The resurrection of the SA Revenue Service (Sars), after it was damaged in the state capture era, is an unadulterated public good. It is again going after tax avoiders and smugglers, while ensuring an efficient system is available to all those who legitimately pay their taxes.
But like any resurgent system, the pendulum can swing too far. And many in the financial sector are feeling that Sars’ reinvigorated efforts risk undermining large parts of the economy.
There are three cases that have caused concern. The first is Sars’ pursuit of Coronation Investment Management for tax it argues was due from profits generated by Coronation’s Irish subsidiary. Sars initially lost its claim in the tax court, won in the Supreme Court of Appeal, and then lost in the Constitutional Court. At worst, Coronation believed it could have owed R761m to Sars, but the Constitutional Court eventually decided it owed nothing.
The case was important not so much for the narrow interests of Coronation, but for all SA companies that operate subsidiaries abroad. In general, subsidiaries abroad should be taxed as if they are competing with other companies there.
Imagine a restaurant chain that has a branch in Dubai. If that restaurant must pay taxes at SA levels (27% corporate rate) versus the Dubai rate (9%) it is obviously going to struggle to compete — its Dubai competitors will have a much lower cost of capital.
So, to enable SA head-office firms to be competitive when setting up subsidiaries around the world, tax legislation has the notion of a foreign business establishment, which is an operating business that is controlled by a South African firm. If the company is an foreign business establishment then it can be taxed under local tax regulations. If it is, however, just a brass plate, then its revenue must be included in its parent’s taxable income.
The Coronation case turned on whether its Irish business really was a foreign business establishment. Ultimately the Constitutional Court decided it was. But many are now nervous.
When Sars initially lost in the tax court, amendments were drafted to the tax legislation that defines foreign business establishments and caused panic. The new wording could well have swept up that restaurant operating in Dubai, and many other foreign SA-owned businesses, and rendered them uncompetitive. That would be a disaster for the economy, making it near impossible to run a multinational from SA. The draft wording was suspended while Sars was pursuing the litigation, but now that the Constitutional Court has ruled, it could come back.
The second major area is the taxation of collective investment schemes. Currently, it is holders of units that are subject to capital gains tax, and the fund itself is not when it trades shares and other financial assets. But this depends on the profits in the collective investment scheme being seen as capital in nature. Sars has caused great concern by issuing assessments to some hedge funds attempting to impose tax on the profits arising in the funds on the basis that trading is frequent and therefore the gains are not of a capital nature.
Given that hedge funds usually are aiming to reduce volatility for their ultimate investors by trading derivatives and other risk tools, taxing the income arising in the fund seems nonsensical — it will only serve to make it impossible for funds in SA to apply the risk strategies used widely in the rest of the world. It is also highly unpractical — if Sars prevails, and tax should be paid, who should pay? People invest and exit funds all the time. If such an assessment is found to be binding, must the current unit holders foot the bill?
The third concern is Sars’ claim against small bank Sasfin. The bank got itself into a serious mess after staff of its foreign exchange division got embroiled in a syndicate of tobacco smugglers aiming to get money out of the country. The Reserve Bank last month fined Sasfin R210m for violations of foreign exchange laws.
Sasfin closed down the division and pursued criminal charges against those implicated. But what shocked everyone was a claim from Sars for R4.9bn on the grounds that the bank was responsible for its inability to collect taxes from the syndicates who were moving money through the bank.
Just about every legal expert I’ve spoken to believes this claim to be hopeless — it would amount to holding a bank liable for any payment made from an account by any client that thereby renders the money unreachable by Sars. Sasfin only has R1.2bn of capital, so the claim, if successful, would render the bank insolvent. Such a claim is an exceptionally damaging thing to do to a bank, given that its business depends on depositors maintaining confidence in it.
On all three of these fronts, the financial sector has an understandable concern about Sars’ efforts. It is perfectly legitimate to pursue to the furthest extent problem all tax due, but Sars should avoid overzealous cases that risk undermining confidence in the financial sector and wider economy.
Stuart Theobald is chair of research-led consultancy Krutham (formerly Intellidex).
This article first appeared in Business Day.
