South Africa’s long-awaited “headquarter company” tax regime, which aims to establish the country as a gateway for investment into Africa, came into effect in 2010.
However, although the new regulations have provided qualifying companies with various tax benefits, the approach of the South African Revenue Service (SARS) to determining a company’s “place of effective management” means that that many of the qualifying companies’ subsidiaries will be South African tax residents, exposing them to tax in South Africa on the totality of their income, and the prospect of claiming a rebate for taxes paid in foreign jurisdictions where they operate effectively negates the tax benefits offered by the new regime.
To address this, SARS recently released a discussion paper providing an analysis of potential revisions to the way a company’s place of effective management is determined.
Place of effective management
No internationally accepted meaning of the concept of “place of effective management” has yet evolved. However, it is generally accepted to include at least two interpretations: either the place where the board of directors meets, or the place where senior management conduct the operations of the company.
What SARS has adopted is the latter view. Interpretation Note 6, issued in 2002, sets out the general approach, stating that the effective criteria should be the place where the company is managed and controlled on a day-to day basis by its senior management, irrespective of the place where the board of directors meets.
The three-stage enquiry
From a practical point of view, the interpretation note sets out a three-stage enquiry.
- First, if the relevant management functions are exercised at a single location, this will be the place of effective management.
- However, if they are performed at multiple locations, the place of effective management will be the place where day-to-day operational management occurs and where commercial decisions are taken and implemented by senior management.
- Lastly, if business operations are conducted at various locations, the place of effective management is the place where the strongest economic nexus to the company exists.
This test, which focuses on the location where strategic corporate decisions are taken and implemented, contradicts accepted international practice over the question of corporate residence, which focuses usually on the location where ultimate authority in the company is exercised – in other words, where the board of directors takes necessary decisions. Internationally, this is known as the “board-centric” approach.
However, while SARS’ practice puts South Africa in a minority, the board-centric standard was recently scrutinized in a United Kingdom case and found to be wanting. In Laerstate BV v HMRC, the court held the real test when assessing liability to corporate income tax should be to determine where a company is actually managed and controlled. The actions of the directors were held to be insufficient as it was clear that the mere signing of resolutions and other company documents does not necessarily amount to actual management of a company. The OECD has also recently moved away from a board-centric approach.
The discussion paper makes it clear that SARS will not abolish the current South African rules as set out in the Interpretation Note. Instead, it proposes to refine them to ensure greater clarity in the way they are applied. Any revision will be focused specifically on removing uncertainty created by the adoption of an approach which appears to conflict with most international authority on corporate residency rules, those being that the place where decision-making takes place is the “place of effective management”.
Any revisions to the Interpretation Note will therefore aim to ensure flexibility to accommodate the broad variety of factual situations that can arise, given that both international and local authorities now seem to recognize that no single set of rules is sufficient to meet this challenge. The discussion paper emphasizes that SARS will continue to look at second-level management, with primary focus on the senior officers or executives who are responsible for actually developing key operational or commercial strategies, or taking decisions relating to key operational or commercial actions by the company, and ensuring that they are implemented. This will apply regardless of whether those strategies, policies and decisions are subject to formal approval by a board or similar body.
Furthermore, the discussion note proposes that in order to align the South African approach with the international norm, current references to “implementation” contained in the existing rules be deleted. This will mean that a company’s “place of effective management” will be the location where second-level management makes decisions, regardless of where these are implemented or (perhaps) rubber stamped. This is a change from the current practice and appears to be an attempt to align South African policy with mainstream international policy on this point.
The discussion paper also highlights the fact that any revised Interpretation Note will not lay down definitive rules regarding the assessment of a company’s place of effective management, and that any determinations SARS may make will ultimately remain a factual enquiry based on all the surrounding circumstances. SARS invited all practitioners and taxpayers to submit comments regarding the interpretation of corporate residency rules before 30 October 2011.
Multinational companies should be careful to consider the potential impact these proposals will probably have on their international group companies, given the possibly profound tax implications that may flow from decisions made by South African tax authorities on this issue.
Bernard du Plessis is the joint head of tax at Edward Nathan Sonnenbergs
150 West Street
Tel: +27 11 269 7400
Fax: +27 11 269 7899