The new reportable arrangement provisions contained in sections 80M to 80T of the Income Tax Act have been activated with effect from 1 April 2008. Unfortunately for taxpayers and their advisers, this is no April Fools Day hoax. The new provisions are far wider in their ambit than those that they replace in the previous version encapsulated in section 76A of the Income
The first aspect that renders the new provisions wider in their ambit is that they apply to both promoters and persons deriving a tax benefit from the arrangement. The previous version only imposed a reporting obligation on the person deriving the tax benefit from the reportable arrangement. A promoter is defined in section 80T as any person who is principally responsible for organising, designing, selling, financing or managing a reportable arrangement. The primary reporting obligation lies with the promoter.
Unfortunately, in certain circumstances, it may be difficult to identify if a person is a promoter in relation to the reportable arrangement or, given that the definition of a promoter is given with reference to a number of alternative functions that may be performed in relation to the reportable arrangement, there may be two or more promoters in relation to that arrangement. For example, it is possible that a company’s tax advisers could design the scheme in question, but this requires funding, which is provided by a third party bank. Who then has the primary reporting responsibility? It is submitted that, in such circumstances, all of these persons would be promoters and they would be obliged to report the arrangement unless they obtain a written statement from one of the other promoters that it has disclosed the arrangement as required. In the absence of such a written statement, where a promoter fails to disclose the arrangement as required, that person could be liable for a penalty of up to R1 million.
The other major departure from the old provisions concerns what constitutes a reportable arrangement. The definition of a reportable arrangement in section 76A of the Income Tax Act was limited to arrangements where the calculation of interest, finance costs, fees or other charges was wholly or partly dependent on the tax treatment of the arrangement. Provision was made for the variation thereof in the event that the actual tax treatment differed from the anticipated treatment and the potential variation exceeded R5 million. Also included were arrangements that would have constituted hybrid equity instruments or hybrid debt instruments if the prescribed periods applicable thereto had been five years.
The list of reportable arrangements has been significantly extended. Arrangements that constitute or would have constituted hybrid debt instruments or hybrid equity instruments remain reportable arrangements, but the prescribed period for determining this has been extended to ten years. Arrangements where the calculation of interest, finance costs, fees or other charges is wholly or partly dependent on the tax treatment of the arrangement also remain reportable arrangements. However, the requirement that provision is made for the variation thereof has been removed.
In addition, the following arrangements have been added as reportable arrangements –
- Those that have characteristics of or characteristics that are substantially similar to round trip financing as contemplated in section 80D of the Income Tax Act, an accommodating or tax indifferent party as contemplated in section 80E of the Income Tax Act or elements that have the effect of offsetting or cancelling each other.
- An arrangement that is or will be disclosed by a participant as giving rise to a financial liability for purposes of generally accepted accounting practice, but not for purposes of the Income Tax Act.
- An arrangement that does not result in a reasonable expectation of a pre-tax profit for any participant.
- An arrangement that results in a reasonable expectation of a pre-tax profit for any participant that is less than the value of the tax benefit to the participant if both are discounted to a present value at the end of the first year of assessment when that tax benefit is derived using a reasonable discount rate.
It is the new additions to the definition of a reportable arrangement that primarily are cause for concern. The tests in this regard are largely subjective. Nowhere is this more apparent than in respect of the last two listed above with their references to “a reasonable expectation of a pre-tax profit” and a “reasonable discount rate”.
However, it is the first new reportable arrangement that is likely to result in the most difficulty for taxpayers. The problem with this provision is that it may capture many legitimate transactions. The difficulty arises because it is linked to the “lack of commercial substance” test for purposes of the general anti-avoidance rule (the GAAR) in Part IIA of the Income Tax Act. Unfortunately, it is linked not to the definition of this term for the purposes of the GAAR, but to certain characteristics that have been listed merely as indicators of a lack of commercial substance. Of course, many legitimate transactions will also include these characteristics, but will have a significant effect on the business risks of the party deriving the tax benefit and would therefore not be regarded as lacking commercial substance for purposes of the GAAR. However, such transactions may still constitute reportable arrangements. Legitimate transactions that may well be captured by this provision include private equity transactions, BEE transactions and intra-group restructurings.
Fortunately, certain arrangements are excluded from being reportable arrangements, notwithstanding that they would meet the requirements. Excluded are certain loans, leases, transactions undertaken through an exchange and transactions in participatory interests in collective investment schemes. However, these are only excluded where they are undertaken on a stand-alone basis and are not dependent on any other arrangement. Furthermore, these arrangements are not excluded where they are entered into with the main purpose of obtaining or enhancing a tax benefit or in a specific manner or form that enhances or will enhance a tax benefit.
In addition to the above, the Minister of Finance has determined that certain other arrangements will be excluded from being reportable arrangements. These are arrangements where the tax benefit derived from the arrangement does not exceed R1 million or where the tax benefit was not the main or one of the main benefits of the arrangement.
Unfortunately for participants in arrangements, the exclusions, with the exception of those with a tax benefit of R1 million or less, contain a great deal of subjectivity. The effect of this is that participants are going to have to make significant judgement calls on whether or not an arrangement is a reportable arrangement. Given the potential penalties involved, it would be advisable for participants to err on the side of caution and report any arrangements that give rise to any sort of tax benefit, and could potentially be reportable.
Given this state of affairs, it would be expected that the South African Revenue Service is likely to be inundated with disclosures relating to legitimate commercial transactions where the tax benefits that arise are merely due to the transactions being carried out in a tax efficient manner. Should this happen, it will, of course, detract from the purpose of the reportable arrangement provisions, which is to identify those transactions potentially giving rise to so-called undue tax benefits at an early stage, rather than years down the line.
Kyle Mandy CA(SA), PGDipAcc, Adv Tax Cert, is a Director: Werkmans Tax.