1. Davis Committee Submission: Base Erosion and Profit Shifting (First Interim Report) Keith Engel: Deputy CEO of SAIT (31 March 2015)

2. Factual Information Overview Limited Information Available

3. Quick Summary of Reserve Bank Numbers Categories Percentage Increase from 2008 to 2011 Impact Intellectual Property Under 10% per annum Non-significant Legal, accounting and management consulting services Approximately 50% aggregate increase Biggest stated concern Advertising and market research DeclinedNon-significant R&D Approximately 3% Non-significant Architectural, engineering and technical services Approximately 8% Non-significant Agriculture, mining etc. Approximately 29% Significant

4. Preliminary Thoughts Tax and Economic Recession – No proof exists in SA or internationally that an economic decline leads to greater tax avoidance by multinationals – To the extent that a BEPS problem exists, it predates the recession (note: OECD harmful tax practice concerns in the late 1990s) – Most companies are focusing on core compliance; while tax avoidance exists, many have taken far less aggressive positions due to the growing audit risk and reputational risk Some causes for the numbers – The legal, accounting and management fee numbers could be a cause for concern, but the high usage by State-owned enterprises runs contrary to this thought (the BEPS risk is with connected persons such as multinationals, not with state-owned enterprises which are independent from the service-provider) – Many companies are reducing labour costs and are accordingly centralising back-office functions (tax often not a consideration) – Global mining has been cutting middle-management in South Africa to reduce their risk profile given the local political aversion to mining – other businesses are doing the same

5. Marketplace Traditional source of tax avoidance – Finance transactions Circular financing flows (boutique firm driven but increasingly resisted) Conversion of taxable income to exempt amounts – e.g. interest converted to dividends (sophisticated financiers) – Mergers and acquisitions – Global supply chain management (BEPS concerns tax but it is only one leg; often other cost savings) Overall climate – Multinationals are cutting tax staff (which is seen as a cost) – Most South African operations of foreign multinationals have only 2/3 tax staff and have most of their pricing and cross-border structuring set by the foreign global office – Increasing focus is on normal tax compliance given the rising efforts of revenue officials – Reputational issues and administrative hassle are reducing aggressive planning – However, company tax directors may take aggressive positions to preserve expected levels of tax (often if the original estimate is in error)

6. Need for Better Forms (and Capturing) Traditional Income Tax Form IT14 Company Tax Form – No distinction between a local company versus a foreign company operating in SA, except a box checkmark – SARS does not divide the two into separate audit tracks But rise of IT14SD for transfer pricing Cross-Border Withholding Outgoing royalty form Outgoing interest form (in progress) Outgoing services (pending) Need: – Country-by-country breakdown – Need for statistical claims of tax treaty protection

7. Debt (Picture Unclear) Recent Numbers “Public corporation” debt increases from R12,608 million to R27,407million from 2007 to 2013 – Jumped in 2007/2008 and again 2010/2011 – Does this include State-owned enterprises? Private debt stayed in the same band Countries to watch for: – Netherlands R268,328 million; Luxembourg R29831 million; Malta R17829 million; Switzerland R15,026 million; Mauritius (R10 510 million); others Bermuda and Singapore Anti-avoidance Legislation Hybrid Debt (2013/14) Section 23M overall limits (2014/15) Section 23N acquisition debt limits and old section 23K (2011 – 2015) Transfer pricing (2011/2012 plus tightening enforcement) General judicial enforcement plus GAAR

8. Some Conceptual Thoughts Background BEPS

9. “Base Erosion Profit Shifting” Targets Level 1: Shareholder-level considerations (not a BEPS focus/but an African focus) Level 2: Underlying company level considerations – Concerns about excessive interest deductions – Concerns about other excessive deductions (e.g. technical fees) – Use of withholding as a blunt instrument Level 3: Tax treaties – Treaties are a compromise on sovereignty – Increased desire for information exchange – UN interpretations are generally preferred by African countries

10. BEPS Versus Developing Country Focus Foreign Holdco (No/Low Foreign Tax) SA Subsidiary (28% tax base) 100% Capital gains & dividends Base Erosion and Profit Shifting (OECD concern): Preservation of the SA Subsidiary tax base (28%) India (developing country concern): Preservation of local tax on foreign dividends/SA subsidiary

11. Deductible Payments Paid Offshore Payment type South African Company Level Foreign Shareholder Level Dividends Company income with no deduction (R100) 5% or 10% dividends tax Deductible amounts (BEPS) (typically interest, royalties and manageme nt fees) Company income with deduction (R100 – R100) Often no tax Potential Answers to BEPS: – Deny/limit deductions if the payee has no global taxable income – Increase tax at the shareholder level Increased withholding taxes (but note that a tax on gross can be very distortionary) Limit the application of treaties – Rebalance the profit so the profit arises where the true economic substance lies

12. BEPS Risks and Options CategorySA PayorForeign PayeePolicy Options ServicesDeductible Treaty relief for foreign source or limited SA source (i.e. no PE) 1. Transfer pricing RoyaltiesDeductible Treaty rates often reduced to 0/5% 2. Cross-border reporting InterestDeductible Treaty rates often reduced to zero 3. Deny / limit deductions if not discriminatory DividendsNot Deductible Treaty rates reduced to 5/10% 4. Change treaty (e.g. rates plus anti- avoidance rules)

13. Action Points Comments

14. Action Plan #1: Digital Economy (Income Tax) Agree no urgency here – While SA has modernised to a degree, SA economy has not reached the US, European level (e.g. most internet companies in Africa remain small and relatively unprofitable) Not seeing the rise of local e-commerce businesses from abroad (other than Amazon) Little CFC risk – There is a danger in enacting source rules in opposition to the international grid (i.e. tax treaties do not resolve conflicts in source only residency/source conflicts) – Is there any evidence of a foreign taxpayer within South Africa utilising e- commerce as a means of avoiding the status of a permanent establishment? Query – Is e-commerce really something separate? Is it only a means of connecting an underlying activity? Or does it just blur the line? – Examples: E-books – are they a purchase of a book or a right of use (the latter being taxable on a payor source principle like a royalty)? – Often e-commerce can merely be a means of transmitting a service – To restate, it is hard to impose a consumption principal for income tax (that is for VAT), the same concept may be better expressed as a payor principle (like a royalty)

15. Action Plan #1: Digital Economy (VAT) Regulations (primarily intended to cover B2C) – Educational services – Games of chance – Internet-based auction service – Miscellaneous services (e-books, audio-visual content, still images and music) – Subscription services Why is business-to-business included at all? The compliance cost of these items outweigh the tax? Note on Bank VAT systems (blocked or real-time): The banks are increasingly becoming agents of SARS. These costs are not insignificant. Any VAT system of this nature will be very expensive with costs eventually passed onto customers

16. Action Plan #2: Hybrid Instruments Note – not just a cross-border problem: The debt/equity distinction is important because taxpayers should not be able to choose tax results based solely on form: – Debt label (deduction for payor/income for payee) – Dividend label (no deduction for payor/payee either exempt or subject to a 5/15% rate) – Hence, sections 8E, 8EA, 8F and 8FA may have to be retained for domestic law purposes As a cross-border concern, there is a lot to be said for reliance on foreign tax law – Current law: The participation exemption does not apply if payment in respect of the foreign counter-party is deductible in the foreign country – Proposal: Section 11 deductions should not apply if the receipt of payment does not treat the amount as interest income in the foreign country – What to do with intermediary zero-tax countries (payment of interest on debt to low tax country followed by a dividend from the low tax country to the third country) – Are there other mismatch instruments? (financial leases? Services versus royalties in terms of e-commerce?)

17. Action Plan #2: Hybrid Entities It is not entirely clear whether hybrid entities are a significant base erosion tactic in the South African context Current law applies partnership principles to a foreign entity that is treated as a foreign tax partnership; silence exists as to foreign tax company status – Not clear what impact the rule has? – What happens if more than 2 countries are involved The probable big threat – US check-the-box regulations – An SA company treated as a US tax partnership (bigger issue is the undermining of the US CFC rules) – Alternatively, the SA tax system probably treats a foreign LLC as a company unless the foreign country treats the entity as a foreign tax partnership

18. Action Plan #2: Note on Excessive Debt Exchange control fully controls the maximum interest rate; at issue is excessive debt with reasonable interest – Excessive debt has terms like normal debt and no explicit hybrid features (except actual payment is effectively not required if unavailable) – There comes a point excessive debt acts like equity The excessive debt rules are incomplete – Three-parts initially envisioned Safe harbour (transfer pricing) Facts-and-circumstances (transfer pricing) Per se bad (section 23M) – Section 23M is too broad because the 50% threshold fails to account for genuine minority/independent interests (BEE)

19. Action Plan #5: Harmful Versus Acceptable Tax Preferential Regimes Late 1990s revisited – Does the local regime fully apply to local activities or just external activities? – Things like local special economic zones are acceptable because the local activity is real and the local country is sacrificing its own tax base – A harmful tax practice compromises another country’s tax base (e.g. the Mauritius GBL1 & 2) Is the substantial activity test really useful? – Note: Most low-tax countries actually want activity – The history of these tests is not exciting (note: the CFC foreign business establishment test)

20. Action Plan #5: Headquarter Company Regime? Concerns mitigating against the regime – Lack of activity required? – Makes SA politically vulnerable On the other hand – Many European countries are doing the same (e.g. royalty boxes) – Mauritius GBL – Need for SA as a financial gateway location? Query – If the report wants the regime to operate as headquarter versus a holding company regime, why is section 6quin on the list for termination (the purpose of section 6quin was to provide service gateway status both inside the tax preferential regime and all other companies to avoid the harmful criteria)?

21. Action Plan #6: Prevent Tax Treaty Abuse (Overall Comments) Application of GAAR/SA law – Clarify the role of section 108 – Check to ensure that local GAAR/judicial precedent is in line with tax treaty principles Tax treaties – Tax treaties with low tax countries should be terminated or treated with greater care (less preferential terms); too much has been given in the past to risky countries – Not in favour of the US limitation on benefits (just a complex activity test) – A tax treaty GAAR should be introduced Note: Not all treaty benefits cause a risk for SA – only payments that are deductible in SA like interest payments (whereas, outward dividends do not threaten the local tax base)

22. Action Plan #6: Treaty Abuse (Problematic Tax Treaties) Interest article: Switzerland, Luxembourg and Netherlands Mauritius Article: Revised treaty supported – the only question may be the tie-breaker clause for residence given Exchange Control (i.e. use of foreign incorporated SA tax residence entities to avoid exchange control without tax relief) Zambia: SA should place some pressure for a revised treaty Brazil: Removal of tax credit schemes Should SA introduce a technical fee article like most African countries (impose tax at 5%)? Tax sparing: Not a real consideration other than Mauritius; most tax sparing clauses require further secondary negotiation

23. Action Plan #8: Transfer Pricing and Intangibles (Need for Action?) Report rightly points out: – Section 31 transfer pricing fully in place – Exchange control rules – Section 23I for former SA intellectual property – GAAR/beneficial ownership tests – Statistics do not show an overwhelming concern – Note: Most charges contain only a 5% mark-up Can SA go further? Check the royalty rates of certain low tax jurisdictions not known for developing intellectual property

24. Action Plan #8: Focus on Services? In South Africa (like the rest of Africa), the bigger issue is services Types – Stewardship (central management) – Offshore technical support – Local technical visits (focus on high mark-up activities – e.g. management consulting/technical engineering Is there something to be said for local and foreign withholding at 5% – Note: Taxpayers often engage with a local company for indirect foreign technical service support – Note: There is also a local tax evasion problem Can the new withholding tax on service rules be improved so the compliance costs are reasonable?

25. Action Plan #13: Transfer Pricing Documentation Practice Note 7 – It should be updated as suggested by the Committee – The Practice note should not restate the OECD guidelines word-for-word but merely refer to guidelines that will be followed (to avoid unintended differences) – However, some relief should exist for investments into “Rest of Africa”; services are often undercharged for non-tax reasons; these low-cost services are really indirect capital contributions to offshore subsidiaries (alternative to section 6quin) Forms – Are the current forms relating to transfer pricing the most effective? – Can SARS see the supply chain?

26. Action Plan #13: Materiality Rationale for Materiality – Company compliance costs are rising – Tax staffs are much smaller than one realises (foreign-owned entities typically do not have more than 4 full-time personnel) even if part of a large company group – Pricing is set globally based on a global mandate in which SA is typically very small – There are simply too many small transactional items to keep control (in terms of time and operational activity) Safe harbours or semi-safe harbours – Offshore royalties rarely have a mark-up exceeding 5% – One can have a safe harbour and per se risk areas (perhaps by shifting burdens of proof) – Note: The problem is often not in the mark-up but in how centralised services are allocated (e.g. turnover method or per country-method)

27. Action Plan #13: Training? Like most of the world, SA suffers a severe shortage in Transfer Pricing expertise – One must either create simplifying presumptions to reduce the numbers; or – Increase skills How to increase skills? – Is there a way to create a combined institution for training? (“a shared understanding”) – Need for business and SARS to work together (government knows the policy/taxpayers know the business)

28. Action Plan #14: Multinational Instrument Multinational instruments are supported – Speed – SA stays in sync with international practice (i.e. does not lose competitive advantage) Country-by-country reporting – Inevitable – How do we prevent over-reaching leading to double taxation? Enforcement of taxpayer rights – While it is accepted that treaties should not lead to double taxation, how can we ensure that treaties are actually applied to prevent double taxation (i.e. competent authority) – Should competent authority remain solely with SARS (e.g. Tax Ombud)?

29. Thank you