem that the services withholding tax will serve a dual purpose of:

  • revenue collection in respect of service fees paid to non-treaty countries; or in lesser instances, countries with a technical fee article in the treaty; and 
  • act as the opening gambit for the information gathering process, which has subsequently been augmented with the filing and reportable arrangements requirements outlined below.

Filing obligation 

In June 2014, SARS issued a notice that required every non-resident juristic person to furnish an income tax return if it, among others, derived "service income” from a source within South Africa. The obligation to file exists even where a DTA provides protection to a non-resident, in which case a nil return has to be filed. 

The 2015 notice extends the filing threshold by requiring non-residents who receive any "income” (including service fees) sourced in South Africa to file a return. However, income is specifically defined in the Income Act (58 of 1962). Service fees that are not taxable in South Africa as a result of the application of a DTA will arguably not constitute income.

However, some argue that taxpayers should file an income tax return irrespective of whether or not South Africa ultimately imposes a tax on the income. In that case, the filling is likely to only yield information that may be used in other areas.

Reportable arrangements

In March 2014, SARS issued a draft public notice in respect of six arrangements it intended to add to a list of reportable arrangements. This included fees of a technical, managerial and consultancy nature paid by a resident to non-residents that exceeded R5m. 

Although the services arrangement was ultimately removed when the notice was finalised, SARS issued a subsequent draft Public Notice on Reportable Arrangements on 19 June 2015, specifically dealing with inbound services. 

The notice proposed that the following inbound technical, managerial or consultancy services (the terms are not defined) must be reported to SARS within 45 days after becoming a reportable arrangement:

  • If the non-resident, its employees, agents, or representatives are  or will be physically present in South Africa rendering such services; 
  • The expenditure in relation to the rendering of the services will exceed or exceeds R10m in the aggregate.

Failure to report may lead to penalties ranging from R600 000 to R3.6 million, depending on whether the person is a participant or the promoter to the arrangement, or the quantum of the tax benefit.

Reported information is generally used as a forewarning to assess whether the foreign service provider has a tax presence in South Africa (permanent establishment), and to gather information on Pay as You Earn (PAYE) and Value Added Tax (VAT) compliance. Past experience has indicated an increase in SARS audits of reportable arrangements.  

It is evident that SARS has set out to tackle inbound services with vigour and has been equipped with the necessary tools to effectively bridge the information gap between BEPS practices and legitimate intra-group services.  This is likely to result in an increase in the income tax, PAYE and VAT audits relating to inbound services. 

If not properly managed, these measures are likely to catch the unaware, and will test legitimate global intra-group service business models. 

A word on the decision in AB LLC and BD Holdings LLC 

It is vital to consider the judgement handed down by the Tax Court in AB LLC and BD Holdings LLC v Commissioner of the South African Revenue Services (13276) [2015] when considering the tax consequences on inbound services. 

In this case the court held that a service permanent establishment as contemplated in Article 5(2)(k) of the South Africa/United States DTA may exist even where the requirements of Article 5(1) are not present i.e. there is no need to establish the existence of a "fixed place of business through which the business of an enterprise is wholly or partly carried on”.

Although this interpretation adopted by the court has been subject to much debate, it does seem to be in line with international precedent. In this regard the Indian Income Tax Appeal Tribunal in Linklaters LLP v Income Tax Officer-International Taxation, Ward 1(1)(2), Mumbai ITA Nos 4896/Mum/03, 5085/Mum/03 similarly concluded that, while articles 5(2)(a) to (i) of the India-United Kingdom DTA were merely illustrative of the basic rule in Article 5(1), Article 5(2)(k) was an extension of the basic rule and, therefore, constituted a freestanding category of permanent establishment (See Schwarz - UN Model Services Permanent Establishment: What you do – not where you do it, Kluwer Tax Blog 12 August 2015).

Accordingly, foreign service providers rendering services in South Africa must ensure that adequate structures and tracking systems for employees are in place in order to avoid triggering a South African tax liability.

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This article first appeared on the January/February 2016 edition on Tax Talk.


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