Unstructured CPD 150mins TAX CHRONICLES...Unstructured CPD 150mins Issue 5 | 2018 December THE POWER OF SARS TO ISSUE REDUCED ASSESSMENTS CONTENTS 05 03 01 08 10 WELCOME TO TAX CHRONICLES

TAX CHRONICLES MONTHLY

CLOGGED-LOSS RULESTREASURY CLARIFIES

TAX TREATMENTOF FOREIGN TRUSTS

EXCHANGE CONTROL AMENDMENTS TO NOTE

Official Journal for the South African Tax Professional

Unstructured CPD 150mins

Issue 5 | 2018December

THE POWER OF SARS TO ISSUE REDUCED ASSESSMENTS

CONTENTS

05

03

01

08 10

WELCOME TO TAX CHRONICLES MONTHLY!

As the year draws close, we see Tax Chronicles Monthly now settling in with other publications available to tax professionals. Since its inception, the magazine is standing side by side with other tax reads, offering up-to-date and relevant tax information. The various past editions have addressed topics which are of great value to tax professionals at large.

In this issue, read about the taxation of foreign trusts, funding of loans to foreign trusts, the draft TLAB on cryptocurrencies, SARS’ powers to issue reduced assessments, and many other interesting topics to enjoy.

We trust you will find this edition insightful!

Editorial panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan, Prof KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC Foster

Tax Chronicles Monthly is published as a service to members of the tax community and includes items selected from the newsletters of firms in public practice and commerce and industry, as well as other contributors. The information contained herein is for general guidance only and should not be used as a basis for action without further research or specialist advice. The views of the authors are not necessarily the views of the editorial panel, the South African Institute of Professional Accountants or the South African Institute of Tax Professionals.

15

CAPITAL GAINS TAX1 0053. Clogged-loss rules:

Treasury clarifies

CRYPTOCURRENCIES3 0054. Draft tax legislation

ESTATES AND TRUSTS5 0055. Taxation of foreign trusts

8 0056. Loan funding to offshore trusts

EXCHANGE CONTROL10 0057. Amendments to Currency

and Exchanges Manual

TAX ADMINISTRATION12 0058. The power of SARS to

issue reduced assessments

TRANSFER PRICING15 0059. South Africa’s first case:

court considers section 31(7)

1 TAX CHRONICLES MONTHLY ISSUE 5 2018

A ccording to the Explanatory Memorandum on the draft TLAB, the proposed amendment seeks to clarify that capital losses between connected persons will be ring-fenced, where a person redeems its interest in the other person (such as a company) and the two

persons are connected persons in relation to each other.

THE CLOGGED-LOSS RULEParagraph 39 is a capital gains tax (CGT) anti-avoidance provision which requires a capital loss to be treated as a “clogged loss” where

a person disposes of an asset to a connected person and incurs a capital loss. The clogged-loss rule comes into play when determining the disposer’s aggregate capital gain or aggregate capital loss and requires that the loss be entirely disregarded. In this way, the capital loss is ring-fenced and may be set off only against capital gains arising from disposals to the same connected person.

RESTRICTIONS IN THE RULESThe clogged-loss rule restricts the deduction of capital losses if the asset in question is disposed of to a person who was a connected

CAPITAL GAINS TAX

CLOGGED-LOSS RULES: TREASURY CLARIFIES

Amendments to paragraph 39 of the Eighth Schedule to the Income Tax Act, 1962 (the Act) have been proposed in National Treasury’s draft Taxation Laws Amendment Bill (the draft TLAB), as published in July 2018 for public comment.


person in relation to the disposer of the asset immediately prior to the disposal, or if the asset is disposed of to a person which, immediately after the disposal of the asset, is a member of the same “group of companies” as the disposer or is a trust with a company beneficiary that is a member of the same group of companies as the disposer.

The ring-fencing restrictions are extended so that the capital losses, in addition to only being permissibly deducted from capital gains arising from disposals of assets to the same connected person, may only be deducted from the arising capital gains during the same or a subsequent year of assessment.

The timing of the disposal is governed by a further restriction, in that the disregarded capital loss may be deducted only if the other person to whom the subsequent disposals are made is still a connected person in relation to the disposer at the time when the disposer makes the disposals.

THE RELEVANCE OF RING-FENCINGThe provisions of paragraph 39 become relevant where, for example, a shareholder disposes of an asset to their company, which is a connected person, and incurs a capital loss. In this situation, the capital loss may not be brought into account when determining the shareholder’s aggregate capital gains or losses for the year of assessment in which the transaction took place. Instead, the disregarded capital loss may only be deducted against capital gains made from the shareholder’s disposal to their company during the same or subsequent years of assessments, provided that the company is still a connected person to the shareholder at the time of any subsequent disposals.

CONFUSION IN THE CLOGGINGParagraph 39 is only applicable where an asset has been “disposed” of “to” a person. Taxpayers have often been confused by this aspect of paragraph 39, as many situations give rise to an asset having been disposed of “to” no one in particular. The 7th issue of SARS’ Comprehensive Guide to Capital Gains Tax demonstrates that “disposing to” no one is a common scenario which occurs, for example, in the scrapping or extinction of an asset or when an asset is deemed to be disposed of and the deeming provision does not specify an acquirer.

The difficulty that arises where there is no transfer to a connected person of an asset or of the rights encapsulated by the asset was brought to the tax court’s consideration in the 2012 Income Tax

Case No. 1859 (IT 1859). The court in this instance had to consider the applicability of paragraph 39 where Company A purchased redeemable preference shares in Company B (within the same group of companies from various third-party banks), shortly following which Company B redeemed the shares and Company A incurred a resultant capital loss on the redemption. The court needed to determine whether the redemption of shares constituted a “disposal to”. The court identified the difficulty herein as, while the wording of paragraph 39 clearly covers transactions such as sales or the transfer of assets and shares from the disposer to a connected person, the legislation is not clear where there is no transfer of the asset.

ACCORDING TO THE COURTS – MEANING OF DISPOSALIT 1859 was a landmark case for the interpretation of “disposal” in terms of paragraph 39. As part of its considerations, the court relied on the “canons of construction” to conclude that the use of the preposition “to” in paragraph 39(1) cannot be ignored. It was therefore held that, while the redemption of shares constituted a “disposal” as defined in paragraph 11 of the Eighth Schedule, the redemption was not a “disposal to any other person” as envisaged in paragraph 39. The court reasoned that the redemption of shares results in the extinction and not the transfer of the rights embodied in the shares to the redeeming company.

A precedent has since been set that the redemption of shares is not subject to paragraph 39 because the shares contemplated herein have not been disposed of as set out in the provisions. The court demonstrated that a literal interpretation of the legislation must be used, and relied on the meaning of the word “to” in the Concise Oxford Dictionary to decide that “the disposal of the asset must thus be ‘in the direction of ’, or ‘so as to reach’ the connected person”.

MEANING UNCLOGGEDThe draft TLAB has directly addressed the effect of the IT 1859 decision by specifically setting out that, for the purposes of disregarding capital losses in terms of paragraph 39, where a company redeems its shares, the holder of those shares must be treated as having disposed of them to that company. As such, though the literal interpretation of paragraph 39 will still have to be managed due to the impact of IT 1859, the draft TLAB has clarified the position in respect of the redemption of shares, to the benefit of SARS. ■

“The ring-fencing restrictions are extended so that the capital losses, in addition to only being permissibly deducted from capital gains arising from disposals of assets to the same connected person, may only be deducted from the arising capital gains during the same or a subsequent year of assessment.”

Cliffe Dekker Hofmeyr

Editorial Comment: Draft documents should always be treated with care as there is no certainty that the final version will be identical to the publicly issued draft.Act sections: Income Tax Act 58 of 1962: paragraphs 11 (“disposal”), 39 of the Eighth Schedule.Cases: Income Tax Case No. 1859 [2012] 74 SATC 213.Documents: SARS’ Comprehensive Guide to Capital Gains Tax, October 2018.Tags: Ring-fenced losses.

CAPITAL GAINS TAX


CRYPTOCURRENCIES

DRAFT TAX LEGISLATIONOn 16 July 2018, National Treasury’s draft Taxation Laws Amendment Bill (the draft TLAB) was published for public comment. The draft TLAB has encapsulated a first for South African taxpayers by introducing legislative provisions for cryptocurrency in the proposed amendments.

TAXATION PRIOR TO THE DRAFT TLABSARS announced on 6 April 2018 that normal tax rules would apply to cryptocurrency in South Africa. Despite the continued popularity of cryptocurrency trade, South African legislation had, until the 2018 draft TLAB, been silent on the taxation and regulation of cryptocurrency.

In their operations within the cryptocurrency sphere, taxpayers have thus far simply been required to declare any cryptocurrency gains or losses as part of their taxable income. Moreover, in accordance with SARS’ April announcement, in order to determine whether cryptocurrency and cryptocurrency transactions are of a

capital or revenue nature, the taxpayer’s intention when acquiring the cryptocurrency would be considered. For example, if the taxpayer obtained cryptocurrency so as to pursue profit-making, the cryptocurrency would be considered trading stock and any transactions would be of a revenue nature. This test is applied to the facts and circumstances of each individual case.

PROVISIONS IN THE DRAFT TLABThough the draft TLAB has included cryptocurrency in three separate sections and with effect in both the Value-Added Tax Act, 1991 and in the Income Tax Act, 1962 (the Act), this article will focus solely on the impact of the proposed amendments in the Act.


The definition of “financial instrument” in section 1 of the Act may be amended to include “any cryptocurrency”, while section 20A may be amended to include “the acquisition or disposal of any cryptocurrency” under the contemplated trades within the ring-fencing provisions thereof.

DEFINITION OF “FINANCIAL INSTRUMENT”Per the proposed amendments, cryptocurrency will be found alongside, for example, loans, debentures, financial arrangements determined with reference to the time value of money, bonds, option contracts and interest-bearing arrangements in the definition of “financial instrument” in section 1.

One of the contexts in which the inclusion of cryptocurrency in the definition of “financial instrument” in the Act is relevant is the trading stock provisions in section 22. This section sets out the amount to be taken into account in respect of the value of trading stock in relation to the determination of taxable income. Financial instruments are excluded from trading stock for the purposes of section 22(1)(a).

Furthermore, there may be capital gains tax implications for including cryptocurrency in the definition of “financial instrument”. One example of where its impact may be felt is in the context of paragraph 42 of the Eighth Schedule to the Act, which provides for the taxation of short-term disposals and acquisitions of identical financial instruments. This paragraph applies where a person makes a capital loss on the disposal of financial instruments and that person or any of its connected persons has acquired or acquires a financial instrument that is of the same or equivalent quality within a 91-day period (beginning 45 days before the date of disposal and ending 45 days after that date). In these instances, according to paragraph 42, the capital loss cannot be taken into account at the time of disposal and must instead be carried forward and added to the base cost of the replacement instrument.

According to the Comprehensive Guide to Capital Gains Tax, paragraph 42 essentially encompasses an anti-avoidance rule which governs instances that are informally referred to as “wash sales”, where financial instruments are disposed of towards the end of a year of assessment, in order to realise losses. Considering the nature of cryptocurrency trade, it is conceivable that short-term disposals and acquisitions are common, and that paragraph 42 will therefore seek to ensure that traders who hold cryptocurrency as capital in these circumstances will be treated as having disposed of the asset for proceeds equal to base cost, with the capital loss being “held over”. The exclusions in paragraph 42(3) and (4) will still apply.

RING-FENCING PROVISIONSThe acquisition or disposal of any cryptocurrency is now, due to the proposed amendments, contemplated as a specified trade in section 20A, should the amendment come into effect. As such, section 20A becomes relevant to cryptocurrency traders, as the section ring-fences assessed losses associated with the acquisition or disposal of any cryptocurrency. This section applies to natural persons only and effectively prevents the taxpayer from setting off assessed losses incurred from the kinds of trades contemplated in the section against the income derived from carrying on other trades. In other words, assessed losses derived from a trade listed in section 20A may only be set off against income derived from that trade in future years of assessment.

Colloquially, section 20A has been said to ring-fence the setting-off of assessed losses associated with “suspect trades”. The Act lists among such contemplated trades at section 20A(2)(b), for example, dealing in collectibles, the rental of residential accommodation to connected persons, any form of gambling or betting and the practising of sports. In this way, section 20A differentiates between losses resulting from the actual trading activities of a taxpayer and the losses resulting from what could be perceived as the taxpayer’s hobbies or lifestyle activities.

As a result of this proposed amendment, taxpayers who trade in cryptocurrency may face potential restrictions in netting off their assessed losses incurred in trading cryptocurrency against their taxable income. The inclusion of “acquisition or disposal of any cryptocurrency” certainly limits the taxpayer who does not hold cryptocurrency as a capital asset. However, cryptocurrency traders are not prevented from setting off losses from their cryptocurrency trade specifically against the income from their cryptocurrency trade.

NATIONAL TREASURY’S STANCEIn a volatile market such as cryptocurrency trading, losses are to be expected. The proposed amendment to section 20A appears to be an attempt to limit the effect of these losses on SARS’ revenue collection prospects. This is further evident in the proposed effective inclusion of cryptocurrency in the anti-avoidance provisions of paragraph 42.

The draft TLAB has given an indication of National Treasury’s approach in respect of the tax treatment of cryptocurrencies, with the proposed amendments displaying an identifiable impact on cryptocurrency traders at the outset. While taxpayers may welcome the further clarifications in the ever-expanding cryptocurrency environment, SARS and National Treasury have invited written public comment in respect of the suggested amendments and are engaging in a full consultation process. ■

“The ring-fencing restrictions are extended so that the capital losses, in addition to only being permissibly deducted from capital gains arising from disposals of assets to the same connected person, may only be deducted from the arising capital gains during the same or a subsequent year of assessment.”

CRYPTOCURRENCIES


Editorial Comment: Draft documents should always be treated with care as there is no certainty that the final version will be identical to the publicly issued draft.Act sections: Income Tax Act 58 of 1962: sections 1 (“financial instrument”), 20A, 22; paragraph 42 of the Eighth Schedule; Value-Added Tax Act 89 of 1991.Tags: Cryptocurrencies.


ESTATES AND TRUSTS

TAXATION OF FOREIGN TRUSTSThe draft Taxation Laws Amendment Bill (the draft TLAB), which was published on 16 July 2018, introduces many of the tax proposals announced in the 2018 Budget Review.

C onsistent with the general trend of combatting perceived areas of tax avoidance, among the changes contained in the draft TLAB are proposed amendments to the provisions in the Income Tax Act, 1962 (the Act) dealing with foreign trusts that

hold the majority of the shares in an underlying foreign company. The Explanatory Memorandum on the draft TLAB states that the proposed amendments are intended to close the loophole in the current legislation regarding the use of trusts to defer tax or recharacterise the nature of income.

The current position is that the controlled foreign company (CFC) rules in the Act do not apply to foreign companies that are held by interposed foreign trusts or other foreign foundations that have South African resident beneficiaries.

In 2017, the CFC rules were extended to South African resident companies having an indirect interest in a foreign company through a foreign trust or foreign foundation whose financial results form part of the consolidated financial statements of a group of which the parent company is a South African resident.


ESTATES AND TRUSTS

The proposed amendments will expand the ambit of the donor attribution rules for South African resident donors of a foreign trust and the taxation of capital distributions from a foreign trust in the hands of the South African resident beneficiaries.

DONOR ATTRIBUTION RULES

The proposed amendments apply to section 7(8) and paragraph 72 of the Eighth Schedule to the Act and are summarised below.

Section 7(8) may attribute the income of a foreign trust to a South African resident who has made a donation, settlement or other disposition (including a loan that incurs interest at less than a market-related rate) to a foreign trust. The resident donor is currently subject to tax on the accruals of the trust which would have constituted income (as defined) had the trust been a resident and which are attributable to that donation/disposition. However, where the income of the foreign trust comprises foreign dividends from a foreign company and at least 10% of the equity shares and voting rights are held by that trust, such foreign dividends may not have constituted income (as defined) had the trust been a resident because of the participation exemption in section 10B(2)(a) of the Act.

Section 10B(2)(a) exempts foreign dividends received by or accrued to a person that holds at least 10% of the total equity shares and voting rights in the foreign company declaring the foreign dividend. As a result, such foreign dividends accruing to the foreign trust would not be attributed to the resident donor in terms of section 7(8).

The amendment to section 7(8) proposes that the participation exemption must be disregarded in determining the amount that would have constituted income had the trust been a resident, where the foreign trust, or any one or more connected persons in relation to the trust, holds more than 50% of the total participation rights or voting rights in the foreign company, and the South African resident donor (or any relative of the donor or any trust of which the donor or relative is a beneficiary) is a connected person in relation to the foreign trust (eg a beneficiary or a relative of a beneficiary). It is proposed that this amendment will come into operation on 1 March 2019 and will apply to amounts received or accrued on or after that date.

However, it is not clear from the wording of the proposed amendment whether the South African resident donor would still benefit from the partial tax exemption that applies to all foreign dividends in terms of section 10B(3) or whether the full amount of the foreign dividend would be included in the income of the resident donor in these circumstances. It seems that the partial exemption should apply in these circumstances.

Paragraph 72 is similar to section 7(8) and provides for the attribution of a capital gain arising in a foreign trust (including an amount which

would have constituted a capital gain had the trust been a resident) to a South African resident who has made a donation, settlement or other disposition to that foreign trust. However, where a gain arises from the disposal by a foreign trust to a third party of shares held in a foreign company and the requirements of the participation exemption in paragraph 64B of the Eighth Schedule are met, the gain would not have constituted a capital gain had the trust been a resident.

Paragraph 64B provides a capital gains tax exemption for any capital gains or losses that arise from the disposal of equity shares in foreign companies subject to certain requirements being met, including that the person held an interest of at least 10% of the equity shares and voting rights in that foreign company and that the interest in the foreign company was disposed of to a non-resident (other than a connected person). If the paragraph 64B exemption applied to the trust had it been a resident, such gain would not be attributed to the resident donor in terms of paragraph 72.

The proposed amendment to paragraph 72 is that the participation exemption in paragraph 64B must be disregarded in determining the amount which would have constituted a capital gain had the trust been a resident. Disregarding the participation exemption would mean that, even if a gain from the disposal of equity shares in a foreign company would have been exempt in terms of the participation exemption if the trust had been a resident, that gain would still be attributed to and taxed in the hands of the resident donor. It is proposed that this amendment will come into operation on 1 March 2019 and will apply to amounts vesting on or after that date.

CAPITAL DISTRIBUTIONS TO SOUTH AFRICAN RESIDENT BENEFICIARIES

In terms of section 25B(2A), capital distributions to a South African resident beneficiary of a foreign trust which arose from prior year’s receipts and accruals of the trust which would have constituted income (as defined) if the trust had been a resident may be taxable in the hands of the resident beneficiary.

The current position is that capital of a foreign trust arising from a prior year’s foreign dividends derived from the foreign company, the shares in which are held by that trust, would have been exempt from tax if the trust had been a resident in terms of the participation exemption in section 10B(2)(a). Therefore, a capital distribution to a South African resident beneficiary of capital arising from such foreign dividends would not be taxable in South Africa in the hands of the beneficiary, on the basis that no amount of income (as defined) would have arisen for the trust had it been a resident.

The proposed amendment to section 25B(2A) is that the participation exemption in section 10B(2)(a) must be disregarded in determining the amount received or accrued to the foreign trust consisting of a foreign dividend if more than 50% of the total participation rights or voting rights in the foreign company are held/exercisable by the trust or by any one or more connected persons in relation to the trust. Accordingly, capital distributions by a trust which are derived from such foreign dividends would be taxable in the hands of the South African resident beneficiary. It is proposed that this amendment to section 25B(2A) will come into operation on 1 March 2019 and will apply in respect of any year of assessment commencing on or after that date.

However, as is the case with the proposed amendment to section 7(8), it is not clear whether the South African resident beneficiary would still benefit from the partial tax exemption which applies to all

“The proposed amendments will expand the ambit of the donor attribution rules for South African resident donors of a foreign trust and the taxation of capital distributions from a foreign trust in the hands of the South African resident beneficiaries.”


ESTATES AND TRUSTS

foreign dividends in terms of section 10B(3) or whether the capital distribution would be taxed in full in these circumstances. It seems that the partial exemption should apply in these circumstances.

Capital gains are dealt with in paragraph 80 of the Eighth Schedule and the proposed amendments to paragraph 80 will significantly expand its scope to include foreign trusts.

Paragraph 80(1) provides that if a trust vests an asset in a resident beneficiary, the beneficiary would be subject to capital gains tax in respect of this capital gain. Paragraph 80(2) provides that if a trust disposes of an asset and vests the resultant capital gain in a resident beneficiary in the same tax year, the beneficiary would be subject to capital gains tax in respect of the capital gain. It seems that these provisions do not currently apply to foreign trusts unless they hold assets that are subject to South African capital gains tax (eg South African immovable property). However, the proposed amendments will extend the ambit of these provisions to include gains made by foreign trusts that would have constituted capital gains if the foreign trust had been a resident.

Paragraph 80(3) provides that if a foreign trust vests an amount of capital arising from a prior year’s capital gain (or what would have been a capital gain if the foreign trust had been a resident) in a South African resident beneficiary, the beneficiary would be subject to capital gains tax on this capital distribution. Similar to the amendment proposed to paragraph 72, it is proposed that the participation exemption in paragraph 64B must be disregarded in determining the amount which would have constituted a capital gain had the trust been a resident.

It is proposed that these changes to paragraph 80 will come into effect on 1 March 2019 and will apply in respect of disposals on or after that date.

CONCLUSION

The due date for comments from the public was 16 August 2018. However, given the potentially adverse tax effects for South African resident individuals with interests in foreign trusts, the impact of the proposed changes should be carefully considered before the expected effective date of 1 March 2019. ■

ENSafrica

Editorial Comment: Draft documents should always be treated with care as there is no certainty that the final version will be identical to the publicly issued draft.Act sections: Act sections: Income Tax Act 58 of 1962: sections 7(8), 10B, 25B(2A); paragraphs 64B, 72, 80 of the Eighth Schedule.Cases: Foreign trusts.Tags: Binding Private Ruling 291 (2018).

“Similar to the amendment proposed to paragraph 72, it is proposed that the participation exemption in paragraph 64B must be disregarded in determining the amount which would have constituted a capital gain had the trust been a resident.”


LOAN FUNDING TO OFFSHORE TRUSTSSouth African tax resident individuals may consider, whether for estate planning purposes or otherwise, to advance funds to offshore trusts for investment abroad. The South African tax implications arising from the terms of the loan funding arrangement with the offshore trust should, however, also be taken into account. Certain tax anti-avoidance measures are aimed at curbing the transfer of wealth to offshore trusts on loan account where such loans bear interest at below market-related rates.

T he aforesaid measures include the donor attribution rules in section 7, read with paragraph 72 of the Eighth Schedule to the Income Tax Act, 1962 (the Act), and the transfer pricing principles in section 31 of the Act in the case of an individual who is a connected person in

relation to the offshore trust (such as a beneficiary of such trust or a relative of such beneficiary). With effect from 1 March 2017, section 7C

of the Act deems interest to be charged on loans to offshore trusts by South African connected persons at the rate not lower than the official rate of interest (as defined).

The interaction between section 7C and the above-mentioned long-standing anti-avoidance measures is complex and has been the subject of much discussion in recent years.

ESTATES AND TRUSTS


MARKET-RELATED LOANSThe donor attribution rules and transfer pricing principles essentially require a South African tax resident individual to charge an arm’s-length (ie market-related) rate of interest on the provision of loan funding to an offshore trust. The individual should take into account certain factors in determining this market-related interest rate and retain sufficient record thereof. This could include, for example, the principal amount, duration and terms of the loan, the currency in which the loan is denominated and whether comparable loans exist between unrelated parties. If a market-related interest rate is charged, the individual should only be taxed on the actual foreign interest accrued at the applicable marginal rate of income tax (between 18% and 45%).

The “official rate of interest” contemplated in section 7C is, however, specifically defined in the context of a foreign currency denominated loan as “a rate of interest that is the equivalent of the South African repurchase rate applicable in that currency plus 100 basis points”. The market-related rate of interest as above could, therefore, differ from the official rate of interest for the relevant tax year. If the market-related rate is less than the official rate, the difference may be treated as a donation made to the offshore trust by the South African tax resident individual for donations tax purposes and be taxable at a flat rate of 20% (after taking into account the available R100 000 annual exemption). This risk may be mitigated through the terms of the loan funding arrangement between the South African tax resident individual and the offshore trust.

LOANS BELOW MARKET-RELATED INTEREST RATESIf the loan advanced by the South African tax resident individual to the offshore trust is interest-free or if interest is charged at below the market-related rate, the individual may be regarded as having made a donation, settlement or other (gratuitous) disposition to the offshore trust for purposes of the application of the donor attribution rules. In terms of these rules, the income and capital gains of the offshore trust may then be attributed to the South African tax resident individual. Such attribution should be limited to the market-related rate of interest that should have been charged on the loan.

The donor attribution rules and transfer pricing rules should not be applied in a manner which results in double taxation for the individual.

Where the requirements for the application of the transfer pricing rules are met and, inter alia, the individual is a connected person in relation to the offshore trust, a primary adjustment would be made to the individual’s taxable income consisting of the difference between any interest charged and a market-related rate. In addition, the primary adjustment would be seen as a deemed donation for donations tax purposes. It should be noted that section 7C does not apply in circumstances where the transfer pricing rules are applicable to an “affected transaction” (as defined).

CONCLUSIONSouth African tax resident individuals should carefully consider the application of the donor attribution rules, transfer pricing principles and the deeming provisions under section 7C to any loan funding arrangements with offshore trusts in light of their specific circumstances. It is also advisable for individuals to obtain advice if any legislative changes to these rules are promulgated in future. ■

“...Section 7C does not apply in circumstances where the transfer pricing rules are applicable to an “affected transaction”...”

ESTATES AND TRUSTS

ENSafrica

Act sections: Income Tax Act 58 of 1962: sections 7, 7C, 31; paragraph 72 of the Eighth Schedule.Tags: Offshore trusts.


AMENDMENTS TO CURRENCY AND EXCHANGES MANUALAs part of its review of South Africa’s exchange control rules, the Financial Surveillance Department of the South African Reserve Bank (FinSurv) from time to time issues exchange control circulars, notifying persons of changes to these rules.

O n 2 August 2018, FinSurv issued Exchange Control Circular No. 12/2018 (Circular 12/2018) and on 20 August 2018, it issued Exchange Control Circular No. 13/2018 (Circular 13/2018), setting out changes made

to the Currency and Exchanges Manual for Authorised Dealers (the Manual).

The Manual must be read in conjunction with the Exchange Control Regulations, 1961 (the Regulations). It sets out the permissions and conditions applicable to transactions in foreign exchange that may be undertaken by Authorised Dealers (ADs) and/or on behalf of their clients in terms of Regulation 2(2) of the Regulations.

AMENDMENTS IN CIRCULAR 12/2018

In section A.1 of the Manual, the definition of the phrase “foreign currency” has been amended. Whereas the definition previously included “Rand to or from a non-resident Rand account”, this no longer forms part of the definition and instead a new definition for the phrase “Non-resident Rand” has been inserted. “Non-resident Rand” has been defined to mean Rand to or from a non-resident account that may be deemed, in certain circumstances permissible elsewhere in the Manual, as an acceptable payment mechanism in lieu of foreign currency. The definition further states that “Non-resident Rand” cannot, in any manner, be defined as foreign currency and is purely Rand held in a non-resident account or Rand received from a non-resident source.

EXCHANGE CONTROL



Act sections: Financial Intelligence Centre Act 38 of 2001; Financial Advisory and Intermediary Services Act 37 of 2002; Regulations promulgated in terms of section 9 of the Currency and Exchanges Act no 9 of 1933.Documents: Currency and Exchanges Manual for Authorised Dealers.Tags: Exchange control.

Section A.4, dealing with guidelines and procedures in respect of treasury outsourcing companies and foreign exchange brokers has been amended. In terms of section A.4(B), such entities must still obtain FinSurv’s written approval before they can commence with foreign exchange business, but, pursuant to the amendment, applicant companies must now obtain and submit the treasury outsourcing company and foreign exchange broker application form that may be downloaded from the South African Reserve Bank’s (SARB) website. Prior to the amendment, the Manual simply stated that applications had to deal with certain aspects referred to in the Manual, for example the operating business model to be followed by the applicant.

The conditions for conducting the business of a treasury outsourcing company and foreign exchange broker, in section A.4(C)(i), have also been amended in three respects.

• Whereas section A.4(C)(i)(a) previously required the treasury outsourcing company or foreign exchange broker, its officers and shareholders to be suitably qualified and be deemed as “fit and proper”, the requirement is now that it must at all times be in possession of a valid Financial Service Provider licence issued by the Financial Sector Conduct Authority.

• Section A.4(C)(i)(b) previously stated the treasury outsourcing company or foreign exchange broker may not buy or sell foreign currency for its own account and may not hold foreign currency or borrow or lend foreign currency. This requirement now appears in section A.4(C)(i)(c). Section A.4(C)(i)(b) now requires that a letter of compliance, on the official letterhead of

the treasury outsourcing company or foreign exchange broker signed by two senior officials, must be submitted to FinSurv on an annual basis, for the period ending 31 December of each year. It must be sent by email to the address specified and the format of the letter of compliance can be downloaded from the SARB’s website.

• In terms of section A.4(C)(i)(l), FinSurv had the right at any stage to carry out an inspection of the treasury outsourcing company’s or foreign exchange broker’s activities, record-keeping, management controls and any other aspects deemed necessary. This requirement now appears in section A.4(C)(i)(m), and section A.4(C)(i)(l) now states that the requirements of the Financial Intelligence Centre Act, 2001 must be complied with by the AD and the treasury outsourcing company or foreign exchange broker concerned. In addition, the treasury outsourcing company or foreign exchange broker must comply with the requirements of the Financial Advisory and Intermediary Services Act, 2002.

Section B.2(K)(i), dealing with legacies and distributions from deceased estates and testamentary trusts, has been amended to clarify the non-resident persons to whom legacies and distributions can be remitted. Previously, section B.2(K)(i)(a) and (b) stated that amounts could be remitted abroad to non-residents, including emigrants, provided the other requirements of these sections were met. These sections have now been amended to state that amounts can be remitted abroad to “non-resident private individuals, non-resident entities and/or trusts with no direct and/or indirect South African interest, including emigrants”, provided the other requirements in the sections are complied with.

Finally, references to the “Financial Services Board” in section B.2 have been replaced with the “Financial Sector Conduct Authority”.

AMENDMENTS IN CIRCULAR 13/2018Two amendments have been made to section B.2(H)(v) of the Manual, dealing with the reporting requirements for South African institutional investors.

In terms of section B.2(H)(v)(a)(cc), all quarterly asset allocation reports had to be submitted within three months of the end of the calendar quarter to Finsurv, either through an AD or via bulk or single direct reporting. Pursuant to the amendment, the period to submit such quarterly reports has been reduced to two months after the end of the calendar quarter. The manner of submission remains the same.

In terms of section B.2(H)(v)(a)(ee), managing institutions that manage assets on behalf of other institutional investors were required to report the asset allocation of such funds or policies to the originating institution as at the end of each calendar quarter within one month of each calendar quarter-end. This section has been amended to state that the reporting of the aforementioned asset allocation must now take place within 15 days of each calendar quarter-end. ■

EXCHANGE CONTROL


TAX ADMINISTRATION

THE POWER OF SARS TO ISSUE REDUCED ASSESSMENTS

In terms of section 93 of the Tax Administration Act, 2011 (the TAA), there are five circumstances under which SARS may issue a reduced assessment so as to reduce a person’s tax liability. While section 93 makes it possible to reduce a tax liability in many ways, taxpayers should be mindful of the requirements that need to be met and the correct process to follow in order to achieve the desired result.

I n Rampersadh and Another v Commissioner for the South African Revenue Service and Others, 2018, the KwaZulu-Natal Division of the High Court had to consider the provisions of section 93. In this case, the applicant taxpayers (the Taxpayers)

lodged a review application requesting the High Court to review SARS’ decision not to issue reduced assessments in terms of section 93(1)(d).

This article will focus mainly on the High Court’s pronouncements regarding section 93 and other provisions of the TAA, but will also briefly discuss the High Court’s findings regarding the application of the Promotion of Administrative Justice Act, 2000 (PAJA) to the facts of the case.

FACTS

The Taxpayers are members of a close corporation, which was audited in respect of its 2011–2013 years of assessment. The Taxpayers had loan accounts in the close corporation and, pursuant

to these loan accounts, the audit was extended to the Taxpayers. The Taxpayers made representations to SARS and provided it with revised loan accounts. SARS issued revised assessments on 23 March 2015, to which the Taxpayers objected on 15 May 2015. Thereafter SARS requested further information arising from the loan accounts. The Taxpayers produced further revised loan accounts and this was followed by another objection on 20 July 2015. In all, the Taxpayers submitted three different versions of the loan accounts. After SARS disallowed some of the objections on 1 December 2015, the Taxpayers were told that they could appeal SARS’ decision within 30 business days.

The Taxpayers failed to appeal SARS’ decision timeously and, instead of lodging the appeal and requesting condonation for the late filing, submitted three requests under section 93(1)(d) that the revised assessments issued by SARS be reduced. The requests were dated 13 July 2016, 19 October 2016 and 17 January 2017. After SARS refused all three requests, the Taxpayers brought this review application


to review some of SARS’ decisions, in terms of PAJA. Prior to the hearing, the Taxpayers had amended the relief sought. At the hearing, the Taxpayers indicated that the only relief sought was against SARS’ decision to refuse the third request, which decision SARS had handed down on 10 March 2017.

JUDGMENT

SARS opposed the relief sought by the Taxpayers and various matters dealt with by the High Court are discussed below under separate subheadings.

Exhaustion of available internal remedies

Having regard to section 7(2) of PAJA, SARS argued that the Taxpayers had not exhausted all the available internal remedies under the TAA before bringing the current review application. For this reason, SARS argued that the review application had to be dismissed.

In response to this argument, the High Court indicated that the crisp issue to consider was whether the Taxpayers could object to or appeal against SARS’ decision to refuse the third request on 10 March 2017. The High Court held that to answer this question, one had to look at the provisions of the TAA. The High Court firstly explained that there are various types of assessments that SARS can raise in terms of the TAA and that only in the case of one type of assessment, a jeopardy assessment, does the TAA create an automatic right to take the decision on review.

The High Court then moved on to section 93, in terms of which SARS may only issue a reduced assessment under the following five circumstances:

• Where the taxpayer successfully disputed the assessment under Chapter 9 of the TAA (section 93(1)(a));

• Where it is necessary to give effect to a settlement under Part F of Chapter 9 (section 93(1)(b));

• Where it is necessary to give effect to a judgment pursuant to an appeal under Part E of Chapter 9 and there is no right of further appeal (section 93(1)(c));

• If SARS is satisfied that there is a readily apparent undisputed error in the assessment by SARS or the taxpayer in a return (section 93(1)(d)); or

• A senior SARS official is satisfied that an assessment was based on the failure to submit a return or submission of an incorrect return by a third party under section 26 of the TAA or by an employer under a tax Act; or the assessment was based on a processing error by SARS; or an assessment was based on a return fraudulently submitted by a person not authorised by the taxpayer (section 93(1)(e)).

Considering that the first three scenarios in section 93 involve the issuing of reduced assessments pursuant to the dispute resolution mechanisms in Chapter 9 being followed, it is clear that a request in terms of section 93(1)(d) cannot be raised by way of objection or appeal. It appears that it is simply raised by way of a request.

The next question is whether the refusal of a request gives rise to the right of objection or appeal under the TAA. To answer this question, one must consider whether the refusal of the request falls within the ambit of section 104(2)(c) of the TAA, where it states that a taxpayer may object to any decision that may be objected to or appealed against under a tax Act, other than the decisions not to extend the period for lodging an appeal or lodging an objection (see section 104(2)(a) and (b)).

TAX ADMINISTRATION


There are at least three refusals where the TAA states that the dispute resolution procedure in Chapter 9 applies:• Where SARS is empowered, in terms of section 220 of the TAA,

to remit a penalty imposed under the TAA for administrative non-compliance, but decides not to remit the penalty;

• Where section 224 of the TAA states that a taxpayer may object and appeal against SARS’ decision to impose an understatement penalty in terms of section 222 or its decision not to remit an understatement penalty in terms of section 223; and

• Where a senior SARS official, in terms of section 231 of the TAA, decides to withdraw relief granted under the voluntary disclosure programme to a taxpayer.

As the TAA does not specifically state that the refusal to issue a reduced assessment under section 93 is subject to objection and appeal and as the High Court’s jurisdiction is only ousted where a decision in section 104 is being disputed, SARS’ decision to refuse the third request was not subject to objection and appeal in terms of Chapter 9 of the TAA. Therefore, the internal remedies in the TAA were not available to the Taxpayers and they can, therefore, bring the review application under PAJA.

High Court’s jurisdiction

The next argument raised by SARS was that the High Court did not have jurisdiction to hear the review application.

Section 105 of the TAA states that a taxpayer may only dispute an assessment or “decision” as described in section 104 in proceedings under Chapter 9, unless a High Court otherwise directs. Section 105 does not oust the High Court’s jurisdiction to hear the current review

application, as the decision to refuse the Taxpayer’s request is not a decision within the ambit of section 104. As SARS’ decision to refuse the request constitutes administrative action in terms of PAJA and as section 6(1) of PAJA allows a person to institute proceedings for the review of administrative action, the High Court has jurisdiction to deal with this application.

Court’s finding on the outcome of the review application

As this section is mainly focused on the application of PAJA, this article will only briefly mention the key findings made by the High Court.• In terms of section 93(1)(d) of the TAA, the Taxpayers had

to show that the claimed errors were, in fact, apparent and undisputed.

• The Taxpayers raised four points in arguing that SARS had made apparent and undisputed errors, but could not provide any documents to substantiate their claims.

• In light of the above, the High Court dismissed the Taxpayers’ review application under PAJA and awarded costs in favour of SARS.

COMMENTThe judgment should serve as a reminder to taxpayers that they must always have documentary proof when trying to argue that SARS had made an error in an assessment. In the matter discussed, such documentary evidence would have in any event been necessary for the Taxpayers to succeed with an objection or appeal. In the current case, it is clear that the basis for the value of the loan accounts could not be proven and that this is probably why the Taxpayers were unsuccessful.

Furthermore, where faced with an audit or where SARS has raised an additional assessment, taxpayers should ensure that they obtain proper legal and professional advice to avoid serious adverse consequences. ■

SAIPA

Act sections: Promotion of Administrative Justice Act 3 of 2000: sections 6(1), 7(2); Tax Administration Act 28 of 2011: sections 26, 93, 104, 105, 220, 222, 223, 224, 231, Chapter 9 (Parts E and F).Cases: Rampersadh and Another v Commissioner of the South African Revenue Service and Others (5493/2017) [2018] ZAKZPHC 36 (27 August 2018).Tags: Objection and appeal.

“Section 105 of the TAA states that a taxpayer may only dispute an assessment or “decision” as described in section 104 in proceedings under Chapter 9, unless a High Court otherwise directs.”

TAX ADMINISTRATION


TRANSFER PRICING

SOUTH AFRICA’S FIRST CASE: COURT CONSIDERS SECTION 31(7)Section 31 of the Income Tax Act, 1962 (the Act) contains provisions for transfer pricing, which constitutes one of the most contentious areas of tax law not only in South Africa, but around the world. Historically, there has been no judicial precedent in South Africa regarding the application of section 31 and in particular the important “arm’s length” principle. However, in Crookes Brothers Ltd v Commissioner for the South African Revenue Service, 2018 (Crookes Bros), the High Court handed down findings regarding the application of certain provisions contemplated in section 31.


TRANSFER PRICING

BACKGROUNDThe taxpayer in Crookes Bros (the Taxpayer) formed part of a group of companies in the commercial agriculture industry operating in Southern Africa. The Taxpayer had advanced what purports to be an ordinary shareholder loan to one of its subsidiaries located in Mozambique (Mozco) to enable it to fund certain costs associated with the establishment of a macadamia nut farm.

In its income tax return for the 2015 year of assessment, the Taxpayer made a transfer pricing adjustment to its taxable income in terms of subsection 31(2) as well as a “secondary adjustment” in terms of section 31(3), resulting in a deemed dividend in specie being declared and paid to Mozco.

Subsequent to the filing of its income tax return, the Taxpayer realised that the transfer pricing adjustment had been made in error on the basis that the shareholder loan fell outside the application of the transfer pricing provisions in terms of section 31(7). In an abbreviated manner, section 31(7) states that a debt will not be subject to the section 31 transfer pricing provisions to the extent that:

• The debt is between a resident company and a foreign company in which the resident holds at least 10% of the equity shares and voting rights;

• The foreign company is not obliged to repay the loan within 30 years of the date the debt is incurred;

• Redemption of the debt is conditional on the value of the assets being greater than the liabilities; and

• No interest accrued on the debt in the year of assessment.

The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2013 provides context to the introduction of the carve-out contemplated in section 31(7) as follows:

“[I]t is proposed that transfer pricing relief should be extended to outbound loans that clearly resemble equity. In effect, taxpayers should not be forced to pay tax on notional interest from a share loan that is in substance nothing more than share capital … A loan that meets the [relevant] criteria is in substance exposed to the same economic risk as equity and thus poses little or no risk to the South African tax base if interest is under-charged (because interest should not be charged at all as an economic matter).”SARS’ contentions

SARS disputed the taxpayer’s reliance on section 31(7) on the basis that clause 7 of the loan agreement was contrary to the requirements

of section 31(7)(b) and (c). The matter therefore turned on clause 7 of the agreement, which in simple terms stated that in the event of Mozco being liquidated, going into business rescue or bankruptcy, the loan would be immediately due and payable. SARS was of the view that, given that liquidation, business rescue or bankruptcy could occur within 30 years, such clause was indicative of an obligation on the part of Mozco to redeem the debt within 30 years (section 31(7)(b)). Furthermore, that the debt was payable, notwithstanding the fact that the market value of Mozco’s assets may be less than its liabilities (section 31(7)(c)). Lastly, SARS was of the view that a subordination agreement entered into between the parties did not override clause 7 of the loan agreement and that it merely altered the taxpayer’s ranking among creditors of Mozco. The conclusion was that the shareholder loan was more akin to debt than equity.

FINDINGSIn respect of whether the shareholder loan fell within the “carve-out” provisions of section 31(7), Louw J agreed with SARS and held as follows at paragraph 17:

“In terms of clause 7 of the loan agreements, the agreements terminate with immediate effect and the loan, or any balance then outstanding, becomes immediately due and payable to the applicant in the event of an application being made for the liquidation of Mozco, or Mozco going into bankruptcy or business rescue or similar type proceedings, or judgment having been taken against Mozco and remaining unsatisfied for a period of 14 days. A situation may therefore arise which obliges the foreign company to repay the loan before expiry of 30 years. It follows that the loan agreements therefore do not comply with the requirement of section 31(7)(b) of the Act.”

“Subsequent to the filing of its income tax return, the Taxpayer realised that the transfer pricing adjustment had been made in error on the basis that the shareholder loan fell outside the application of the transfer pricing provisions.”



Act sections: Income Tax Act 58 of 1962: section 31 Cases: Crookes Brothers Ltd v Commissioner for the South African Revenue Service [2018] 80 SATC 439; Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation [2017] FCAFC 62.Tags: Transfer pricing, Case law

TRANSFER PRICING

Louw J furthermore agreed with SARS that the subordination of the loan did not override clause 7 and that it simply regulated the subordination of the taxpayer’s claim against Mozco to the claims of other creditors for such time as the liabilities of Mozco exceeded its assets.

OBSERVATION ON THE COURT’S FINDINGSClause 7 of the loan agreement appears to be a common clause inserted into most shareholder loan agreements and it is interesting to note that the court was of the view that the happening of an uncertain event (ie liquidation, business rescue or similar) amounted to an obligation on the part of Mozco to redeem the debt within 30 years. In other words, even though one of the eventualities may never occur within 30 years from the date the debt was incurred, the court found that there was nevertheless an obligation to redeem the debt within the stipulated period. Given the ongoing debate on what constitutes an “obligation to redeem”, it will be interesting to monitor whether the taxpayer may in fact appeal the judgment, particularly having regard to the intention of the legislature when it introduced the relevant provision.

DEVELOPMENT OF SOUTH AFRICA’S TRANSFER PRICING JURISPRUDENCENotwithstanding the initial interest that the judgment may have brought relief to the long-standing drought of South African case law dealing with the contentious transfer pricing provisions in section 31, the judgment unfortunately falls short of providing any in-depth analysis of the key “arm’s length” principle, which forms the crux of any transfer pricing analysis.

That said, it is worth noting that in Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation, 2017, the Full Federal Court of Australia recently confirmed the findings of the court of first instance and upheld transfer pricing assessments issued by the Australian Tax Office in respect of cross-border interest payments made under intra-group company loans.

It is understood that the taxpayer withdrew its appeal to the High Court of Australia (Australia’s apex court) and the decision thus provides guidance regarding, among others, the key transfer pricing issue of what constitutes “arm’s length” terms of cross-border loans between intra-group companies. ■

“...the judgment unfortunately falls short of providing any in-depth analysis of the key “arm’s length” principle, which forms the crux of any transfer pricing analysis.”