Capital Gains Tax and Double Taxation Agreement (Tax Court Case ITC 1848)
26 August 2011
Posted by: SAIT Technical
Capital Gains Tax and Double Taxation Agreement
In a recent judgment of the Cape Town Tax Court (ITC 1848, to be reported in the South African Tax Cases Reports Vol 73 Part 4) the issue to be considered by the court was whether the taxable capital gain which arose on the deemed disposal of the taxpayer’s assets triggered the provisions of Article 13(4) of the Double Taxation Agreement between South Africa and the government of the Grand Duchy of Luxembourg and it was held that Article 13(4) was of application in this instance and the Commissioner’s additional assessment, based on a taxable gain arising from a deemed disposal by the taxpayer of an asset in the relevant year of assessment was to be set aside.
The facts were that the taxpayer was an investment holding company incorporated in South Africa which had been listed on the Johannesburg Stock Exchange. The taxpayer’s only relevant asset was its 100% shareholding in TDO Hld Ltd which, in turn, owned 100% of the shares in TDO Ltd, a company incorporated in Guernsey, which owned approximately 65% of the issued share capital in the UK based company, ABC plc. On 2 July 2002, at a meeting of the taxpayer’s board of directors in Luxembourg, it was resolved that all further board meetings would be held in that country and this had the effect that, as from 2 July 2002, the taxpayer had become effectively managed in Luxembourg and liable for tax in that country.
The taxpayer, after that date, had maintained a presence in South Africa in the person of one of its executive directors, Mr M, who continued to perform certain functions on its behalf from its registered office in Industria until 29 January 2003 when he left South Africa in order to relocate to Europe.
Notwithstanding the relocation of the seat of the taxpayer’s effective management to Luxembourg with effect from 2 July 2002, it had remained a ‘resident’ of the Republic for purposes of the Income Tax Act 58 of 1962 by reason of para (b) of the definition relating to any ‘person (other than a natural person) which is incorporated, established or formed in the Republic’ and this status changed with effect from 26 February 2003 when the following was added to the definition: ‘but does not include any person who is deemed exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.’
It was therefore common cause that by 2 July 2002 the taxpayer had become effectively managed in Luxembourg, that by 29 January 2003 any permanent establishment which it might have had in the Republic up to that date had ceased to exist and that by 26 February 2003 it had ceased to be a resident of the Republic. The respondent, being the Commissioner for SARS, contended that when the taxpayer ceased to be a resident of the Republic, it was deemed to have disposed of all its assets (in this instance its shareholding in TDO Hld Ltd) resulting in a capital gain being realised in the 2003 year of assessment and in support of these contentions the Commissioner invoked the provisions of paras 12(1) and 12(2)(a) of the Eighth Schedule to the Income Tax Act.
The taxpayer contended, inter alia, that even if there had been a deemed disposal of the asset by it during the 2003 year of assessment as contended for by the Commissioner, the capital gain that resulted from such disposal was not taxable in South Africa but only in Luxembourg in terms of the provisions of the DTA entered into between South Africa and the Government of the Grand Duchy of Luxembourg and gazetted by proclamation on 6 December 2000. Article 13(4) of the DTA, dealing with capital gains, provided that ‘gains from the alienation of any property . . . shall be taxable only in the Contracting State of which the alienator is a resident’ and the relocation of its place of effective management caused the taxpayer to become a resident of Luxembourg in terms of Article 4(1)(a) of the DTA.
The Commissioner’s answer to the taxpayer’s aforementioned contention was that Article 13(4) of the DTA referred to ‘the alienation of any property’ and not to a deemed disposal of property as contemplated by para 12(2)(a) of the Eighth Schedule to the Act and hence the taxable capital gain which arose on the deemed disposal of the taxpayer’s assets did not trigger the provisions of Article 13(4) of the DTA. Griesel J, who delivered the judgment of the court, stated that the issue before the court was whether a capital gain that had resulted from a deemed disposal of an asset by the taxpayer during the 2003 year of assessment had been taxable in South Africa or in Luxembourg and, in this regard, reference was made to the provisions of the agreement for the avoidance of double taxation (‘the DTA’) entered into between South Africa and Luxembourg and the issue between the parties centred mainly on Article 13, which was concerned with ‘capital gains.’
In terms of Article 13(4) the relevant gain was taxable only in the Contracting State of which the taxpayer was a ‘resident’ as contemplated by the DTA and the relocation of its place of effective management caused it to become a resident of Luxembourg in terms of Article 4(1)(a) of the DTA. Article 4(3) of the DTA in turn provided that where a company is resident in both Contracting States it was deemed to be a resident in the State where its place of effective management was situated and on the facts of this case it was common cause that the taxpayer’s place of effective management since 2 July 2002 had been in Luxembourg. Accordingly, in terms of the DTA, the taxpayer was treated as not being a resident of South Africa. Moreover, para 12 of the Eighth Schedule to the Act provided, inter alia, that ‘a person will be treated for the purposes of this Schedule as having disposed of an asset ....’ when that person ceases to be a resident. Although Article 13(4) of the DTA referred to ‘the alienation of any property’ and not to a deemed disposal of property as contemplated by para 12(2)(a) of the Eighth Schedule, the taxable capital gain which arose on the deemed disposal of the taxpayer’s assets did trigger the provisions of Article 13(4) of the DTA.
The court was of the view that there was no reason why a deemed disposal of property should not be treated as an alienation of property for purposes of Article 13(4) of the DTA and it would be absurd if a taxpayer were to be protected in terms of Article 13(4) from liability for tax resulting from a gain from an actual alienation of property, but not from a deemed alienation of property.
The contention on behalf of the Commissioner that this would mean that the deemed disposal provisions of para 12 of the Eighth Schedule would never apply if a party were to migrate to a country which is party to a DTA was countered by the fact that the same might be said in respect of an actual disposal of an asset which fell within Article 13(4), but this was not a reason for concluding that the Article would not apply in that instance. In the result the appeal was upheld and the Commissioner’s additional assessment in respect of the 2003 year of assessment was set aside.