Treasury ignores pleas to retain incentives
National Treasury has decided to scrap a recently introduced incentive to make South Africa’s service sector more competitive, despite an impassioned appeal from multinational companies not to do so.
The special foreign tax credit for service fees has protected companies from double taxation where South Africa’s treaty partners levied withholding taxes on services rendered by South African companies despite treaty provisions.
Multinational companies and tax experts have warned that the scrapping of section 6quin will undoubtedly result in tax inequity. The cost of a service business in South Africa will increase, harming its competitiveness.
Treasury suddenly argues that this incentive – introduced in 2011 – is a “departure from international tax rules and tax treaty principles as it indirectly subsidises countries that do not comply with tax treaties”.
Elandre Brandt, partner at Webber Wentzel and chair of the international tax committee of the SA Institute of Tax Professionals (Sait), says there is an appreciation of the difficulty for the South African fiscus in compensating for foreign tax.
However, there is a high level of disappointment, especially in the context of South African companies that provide services from South Africa to group companies across the continent.
“Often, transfer pricing in the foreign jurisdiction prevents the grossing up of amounts to compensate for withholding tax leakage and the result is that services are provided at a loss,” he says.
In these circumstances, it comes down to basic economics, Brandt says. “Will you operate the project at a profit or loss? It also has an impact on employment, skills development, and other taxes where work opportunities are lost.
Unilever tax director Karl Muller says the group will review the suitability of using South Africa as a service hub and rather move services elsewhere where the cost may be lower.
“We will definitely shelve all plans to introduce additional services from South Africa, unless there is a really strong business case,” he adds.
He says without the tax relief, profits form services rendered from South Africa in another African country, can be wiped out by withholding taxes. This will mean that the company will be in a break-even position, which will cause new problems in terms of transfer pricing.
“We expect SARS to argue that a zero profit for services is not arm’s length, while the real rational for a zero profit is the abolition of section 6quin,” he explains.
Muller says while it is possible to get a tax deduction it still does not compensate the company completely and places an increased tax burden on South African entities.
Treasury chief director Yanga Mputa further justifies the scrapping by referring to the Davis Tax Committee’s (DTC) recommendation that the concession should be “reconsidered”.
The DTC said in its report on base erosion and profit shifting (Beps) that “South Africa has effectively eroded its own tax base as it is obliged to give credit for taxes levied in the paying country”.
Professor Annet Oguttu, chair of the Beps sub-committee, says the DTC did not categorically recommend the scrapping of the section.
“It has recommended that South Africa’s tax treaty policy needed to be coherent and that the section should be reconsidered.”
Mputa has suggested an amendment so that withholding tax in a foreign jurisdiction will qualify for a tax deduction to mitigate double taxation.
Several tax experts noted that a deduction actually already exists. There are admittedly a few problems with it, and it is unclear whether treasury will address the real issues.
Oguttu said the committee may have to see if the “deduction method” will be a feasible approach to ensure that multinational companies are not disadvantaged.
Muller says the lack of protection against double taxation will be problematic in most African jurisdictions. South Africa does not have double tax agreements with a number of African countries.
In addition, many countries who do have an agreement, levy withholding taxes in contravention of the treaty, which means the taxpayer must carry the burden of enforcing the treaty.
“This unilateral treaty override is the primary reason for the lack of a strong service industry in Africa and the removal of section 6quin will add to the woes of the service industry,” he warns.
Mputa says the mutual agreement procedure available in tax treaties is the “appropriate mechanism” to resolve disputes of double taxation.
The success of this mechanism in Africa has been severely criticised in the past and disputes can drag on for years, resulting in the company paying double tax until the dispute has been resolved.
Despite calls for mandatory arbitration when there is no dispute resolution after a specific time, this has not been introduced.
The SA Institute for Tax Professionals presented a detailed submission to both treasury and parliament suggesting that the scrapping of the incentive could be delayed to allow for the assessment of information gathered through the section 6quin reporting process.
Brandt says some of treasury’s concerns can also be addressed easily. It is stated that section 6quin has been used to claim relief on amounts other than service fees.
“Section 6quin clearly only applies to service fees and taxpayers that incorrectly claim the relief should be reassessed accordingly,” Brandt suggests.
The reporting process has been administratively burdensome. Brandt suggests that minimum reporting requirements can be imposed, ensuring that taxpayers only report material amounts.
Brandt says that although South Africa’s new approach to section 6quin is technically correct, the practical implication of this position is adverse to South Africa’s objective of becoming a regional financial centre.
“As long as this theoretically correct position is maintained, the only viable solution for regional operations is to shift their management location to a low-taxed or no taxed location so as to avoid double taxation,” he warns.