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Don't forget the GAAR when structuring commercial transactions!


Introduction

We have all heard the saying, "If it sounds like a duck, walks like a duck and looks like a duck, it probably is a duck!". The same can be said for tax structures when structuring agreements. When structuring commercial agreements, people often do not give consideration to common law principles of "substance over form" and the South African income tax "General Anti-Avoidance Rules" as set out in section 80 of the Income Tax Act 58 of 1962 (the "Act"). Failure to have regard to the substance over form requirements as well as the GAAR may have severe consequences, in the form of SARS re-characterising the transaction, as well as possibly setting aside any tax benefits the taxpayer have obtained from the transaction, and imposing possible penalties and interest.


The GAAR

Section 80A through 80L of the Act, deals with the General Anti Avoidance Rules (the "GAAR"). There are four requirements which need to be met before the GAAR can be applied to a transaction, namely:

- there must be an arrangement;

-the arrangement must be an avoidance arrangement;

-the sole or main benefit of the arrangement must be to obtain a tax benefit;

-the avoidance arrangement must amount to an impermissible avoidance arrangement.[2]

In terms of section 80G(1) of the Act, an avoidance arrangement is presumed to have been entered or carried out for the sole or main purpose of obtaining a tax benefit unless and until the party obtaining a tax benefit proves that, reasonably considered in light of the relevant facts and circumstances, obtaining a tax benefit was not the sole or main purpose of the avoidance arrangement. The onus of proof in such a situation would be on the taxpayer to prove that the sole or main purpose of the transaction is not to have obtained a tax benefit. The implication of this means that, although there may be other reasons for entering into a transaction, if the main purpose (and not necessarily only purpose) is to obtain a tax benefit, then SARS can apply the GAAR to the transaction.


In SBI v Lourens Erasmus (Edms) Bpk[3] the court in the said case stated that the word ‘mainly’ meant to be a purely quantitative measure of more than fifty percent. It is submitted then, that when structuring commercial transactions, regard must be had to the "whole picture" of the transaction, the reasons for considering one structure over another- if the main reason for preferring another structure is simply that it offers a greater tax benefit, then caution needs to be adopted, especially if the preferred transaction lacks commercial substance. Whilst it is generally acceptable to order your tax affairs in a more efficient tax arrangement (provided it has commercial substance), it cannot extend to tax evasion- by deliberately structuring affairs in a way that it is not intended to actually be carried out.

In IRC v Brebner[4], the House of Lords stated: “...when a genuine commercial transaction is considered and there are two ways of carrying it out, one that involves paying more tax than the other, it is quite wrong to draw inference, as a necessary consequence, that in adopting the course which involves paying less tax, one of the main objectives is to avoid tax”.


In the case of ITC 1625[5] it was stated that in order to determine whether a scheme had the effect of the avoidance of tax, it had to be asked whether the taxpayer would “suffer a tax” were it not for the scheme. Lord Cairns stated in Partington v Attorney-General[6]:if the person sought to be taxed comes within the letter of the law, he must be taxed, however great the hardship may appear to the judicial mind to be. In other words, if there be an equitable construction, certainly such a construction is not admissible in a taxing statute”However, there does need to be something more than choosing one structure over another- if the substance over its form differs, and it lacks commercial substance (commercial reasoning for the transaction).

Before determining whether the arrangement is indeed impermissible in light of the GAAR, section 80A requires an ascertainment of the context in which the arrangement was made (business context, context other than business or any context). In any context, an arrangement will only be impermissible if it would result directly or indirectly in the misuse or abuse of the provisions of the Act or it has created rights or obligations that would not normally be created between persons dealing at arm’s length.[7] As such, the form of the arrangement would not normally differ from what the parties really intend.


The risk in structuring transactions in ways that are not usual, in order to avoid tax, may fall within the GAAR and may be set aside or re-characterised by the Commissioner of SARS, together with possible penalties and interest. There has been recent case law whereby seemingly "sham transactions" where scrutinised by SARS and the courts, whereby the agreement was looked at, the intention of the parties when entering into the agreement, as well as the steps taken by the parties to carry out the agreement. In such instances, it was in most cases found that intricate structures were adopted whereby the steps carried out did not match what was actually contained in the agreement.


The application of the misuse or abuse test could result in an interpretation of the law which is quite different from what normally occurs. If the wording of a provision is absolutely clear, it must still be applied despite ‘however great the hardship may be to the judicial mind’.[8] Accordingly, it is suggested that parties seek legal counsel at all times when contemplating structuring of commercial transactions, and that such legal counsel are qualified to provide tax advice on the proposed transactions. It is essential that impermissible avoidance arrangements are avoided, and that the true substance of the agreement is contained in the agreement and actually carried out.


Summary

Seek legal advice when preparing agreement. If an agreement lacks commercial substance, this can be an indication that it may be a risk of falling within anti-avoidance provisions. The parties should always assess the purpose behind the vehicle chosen, to avoid potentially falling foul of anti-avoidance provisions. Tax is a specialised field, and hence, we suggest that careful due diligences are undertaken before the fact, and not after.


Disclaimer: This article is for information purposes only, and may contain errors and/or omissions, and should not be regarded as legal advice or tax advice. Always seek advice from your own practitioner. Spence Attorneys will not be held liable for any person acting and/or omitting to act as a result of this article.


[1] Income Tax Act 58/1962 Part 2A: ss80A-L. [2] Croome et al (2013): 490. [3] 1966 (4) SA 434 (A), 28 SATC 233 245. [4] (1967) 1 All ER 779 at 784 [5] 59 SATC 383 [6] (21 L.T. 370): [7] 80Ac (I)(ii). [8] Partington v the Attorney General 21 LT 370.

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