Failure, More Failure and Some Success: GAAR Ten Years On
23 September 2016
Posted by: Author: Ed Liptak
Author: Ed Liptak (Independent Tax Consultant)
The much needed “new” General Anti Avoidance Rule is ten years old. In this two part series, we look at the successes of the law.
Judging the new GAAR ten years on
The new General Anti Avoidance Rule (GAAR), sections 80A to 80L of the Income Tax Act (ITA), was enacted on 6 November 2006 . As the legislation nears it tenth birthday, it is perhaps a good time to assess the legislation and to see what has changed, for better or worse. This article is the first in a two part series. While this article will list the successes of GAAR, the next article, will look at its failures.
The goals of the new GAAR
The new GAAR was intended to address a number of weaknesses in its predecessor, the former section 103(1) of the ITA. These included clarifying that the Commissioner was entitled to apply the GAAR as an alternative or additional basis for any assessment, that it could be applied to steps or parts of a larger avoidance arrangement, that an objective - rather than subjective -  purpose test be used in accordance with international best practice, and to reinforce the then emerging trend in South Africa toward a more purposive interpretation of tax statutes. Most importantly, the legislation was intended to create a more effective deterrent against impermissible avoidance arrangements, particularly aggressive tax shelter arrangements that have little or no commercial substance.
The need for an effective GAAR – Now more than ever
Income inequality is one of the most pressing economic and social issues currently facing not only South Africa, but many countries throughout the world. Not only has the gap between rich and poor grown, it has become increasingly entrenched.
One of the most effective tools that a government has to redress such inequality is a progressive income tax. Abusive tax avoidance radically undermines that remedy. Because sophisticated tax avoidance schemes are typically extraordinarily expensive, they are almost exclusively the domain of the country’s wealthiest and most profitable taxpayers. Tax avoidance is a rich person’s (or company’s) game.
Critics often point to statistics published by National Treasury showing that individuals in the top income bracket account for the lion’s share of the personal income tax collected each year. The problem with these statistics is that they are based on a person’s reported taxable income rather than their true economic income. The damage from abusive tax avoidance has already been done; the horse has left the barn.
The progress that has been made
On the positive side, significant progress had been made in several areas. It is now clear that the Commissioner may apply the GAAR as an alternative or additional basis for an assessment and that it may be applied to steps in or parts or parts of a larger avoidance arrangement. More importantly, the Supreme Court of Appeal has made it clear that a purposive approach to the interpretation of tax statutes must be applied in all cases.
In addition, the courts have now taken cognisance of some of the key characteristics of tax shelter arrangements that lack commercial substance, including the presence of self-cancelling
elements and round-trip financing. The courts have also made it clear that they can recognise such arrangements in practice, even while practitioners still claim to be mystified by the concept.
It is impossible to tell for sure the extent to which, if any, the new GAAR and the extensive discussions regarding tax avoidance that preceded its enactment influenced these developments. Whatever the case may be, SARS, National Treasury and Parliament can take some solace in the progress has been made in these areas.
Section 80J – a mixed bag
Section 80J requires the Commissioner to issue a notice to a taxpayer if, during the course of an audit, they come to believe that the new GAAR may be applicable in determining the tax liability of any party (“Section 80J Notice”). The taxpayer is then given the right to respond to the Section 80J Notice within 60 days or such longer period as the Commissioner may allow (“Section 80J Response”). If, as is usually the case, the taxpayer exercises this right, the Commissioner is then obliged to act within 180 days of the receipt of the 80J response, either by requesting additional information, withdrawing the Section 80J Notice or proceeding to determine the taxpayer’s liability under the new GAAR (“Action Requirements”).
The purpose of section 80J Notice was to ensure that the new GAAR would not be applied lightly or “automatically” by auditors, while at the same time warning taxpayers, at a relatively early stage in the proceedings, that the application of the new GAAR was under consideration.
The purpose of the 80J Response was to provide taxpayers with an opportunity to address the Commissioner’s concerns, again at a relatively early stage in the proceedings before both sides were forced to incur the time and expense typically involved in a full-blown investigation under the new GAAR. Finally, the purpose of the Action Requirements was to ensure that audits would proceed in an expeditious fashion and put an end to situations in which taxpayers were faced with multi-year delays by SARS in acting upon information submitted by them in response to audit queries.
Section 80J has been successful in discouraging auditors from applying the new GAAR without due consideration. Indeed, it may well have been successful and may well be a factor in the Commissioner’s reluctance to invoke the new GAAR and to rely perhaps too heavily instead upon the substance over form doctrine following the NWK judgement, notwithstanding the subsequent judgements in Roshcon and Bosch that reaffirmed the limits of that doctrine.
Section 80J has been a dismal failure, however, in providing an “early warning” to taxpayers and giving them the opportunity to pre-empt inappropriate applications of the new GAAR before the audits have gone too far. Instead, SARS has generally waited until an audit has been virtually completed before issuing an 80J Notice, forcing both itself and taxpayers to incur the full time and expense involved in such disputes in virtually all cases, even where giving the taxpayer an earlier opportunity to explain an arrangement and its purpose might have enabled everyone to avoid that ordeal. In addition, this misapplication of section 80J was almost certainly a factor behind the amendments to section 99 of the Tax Administration Act, which extended the prescription period in cases under the new GAAR. Given the tendency of work according to the time available to complete a specific task, one can only expect this change to exacerbate the problem.
As can be seen, at least some progress has been made since the new GAAR was enacted in 2006. Unfortunately, as Part II of this article will show, the bad far outweighs the good.
 SARS Discussion Paper on Tax Avoidance and Section 103 of the Income Tax Act at pp 43 – 44 (November 2005) (“Discussion Paper on Tax Avoidance”); Tax Avoidance and Section 103 of the Income Tax Act at pp 20 - 22 (September 2006) (“Revised Proposals”).
 Revised Proposals” ante note 2 at 15 -19.
 Discussion Paper on Tax Avoidance ante note 2 at pp 41 – 42 (November 2005); Revised Proposals ante note 2 at pp 6 -13.
 Haroon Bhorat, Is South Africa the most unequal society in the world?, Mail & Guardian (30 September 2015). (Available online at http://mg.co.za/article/2015-09-30-is-south-africa-the-most-unequal-society-in-the-world.)
 For a general discussion of this issue in the United States and its impact on American society and politics, see Thomas B. Edsall, How Falling Behind the Joneses Fuels the Rise of Trump, New York Times (7 July 2007). (Available online at http://www.nytimes.com/2016/07/07/opinion/campaign-stops/how-falling-behind-the-joneses-fueled-the-rise-of-trump.html?ref=opinion.)
 Thomas Piketty and Nancy Quan, Income Inequality and Progressive Income Taxation in China and India, 1986 – 2015, American Economic Journal: Applied Economics, 2009, 1:2, p 53 (“Progressive income taxation is one of the least distortionary policy tools available that controls the rise in inequality by redistributing the gains from growth”). (Available online at http://piketty.pse.ens.fr/fichiers/public/PikettyQian2009_AEJPP.pdf.) Other options include progressive taxes on consumption, an approach advocated by no less a capitalist and successful entrepreneur than Bill Gates. Bill Gate, Why Inequality Matters, gatesnotes, 13 October 2014)(Available online at https://www.gatesnotes.com/Books/Why-Inequality-Matters-Capital-in-21st-Century-Review), and progressive taxes on capital, a much more controversial option.
 C:SARS v Bosch and Another  ZASCA 171 (19 Nov 2014).
 Roshcon (Pty) Ltd v Anchor Auto Body Builders CC and Others  2 All SA 654 (SCA); Commissioner for the South African Revenue Service v NWK Ltd, 2011 (2) SA 67 (SCA).
 Recognition of these issues by the courts has even extended to litigation involving non-tax matters. See, eg Cape Empowerment Trust Ltd v Fisher Hoffman Sithole  ZASCA 16 (20 March 2013).
 Section 80J(1).
 Section 80J(3)(a) – (c).
 Revised Proposals ante note 2, at p 19.
 Roshcon ante note 8.
 Bosch ante note 9.
 A cautious approach by SARS in the first cases under the new GAAR can be forgiven insofar as it may have reflected concerns
 Section 99(4) of the Tax Administration Act, No 28 of 2011, as amended by section 51(c) of the Tax Administration Amendment Act, No 23 of 2015
 Ironically, SARS’s misapplication of section 80J deprives it of the opportunity to ‘flush out’ at taxpayer’s position early on and to focus its energies on the issues in dispute.
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This article first appeared on the September/October 2016 edition on Tax Talk.