Tax havens are countries where minimal or no taxes are levied on non-residents. The Economist defined a tax haven as having “a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance”1. A key feature of a tax haven is a lack of transparency – some examples include secret rulings and negotiated tax rates. Although most dealings with tax havens are lawful, some taxpayers exploit the secrecy laws of those countries to conceal their assets or income. In so doing, they evade the tax payable under the law.
The problem of tax evasion is as old as the “problem” of taxes itself. Tax havens purportedly2 originated in ancient Greece, where neighbouring islands were used as a refuge where traders put their goods to avoid the 2% Athens tax on imports and exports. During the early 18th century, American colonies avoided English taxes by trading from Latin America. Swiss banks have long been a capital haven for people fleeing the social upheavals in Russia and Germany. Nowadays, tax havens have grown due to the internationalisation of businesses in a global economy. Whatever the reason, tax havens have always been an attractive tool used in tax planning, whether legally or illegally. This legal grey area necessitates a closer look at the difference between tax evasion and tax avoidance.
According to Silke3, tax evasion refers to illegal activities deliberately undertaken by a taxpayer to free himself from a tax burden, e.g. omitting income received from a tax return. Tax avoidance, however, is where a taxpayer has arranged his affairs in a perfectly legal manner, with the result that he has reduced his taxable income.
Of course, although tax avoidance is legal, SARS has various anti-avoidance rules in place. For some of the specific anti-avoidance rules (for example paragraph (c) of the gross income definition in s1 of the Income Tax Act4) please refer to the flowchart on page 6 of the Act. The general anti-avoidance rule previously contained in s103(1) was replaced by s80A to s80L which are applicable to impermissible tax avoidance agreements entered into on or after 2 November 2006. As most transactions with a tax haven are entered into with the view to avoiding tax, the requirements of “impermissible tax avoidance agreements” will briefly be explored.
The definitions in s80L relevant to this article are as follows:
“arrangement”: any transaction, operation, scheme, agreement or understanding (whether enforceable or not), including all steps therein or parts therof, and includes any of the foregoing involving the alienation of property.
“avoidance arrangement”: any arrangement that, but for this Part, results in a tax benefit.
“tax benefit”: any avoidance, postponement or reduction of any liability for tax.
According to s80A, an avoidance arrangement is an impermissible avoidance arrangement if its sole or main purpose was to obtain a tax benefit and—
- a) in the context of business—
- i) it was entered into or carried out by means or in a manner which would not normally be employed for bona fide business purposes, other than obtaining a tax benefit; or
- ii) it lacks commercial substance, in whole or in part, taking into account the provisions of section 80C;
- b) in a context other than business, it was entered into or carried out by means or in a manner which would not normally be employed for a bona fide purpose, other than obtaining a tax benefit; or
- c) in any context—
- i) it has created rights or obligations that would not normally be created between persons dealing at arm’s length; or
- ii) it would result directly or indirectly in the misuse or abuse of the provisions of this Act (including the provisions of this Part).
This article will only focus on business transactions that lack commercial substance [i.e. s80A(a)(ii)]. Section 80C provides a general rule for determining whether an avoidance agreement lacks commercial substance:
1) For purposes of this Part, an avoidance arrangement lacks commercial substance if it would result in a significant tax benefit for a party (but for the provisions of this Part) but does not have a significant effect upon either the business risks or net cash flows of that party apart from any effect attributable to the tax benefit that would be obtained but for the provisions of this Part.
Section 80C(2) contains a non-exclusive set of characteristics that serves as indicators of a lack of commercial substance:
2) For purposes of this Part, characteristics of an avoidance arrangement that are indicative of a lack of commercial substance include but are not limited to—
- a) the legal substance or effect of the avoidance arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps; or
- b) the inclusion or presence of—
- i) round trip financing as described in section 80D; or
- ii) an accommodating or tax-indifferent party as described in section 80E; or
iii) elements that have the effect of offsetting or cancelling each other.
Essentially, a tax-indifferent party is a person who is not subject to tax under the Income Tax Act or a person who participates in such a way that his income in connection with the scheme is substantially matched or offset by expenditure. A tax haven is the ideal breeding-ground for tax-indifferent parties, as its financial, legal and tax systems all seek to attract foreign investment. A company, for example, that is set up in a tax haven, can be regarded as an accommodating or tax-indifferent party [s80C(2)(b)(ii)], if the requirements of s80E are met:
1) A party to an avoidance arrangement is an accommodating or tax-indifferent party if—
- a) any amount derived by the party in connection with the avoidance arrangement is either—
- i) not subject to normal tax; or
- ii) significantly offset either by any expenditure or loss incurred by the party in connection with that avoidance arrangement or any assessed loss of that party; and
- b) either—
- i) as a direct or indirect result of the participation of that party an amount that would have—
- aa) been included in the gross income (including the recoupment of any amount) or receipts or accruals of a capital nature of another party would be included in the gross income or receipts or accruals of a capital nature of that party; or
- bb) constituted a non-deductible expenditure or loss in the hands of another party would be treated as a deductible expenditure by that other party; or
- cc) constituted revenue in the hands of another party would be treated as capital by that other party; or
- dd) given rise to taxable income to another party would either not be included in gross income or be exempt from normal tax; or
- ii) the participation of that party directly or indirectly involves a prepayment by any other party.
2) A person may be an accommodating or tax-indifferent party whether or not that person is a connected person in relation to any party
S80E(3) contains safe-harbour rules that are necessary to ensure that a foreign party is not automatically regarded as a tax-indifferent party3. The safe-harbour rules are applicable if either:
- a) the amounts derived by the party in question are cumulatively subject to income tax by one or more spheres of government of countries other than the Republic which is equal to at least two-thirds of the amount of normal tax which would have been payable in connection with those amounts had they been subject to tax under this Act; or
- b) the party in question 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 must be attributable to a place of business, place, site, agricultural land, vessel, vehicle, rolling stock or aircraft that would constitute a foreign business establishment as defined in section 9D(1) if it were located outside the Republic and the party in question were a controlled foreign company.
4 For the purposes of subsection (3)(a), the amount of tax imposed by another country must be determined after taking into account any applicable agreements for the prevention of double taxation and any assessed loss, credit or rebate to which the party in question may be entitled or any other right of recovery to which that party or any connected person in relation to that party may be entitled.
It is not the purpose of this article to address and discuss the requirements of s80E. The author merely intends to illustrate that a transaction with a tax haven is potentially subject to the provisions of s80A, unless the taxpayer can prove that the main purpose was not to obtain a tax benefit. The flow-chart below provides a quick reference to check whether a business deal involving a tax haven might be considered an impermissible tax avoidance agreement: see Diagram 1 below.
If all the above requirements are met, and a transaction with a tax haven is considered to be an impermissible tax avoidance arrangement, the Commissioner may invoke s80B. The tax consequences are as follows:
1) The Commissioner may determine the tax consequences under this Act of any impermissible avoidance arrangement for any party by—
- a) disregarding, combining, or re-characterising any steps in or parts of the impermissible avoidance arrangement;
b disregarding any accommodating or tax-indifferent party or treating any accommodating or tax-indifferent party and any other party as one and the same person;
- c) deeming persons who are connected in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;
- d) re-allocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;
- e) re-characterising any gross income, receipt or accrual of a capital nature or expenditure; or
- f) treating the impermissible avoidance arrangement as if it had not been entered into or carried out, or in such other manner as in the circumstances of the case the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit.
2) Subject to the time limits imposed by section 79, 79A(2)(a) and 81(2)(b), the Commissioner must make compensating adjustments that he or she is satisfied are necessary and appropriate to ensure the consistent treatment of all parties to the impermissible avoidance arrangement.
Still unsure whether you’re dealing with a tax haven? The Organisation for Economic Co-operation and Development (OECD) has identified the following four key factors5 used to determine whether a jurisdiction is a tax haven:
- No or nominal taxes
This criterion is not in itself sufficient to prove a tax haven, as every jurisdiction has the right to determine whether to impose taxes and at what rate.
- Lack of transparency
This requires open and consistent application of tax laws and the availability of information needed by tax authorities, for example, accounting records.
- Ineffective exchange of information
Certain laws or administrative practices of countries prevent the effective exchange of information between authorities. The OECD encourages countries to adopt information exchange on an “upon request” basis. Safeguards must, however, be in place to ensure adequate protection of taxpayers’ rights and the confidentiality of their tax affairs.
- A lack of substantial activity
A lack of such activities suggests a jurisdiction may be attempting to attract investment and transactions that are purely tax driven.
All these technical definitions and requirements might hinder more than help, so included below is a table6 of red flag arrangements based on the one compiled by the Australian Tax Office (ATO). The table contains some practical examples of arrangements that will attract the ATO’s attention (and probably our own SARS’ attention as well): see Table 1 below.
|TABLE OF RED FLAG ARRANGEMENTS:|
|Anonymous offshore debit cards|
|RSA resident must declare income received from worldwide sources. Non-compliance may lead to penalties or criminal prosecution.|
|Anonymous credit card accounts|
|Bank accounts in tax havens|
|International business company (companies resident in tax haven)|
|Where an RSA resident is the controller of a company resident in a tax haven, the controlled foreign company (CFC) rules may apply.|
|Trusts based in tax haven|
|Where an RSA resident transfers property or services to a trust set up in a tax haven, the income of the trust may be taxed as income of the RSA resident.|
|Tax-free savings accounts|
|Interest derived by RSA resident from sources outside RSA (including a bank account or an investment in a tax haven) is subject to RSA tax.|
|Anonymous international and investment trusts|
|An RSA resident who derives royalties from a source outside RSA (including from a tax haven) is generally assessable on the gross amount of royalties.|
|Re-invoicing (International business company based in tax haven used as intermediary between importers or exporters and their customers)|
|RSA has complicated transfer pricing rules and other international tax rules in place. Non-compliance may lead to penalties or criminal prosecution.|
If none of the red flags are raised and a transaction with a tax haven is completely above board, why still all the fuss? Not only are there the s80B implications with regard to impermissible avoidance agreements, but there are also moral, economical and social dilemmas associated with tax havens. Christian Aid stated that the extent of tax abuse “is so widespread and damaging that it is tantamount to a new slavery”7. The organisation further claimed that a notable method is the use of tax havens where “extreme secrecy encourages a more general criminality”.
The Tax Justice Network has argued that the European Union (EU) has a “slightly schizophrenic” attitude towards the problems posed by massive tax evasion and avoidance8. The Network stated that while the EU has been leading the world in taking initiatives against tax competition, many of the world’s most notorious tax havens are located within the EU (including Luxembourg, the Cayman Islands, Jersey and Guernsey).
During March of this year, Australia’s Tax Commissioner issued a taxpayer alert9 warning people against hiding income or assets offshore. South Africans planning a prolonged stay in Australia would do well to take note of the Commissioner’s warning to be cautious when using offshore structures or tax havens.
Finance Minister, Trevor Manuel, clamped down on aggressive tax planning schemes that involved structured finance deals and tax shelters by introducing s80M to s80T that govern reportable arrangements (with effect from 1 April 2008). This article will not discuss the requirements of reportable arrangements, but please note the similarity with impermissible avoidance agreements (possibly a transaction with a tax haven), for example, a tax benefit that was obtained along with a lack of commercial substance.
Earlier this year, the OECD met in Cape Town where the emphasis was on combating tax avoidance and evasion10. Manuel told the meeting that “up to R1.7bn was lost annually to the coffers of developing countries through the minimising of global taxes”.
Clearly, tax authorities around the world are shifting their focus to address tax avoidance and evasion. Undoubtedly, tax havens will also fall under the scrutinising spotlight of revenue offices, and the fine grey line between avoidance and evasion might eventually disappear. Until then, the reader should bear in mind that no obligation rests on a taxpayer to pay a greater tax than is legally due under the taxing Act3.
As Lord Tomlin succinctly put it in his judgment in Duke of Westminster v IRC11: “Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow-taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.” So, if you can legally avoid tax, do so. But beware if it looks too good to be true: your tax haven might in fact turn out to be a tax hell.
- Doggart, C. 2002. “Tax Havens and their uses” (originally published 1970), Economist Intelligence Unit, ISBN 0862181631.
- Wikipedia. 2008. “Tax haven” [On-line]. Accessed on 29/05/2008. Available: http://en.wikipedia.org/wiki/Tax_haven
- Jordaan, K., Koekemoer, A., Stighlingh, M., van Schalkwyk, L., Wassermann, M., Wilcocks, J. Silke: South African Income Tax 2008. Durban: LexisNexis.
- South Africa. 2008. The Income Tax Act, Act 58 of 1962. Pretoria: Government Printer.
- OECD. 2008. “Tax Haven Criteria.” [On-line]. Accessed on 03/06/2008. Available: http://www.oecd.org/document/63/0,3343,en_2649_37427_30575447_1_1_1_37427,00.html
- Australian Taxation Office. 2007. “Tax havens and tax administration” [On-line]. Accessed on 04/06/2008. Available: http://www.ato.gov.au/content/downloads/LBI_46908_Tax_Havens_w.pdf.
- Business Report. 2008. “Tax-dodging is new slavery – charity” [On-line]. Accessed on 03/06/2008. Available: http://www.busrep.co.za/index.php?fSectionId=&fArticleId=4400844.
- “EUROPE: Tax Havens Cheating the Poor” 2008. [On-line]. Accessed on 05/06/2008. Available: http://www.amandlapublishers.co.za/content/view/664/2/.
- Moneywebtax. 2008. “Australian tax commissioner warns against hiding income and assets offshore” [On-line]. Accessed on 03/06/2008. Available: http://www.moneywebtax.co.za/moneywebtax/view/moneywebtax/en/page269?oid=3007&sn=Detail.
- Business Day. 2008. “Manuel to get tough on tax consultants” [On-line]. Accessed on 04/06/2008. Available: http://www.netassets.co.za/tax/tax.asp?websiteContentItemID=71308.
- Duke of Westminster v IRC 51 TLR 467, 19 TC 490.
Lee-Ann du Plessis, BAcc (Hons), is a tax lecturer at the University