National Treasury says the abuse of double tax agreements by multinational companies is the main reason why the agreement with Mauritius has been renegotiated.
National Treasury head of tax and financial sector policy Ismail Momoniat says companies have often used dual tax residence structures as a tax avoidance tool.
This was made possible because of the different approaches to the concept of “place of effective management”. The effective management tie-breaker test determines which country has the right to tax.
Momoniat says under the old tie-breaker tax residence could be in Mauritius because the company claims to be effectively managed from Mauritius, although the commercial activities happen in South Africa.
Tax experts are now foreseeing a move away from the traditional tie-breaker clause in double tax agreements. The new trend for future treaties is one where the two tax authorities of the treaty countries mutually agree on the tax residence of a company.
This increases the risk of double taxation in the event of no agreement.
The purpose of double tax treaties between countries is to promote international trade and to protect companies against double taxation on the same income generated in one of the treaty countries.
The effective management test has been used in most of South Africa’s double tax agreements, bar a few. The South African Revenue Service (SARS) is aware of at least three disputes under the old tie-break rule with Mauritius.
Ernest Mazansky, tax policy committee member of the SA Institute of Tax Professionals, says he shares the universal (non-governmental) view that it is “most unfortunate” that the traditional tie-breaker article has not been included in the new treaty with Mauritius.
“The consequence is that the matter cannot be brought before the courts in the way a tax dispute of this nature would normally be resolved, and instead the taxpayer is simply excluded from the ambit of the treaty.”
The place of effective management in terms of most treaties is the place where key management decisions are made.
In the mutual agreement procedure tie-breaker the two tax authorities will consider factors such as where the meetings of the board of directors or equivalent body are usually held, where the CEO and other senior executives usually carry on their activities and where the accounting records are kept.
Mr Mazansky says in practice not much has really changed. He says the biggest negative is the denied access to the tax court by way of objection and appeal, and less discipline on revenue authorities to pursue agreement.
Momoniat says government does not apologise for protecting its tax base, nor does it apologise for taking the initiative if it deems it necessary to renegotiate treaties due to abuse.
He says the mutual agreement tie-breaker has been accepted as the main test (replacing the place of effective management test) of the Organisation for Economic Cooperation and Development (OECD) model under the base erosion and profit shifting (Beps) initiative.
Norton Rose Fulbright tax director Dale Cridlan expects an increased use of the mutual agreed procedure tie-breaker where a revenue authority suspects that companies are being set-up in a favourable tax jurisdiction merely to make use of the treaty benefits.
Mr Mazansky says in terms of the Mauritius treaty, the issue of tax residence was always going to be a greater concern for SARS than for the Mauritius Revenue Authority.
“The fact is that the Mauritius Revenue Authority’s primary concern in proving residence is not related to tax collection (because the tax payable by the companies is minimal, if not zero), but rather to maintain Mauritius’s status as an offshore financial centre, whereas SARS’ interest is tax collection,” says Mr Mazansky.
Mr Cridlan says the mutual agreement procedure tie-breaker will give tax authorities the right to question and call for further evidence to support its claim to tax a dual resident company.
Deloitte International tax director Anne Casey says the Mauritius tie-breaker clause and the “hype” around it has made their clients a lot more respectful of the fact that actual substance is required (in the country in which the company claims to be tax resident).
She says in the past there has not been a significant amount of disputes about the resident status of companies. SARS has typically focused more on domestic tax and the structuring of transactions.
“They are now focusing more on permanent establishments and cross-border transactions. I believe we will see an increase in challenges to non-resident (entities),” says Ms Casey.
Hogan Lovells tax partner Natalie Napier says there is a greater awareness of global tax changes, with a bigger focus on Beps and international compliance.
She says although she has not seen a discernible trend towards the inclusion of the mutual agreed procedure tie-breaker, South Africa is known for following international precedent in terms of tax policy developments.