Company taxation in the time of COVID-19 lockdown
Jared Waters a Principal at Bravura Structured Solutions, highlights the potential complexities that could arise for Corporate South Africa amidst the country’s COVID-19 lockdown period.
President Cyril Ramaphosa announced South Africa’s nationwide lockdown for a period of 21 days in an effort to slow down the spread of the Coronavirus (COVID-19). If the lockdown is not extended, it will end on 16 April 2020. Both international and local travel restrictions had previously been put in place on 15 March. Corporate South Africa must now consider the myriad knock-on effects that this will have on business. Amongst these is the critical question of what the tax implications may be for companies with international or dispersed operations.
In the South African taxation context, a person is taxed where they are “resident” as defined in section 1 of the Income Tax Act, 58 of 1962, as amended (“Act”). In respect of companies, there are two tests to ascertain residency, namely the place of incorporation (POI) and the place of effective management (POEM). If a company’s POI or POEM is in South Africa, it will be considered resident here and will be taxable in South Africa on its worldwide income and capital gains. There is one exclusion, which applies to any person who is deemed to be exclusively a resident of another country for purposes of a relevant double taxation agreement.
The Act does not explicitly define POEM and the term has been the subject of debate both in the South African context and internationally. It could be presumed that POEM would be determined by the courts while taking into account international precedents and the SARS interpretation note on the matter, namely Interpretation Note 6 (IN 6).
The SARS IN 6 states that POEM will be at the key place where management and commercial decisions which affect the business are made either primarily or predominantly. The place where operational management of the company’s day-to-day business takes place is of less significance than the place where the company’s strategic and policy decisions are being made by directors and senior management. As the South African Institute of Chartered Accountants (SAICA) writes, this will be where “the shots are called” and most likely where the managing director sits and makes strategic decisions.
SARS IN 6 falls in line with the Organisation for Economic Co-operation and Development (“OECD”) interpretation of POEM which states, “The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. The place of effective management will ordinarily be the place where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined.”
The OECD interpretation does, however, go on to state that no definitive rule can be given and all relevant facts and circumstances must be examined to determine the “place of effective management”. An entity may have more than one place of effective management at any one time.
This fluidity of definition complicates matters from a double taxation agreement (“DTA”) perspective. A DTA between two countries regulates how one of the contracting states will impose tax on income derived by residents of the other state, and vice versa. The purpose of DTAs is to resolve double taxation by providing comprehensive taxing rights on worldwide income of each entity to only one country to a DTA, and limited source taxing rights to the other country party to that DTA. The two contracting states generally aim to resolve an entity’s tax residency by virtue of the country in which its place of effective management is located, but each DTA may have a different definition of what this place of effective management entails.
Strategic board and annual general shareholder meetings are generally held once a year, depending on the nature of a company’s business and the location thereof. It is generally expected that these meetings will be where key management are located (and where commercial decisions are made) thus dictating the POEM of the company.
During the COVID-19 lockdown under South Africa’s State of Disaster as well as various other lockdowns imposed by governments across the globe, it is unclear what the effect of isolation and travel restrictions will have on the ability of an entity to hold such meetings at the desired place, or if at all in the future. This may inadvertently lead to an entity’s place of management being changed from one country to another.
Section 9H of the Act sets out the “exit tax” consequences in case an entity ceases to be a South African tax resident. From a company’s perspective, this would result in a deemed disposal of its assets at an effective normal tax rate of 22.4%, and then also a deemed distribution of its assets as a dividend in specie and depending on the nature of shareholder a possible dividend withholding tax rate of 20%.
Accordingly, should the POEM indeed change from South Africa to another country, this will mostly trigger such “exit tax” unless the company can demonstrate that through no fault of its own, its best intentions and alternative measures taken, the POEM should still remain at its original place of business.
In the constant effort to improve tax revenue, SARS and other tax collection authorities around the globe may well wish to scrutinise the minutes and/or recordings of company board and shareholder meetings, especially those in the public space, during the COVID-19 lockdown, but their approach still remains to be seen.
The more detailed and nuanced implications of the COVID-19 lockdowns across the world, will no doubt be more clearly articulated in the coming weeks and possibly months. While there are no clear solutions at present given that best efforts to slow down virus infection may create longer-term restrictive measures, it will be important for businesses to consider those future scenarios that could pose a threat to residency and thus taxation consequences.