The application of general anti-avoidance provisions
09 May 2012
Posted by: SAIT Technical
By Andrew Seaber (DLA Cliffe Decker Hofmeyr Tax Alert 26 April 2012)
In a recent decision of the Supreme Court of Ireland in the case of O’Flynn Construction Limited v the Revenue Commissioners (case no 264/06), the court was called on to decide, for the purposes of the general anti-avoidance rule, whether a particular tax avoidance scheme resulted in the misuse or abuse of a tax relief provision.
In 1958, the legislature in the United Kingdom sought to encourage the manufacture of products for export by introducing an Export Sales Relief Scheme (ESR Scheme). In terms of the ESR Scheme, profits earned from qualifying exports would be exempt from corporation tax and, furthermore, dividends declared from such profits would also be relieved from income tax in the hands of all shareholders until ultimately the dividend is received into the hands of an individual.
Simplified, the facts were that a certain company that had an Export Sales Relief (ESR) reserve apparently did not have the cash with which to pay a dividend that might be declared in respect of such reserve. A scheme was thus devised by the taxpayers which in essence involved various loans to enable ESR tax free dividends to be declared up the group structure but ultimately into the hands of various shareholders who were not shareholders in the ESR earning company or a related company at the time when the ESR profits were earned.
The issue before the court was whether, applying the general anti-avoidance rule, the scheme resulted directly or indirectly in the misuse or abuse of the ESR provision having regard to the purpose for which it was provided.
In a split decision, the majority of the judges having regard to both its substance and its form stated that the transaction was highly artificial and contrived. According to the judges, the scheme allowed the shareholders in a non-exporting company to benefit from ESR on the profits of the non-exporting company and as such was surely a misuse or abuse of the ESR scheme having regard to the purpose for which provision is provided.
The minority, in arguably a more lucid judgment, said that legislative policy must be anchored in the language used by the legislature and that recourse should, where appropriate, be had to its context as disclosed by the statute (or provision) as a whole. The minority commented that since its promulgation, the ESR provision was amended numerous times over a lengthy period but no attempt was made to restrict or otherwise curtail the benefit of the exemption, as dividends percolated through into the hands of the ultimate recipient. The minority were thus of the view that the scheme did not result in a misuse or abuse of the ESR provision, even though the dividends flowed ultimately to shareholders who were not shareholders of the exporting company at the time the profit was derived.
It should be appreciated that the general anti-avoidance rule contained in section 80A of the Income Tax Act, No 58 of 1962 (Act) also contains a ‘misuse or abuse’ provision. However, unlike its United Kingdom counterpart, it does not expressly provide for regard to be had to the purpose for which the provision of the Act (alleged to have been misused or abused) was provided. In other words, there is no express statutory obligation to have regard to the purpose for which a particular provision of the Act was enacted when determining whether a scheme results in a misuse or abuse of such provision.
Nevertheless, SARS, in its Draft Comprehensive Guide to the General Anti-avoidance Rule, states that the misuse or abuse provision "clearly requires a purposive approach to interpreting the provisions of the Act, which is already the accepted approach to legislative interpretation in South Africa." In this regard, SARS states that a mere literal interpretation of the provisions will no longer safeguard a taxpayer who applies the provisions of the Act in a context or manner which is not intended by the Act.
But, in reiterating the sentiments of the minority judges in the O’Flynn case, establishing the purpose of a particular provision will generally not be an easy task. In doing so, the following words of the minority judges will serve as a reminder to judges of the limits of their judicial authority:
"Any suggestion that the courts could, having identified the legislative policy by whatever means, apply that policy to influence, modify or alter the wording of a taxation provision, would be tantamount to judicial intrusion into this key legislative sphere, and would be an usurpation of such legislative power. Neither the formation of taxation policy nor the creation of a taxation charge are matters for the judiciary. Such would be quite an inappropriate exercise of judicial function."
As yet, there is no South African case law that deals with the misuse or abuse provision in s80A of the Act. It is considered that the proper implementation thereof will cause many a sleepless night for SARS officials, advisors and to a greater extent the members of the judiciary charged with giving effect thereto.