All you need to know about general anti-avoidance rules – focus on SA

Tired of tax acronyms?  Sorry, but GAAR is one of the most important and often ignored, tax concepts, which can scupper all your clever tax plans.  Today we explain what GAAR means and why it’s so important, by reference to South Africa.

Tax frameworks generally have the general rules, the long complex pages of tax law, and then specific anti-avoidance rules generally brought in over time to attack specific tax nefariousness.  The rules around transfer pricing, controlled foreign companies, and disguised remuneration are all examples of specific anti-avoidance rules.  A growing number of countries also have general anti-avoidance rules as an additional mop-up, often in tandem with rules around reportable arrangements (whereby certain types of transaction are deemed de facto dodgy and must be disclosed upfront to the relevant tax authority).  These general anti-avoidance rules differ per country but essentially all say that even if what you’re doing is legal under the tax rules, i.e. not caught by any specific anti-avoidance legislation, if you did it purely or mainly to get a tax benefit, then any such tax benefit can be over-ruled.

So these rules are very powerful and give the relevant revenue authority the power to ignore or re-imagine specific transactions and levy the tax that they think would have been due had the transaction not been entered into.

Scary stuff!  Particularly when we consider that usually, the onus is on the taxpayer to demonstrate that tax was not the main reason for entering into the transaction – i.e. the assumption is that the motive was tax avoidance unless the taxpayer can prove differently – a case of guilty until proven innocent rather than the other way round!

Today we focus on the GAAR in South Africa (“SA”) to explore the mechanics.  The rules are contained in Part IIA of the SA Income Tax Act and came into operation in late 2006. Although it makes up a very small part of the Act, only consisting of 12 sections (sections 80A to 80L), it has big consequences.

In a nutshell:

• Section 80A defines an impermissible tax avoidance arrangement;

• Section 80B lays out the remedies that can be enacted by the South African Revenue Service (“SARS”) with respect to avoidance arrangements;

• Section 80C to 80G expands on the requirements of an impermissible tax avoidance arrangement as set out in section 80A.

• Section 80H to 80L provides general procedures and definitions.

While in theory a taxpayer is allowed to arrange his tax affairs in the most optimal manner, where arrangements are entered into for the sole or main purpose of obtaining a tax benefit (which is any avoidance, reduction, or even postponement of any liability for any SA tax), the GAAR rules will apply and classify such arrangement as an impermissible tax arrangement. In other words, a taxpayer that enters into such an arrangement will be at risk of the SA Revenue Service (“SARS”) challenging the arrangement and enforcing remedies.

Section 80A basically defines the term ‘impermissible tax avoidance arrangement’ to be an arrangement that’s sole or main purpose was to obtain a tax benefit and either the transaction was carried out in a manner which would not normally be employed in the course of business or such arrangement lacks commercial substance.

An arrangement lacks commercial substance where it results in a significant tax benefit for one party but does not have a significant effect on the business risks or net cash flows of that party. Arrangements often have indicators of lack of commercial substance such as:

• Round trip financing, includes funds being transferred between or among parties which results in a tax benefit and significantly reduces or eliminates many business risks incurred by any party in connection with the avoidance arrangement.  An example includes a sale and leaseback arrangement of an asset in which capital allowances initially cannot be claimed. Roundtrip financing is present as funds were transferred from the purchaser to the seller and the seller (now lessee) will repay the same funds to the purchaser (now lessor) and claim a deduction for the lease payments.

• Accommodating or taxing indifferent parties means a party that receives an amount in connection with the avoidance arrangement which is not subject to SA tax or is significantly offset by expenditures or losses and which directly or indirectly results in another party having a reduced taxable income. A party will not be considered an accommodating or tax in-different party where such party continues to engage directly in substantive active trading activities in connection with the avoidance arrangement for a period of at least 18 months, provided these activities constitute bona fide business operations conducted at suitable premises which are suitably equipped with suitable facilities and suitable staff.

An arrangement will also be considered an impermissible tax avoidance arrangement in any context if such arrangement/transaction created rights or obligations that would not normally be created between persons dealing at arm’s length (for example an additional deduction is claimed as a result of such arrangement) or such arrangement would result in the misuse or abuse of the provisions of the Act.

So, what can SARS do if an arrangement meets the definition of an impermissible tax avoidance arrangement as set out in section 80A?  Well, the answer is a whole lot!  Most commonly, SARS will treat the impermissible avoidance arrangement as if it did not exist or in such a manner that SARS deems appropriate. This means that the tax liability linked to such impermissible avoidance arrangement will be calculated in a manner that is normally employed in business or between arm’s length parties, or in practice however SARS decides in order to levy the most tax.

Other remedies include SARS disregarding, combining, or recharacterising any steps or parts of the arrangement, disregarding any tax-indifferent party, deeming persons who are connected persons to be one and the same person for purposes of determining the tax treatment of any amount, and reallocating or recharacterising gross income, expenditure or receipt or accrual of a capital nature.

In summary, for GAAR to apply, there must first be an arrangement (section 80L) in which a tax benefit is derived, secondly, such arrangement’s sole or main purpose must be to obtain a tax benefit and the arrangement must be classified as an impermissible tax avoidance arrangement (section 80A) by having abnormal characteristics, lack of commercial substance (section 80C) or round trip financing (section 80D).

Remember, an avoidance arrangement is presumed to be entered into or carried out for the sole or main purpose of obtaining a tax benefit unless the taxpayer can prove otherwise, so make sure to structure and document your arrangements wisely.

If you would like to discuss this in more detail and how it would impact your business contact us today.