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Tax Avoidance vs Tax Evasion: An Analysis of the General Anti-Avoidance Rules

By Ororiseng Maema

Taxpayers consistently seek new and innovative ways to structure transactions in a manner that has the least possible tax implications. Consequently, the legislature updates taxations laws to curtail tax avoidance. The legislature achieves this by developing and imposing General Anti-Avoidance Rules (“GAAR”).

This article Seeks to

  • identify tax avoidance arrangements to assist the taxpayer to avoid inadvertently entering into one; 
  • advise the taxpayer how to deal with instances where GAAR is imposed; and 
  • inform the taxpayer of the possible consequences should South African Revenue Services (“SARS”) impose GAAR.

Tax avoidance vs tax evasion

Prior to an analysis of the anti-avoidance rules, it is important to define and give meaning to these broad concepts that are sometime very loosely used and other times confused.

Tax avoidance involves the use of legitimate means, i.e., employing provisions of tax legislation in order to pay less tax. Tax evasion on the other hand, involves the use of illegal means by a taxpayer to free himself from a tax burden.

In Commissioner for South African Revenue Service v NWK Ltd wherein:

  • several agreements were concluded between NWK and FNB, and FNB and its subsidiaries, which together showed that a sum of only R50m was lent by FNB to NWK;
  • the transactions were devised to increase the ostensible amount lent so that deductions of interest on a greater amount could be claimed;
  • NWK argued, that there was an honest intention on its part to execute the contracts in accordance with their tenor, and the claims for deductions were valid; and 
  • the Commissioner contended that the Commissioner was satisfied that the transactions in question had been entered into for the purpose of avoiding tax.

It was said by the Court that:

It is trite that a taxpayer may organize his financial affairs in such a way as to pay the least tax permissible.There is, in principle, nothing wrong with arrangements that are tax effective

But there is something wrong with dressing up or disguising a transaction to make it appear to be something that it is not, especially if that has the purpose of tax evasion, or the avoidance of a peremptory rule of law

However, as Hefer JA said in Ladysmith, one must distinguish between the principle that one may arrange one’s affairs so as to ‘remain outside the provisions of a particular statute’, and the principle that a court ‘will not be deceived by the form of a transaction: it will rend aside the veil in which the transaction is wrapped and examine its true nature and substance.” [own emphasis]

Provided that there is no legislative prohibition, a taxpayer cannot be stopped from entering into a bona fide transaction which, when carried out, has the effect of avoiding or reducing a tax liability.

The tax courts have been consistent and firm in their stance that a taxpayer may structure his affairs in a manner that would allow him to pay the least amount of tax. In addition to the above-mentioned case, this principle is clearly set out by an international court in Duke of Westminister v IRC wherein it was stated that:

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.

A legitimate tax avoidance scheme is one where a taxpayer has arranged his affairs so as to minimise his tax liability in a manner that does not involve fraud, dishonesty, misrepresentation or other actions designed to mislead the Commissioner.

Tax evasion on the other hand involves the non-payment of a tax that would properly be chargeable if the taxpayer made a full and true disclosure of income and allowable deductions. 

Tax evasion can include but is not limited to the creation of false financial statements or deliberately presenting false information on a tax return. Non-compliance with Tax Acts as well as the evasion of tax with intent are criminal offences and are subject to severe penalties.

Notwithstanding the legality of tax avoidance arrangements, the implications are that such schemes often result in significant loss of tax revenue to the fiscus. This then necessitates the development and imposition of General anti avoidance rules otherwise known as GAAR to identify and prevent Impermissible Tax Avoidance Arrangements.

Below we discuss what would entail an Impermissible Tax Avoidance Arrangement. 

Impermissible tax avoidance arrangements

Section 80A of the Income Tax Act defines an Impermissible Avoidance Arrangement as an arrangement where:

  • the ‘sole or main purpose’ (of such an arrangement);
  • is to obtain ‘a tax benefit’ ;
  • with one of the ‘tainting’ elements;
  • depending on whether the arrangement is ‘in the context of ‘business’, or ‘in a context other than business’.

(“the Test”)

It is important to note that the elements of the Test must be considered in conjunction when determining whether a transaction is an Impermissible Tax Arrangement. The determining factor when considering all the elements together is whether the manner in which the transaction was entered into or carried out is a manner that would normally be used for business purposes other than to obtain a tax benefit. 

In general, an avoidance arrangement is presumed to have been entered into 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.

Beyond the (objective) Test provided for in section 80A the Income Tax Act provides for tainting elements which will be indicators of impermissible tax avoidance arrangements which include:

lack of commercial substance – which includes where a transaction would result in a significant tax benefit for a party 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;

round trip financing – which includes any avoidance arrangement in which funds are transferred between or among the parties (round tripped amounts) and the transfer of the funds would result, directly or indirectly, in a tax benefit and significantly reduce, offset or eliminate any business risk incurred by any party in connection with the avoidance arrangement.; and 

accommodating or tax indifferent parties – includes any avoidance arrangement in which funds are transferred between or among the parties (round tripped amounts) and the transfer of the funds would result, directly or indirectly, in a tax benefit and significantly reduce, offset or eliminate any business risk incurred by any party in connection with the avoidance arrangement.

Lack of commercial substance 

It is a common practice for taxpayers who want to avoid tax, to insert unnecessary and artificial steps into an arrangement in order to disguise the true substance of the overall arrangement.

The key identifiers for a transaction which lacks commercial substance are:

  • a significant tax benefit for a party; but 
  • no 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. 

The Court in ITC 1625(1996) provided that “a tax benefit has been obtained if the taxpayer would have suffered tax but for the transaction”. Therefore, a tax benefit is generally established by estimating what the tax consequence would have been had the arrangement not been entered into. 

In order to determine the significance of the tax benefit, the specific circumstances of each arrangement will be taken into account since ‘significant’ will differ from person to person.

Lacking commercial substance would include but is not limited to instances where 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. 

An example would be where the ownership of vehicle belonging to an individual who is both a shareholder and an employee of a trading company is changed to a dormant company in the same group of companies on a loan account equal to the value of the vehicle at the time of the transaction. The vehicle is subsequently leased to the trading company for the exact amount required to service the loan on a monthly basis. The trading company would be able to claim the rental amount as an allowable deduction and the creditor of the loan (the individual) would not be required to pay income tax on the money received from the dormant company as it would be the repayment of a loan. Objectively, it is evident that the sole purpose of the net effect of the entire transaction is to minimise tax liability for the trading company and the creditor of the loan. 

When considering a transaction has commercial rationale, it is imperative to consider the substance, i.e., the true intention of the transaction irrespective of what is recorded in the resulting contracts. The case of NWK v C SARS once again finds reference. The Court in this case set the a few important principles relating to substance over form. It was stated by the Court that:

“…the test to determine simulation cannot simply be whether there is an intention to give effect to a contract in accordance with its terms. The test should go further and require an examination of the commercial sense of the transaction i.e. its real substance and purpose.

If the purpose of the transaction is only to achieve an object that allows the evasion of tax, or of a peremptory law, then it will be regarded as simulated
.”

From the above, it is clear that the real purpose of the agreement must be established to see whether the agreement was simulated. 

It must be noted that the principle of ‘substance over form’ has its limitations and cannot simply be used to ignore agreements where the parties in fact and in law intend to give effect to an agreement. This was clarified by the Court in CIR v Cape Consumers (Pty) Ltd where it was stated:

The doctrine of the disguised transaction is not a panacea for appellant to ignore agreements where the parties in fact and in law intend that they must be given their legal effect. This is precisely what occurred in the instant case and accordingly there exists no basis to ignore such agreements.”

Therefore, in establishing true purpose of a transaction one is required to consider whether the parties to the transaction genuinely intended to be factually and legally bound by each step in the transaction as opposed to putting steps in place merely to receive tax benefits from the net result of the transaction.

The lack of a commercial substance could encompass the other tainting elements discussed below. 

Round trip financing

The elements of round-trip financing include:

  • funds are transferred between or among the parties (round tripped amounts); and 
  • the transfer of the funds would result, directly or indirectly, in a tax benefit and significantly reduce, offset or eliminate any business risk incurred by any party in connection with the avoidance arrangement. 

It is imperative to note that the round-trip provision in section 80D of the Income Tax Act applies regardless of the timing, manner and whether or not the amounts can be tracked. 

Typically, funds are made to appear to pass between the participants by way of a commercial consideration, but, in reality, the funds travel in a circle and in the end every participant is financially in the same position as they were at the start, except for the tax benefit that was created through this arrangement and the payment of fees to the intermediaries.

In round-trip financing agreements, accommodating or tax indifferent parties could be used. 

Accommodating or tax indifferent parties

The inclusion of an accommodating or tax indifferent party will indicate a lack of commercial substance. The characteristics of accommodating a tax indifferent party are as follows:

  • any amount derived by the party in connection with the avoidance arrangement is either not subject to normal tax; or 
  • 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
  • either as a direct or indirect result of the participation of that party an amount that would have –
  • 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
  • constituted revenue in the hands of another party would be treated as capital by that other party; or
  • given rise to taxable income to another party would either not be included in gross income or be exempt from normal tax; or
  • the participation of that party directly or indirectly involves a prepayment by any other party.

A person may be an accommodating or tax indifferent party whether or not that person is a connected person in relation to any party.

In order to ensure that normal business transactions do not fall within the net the following exclusions to the definition of an accommodating party have been incorporated:

  • the amounts derived by the accommodating party are cumulatively taxable in another country in an amount equal to at least two-thirds of the tax that would have been payable in SA; or
  • if the accommodating party continues to engage directly in substantive active trading activities in connection with the avoidance arrangement for a period of at least 18 months and the activities are attributable to a proper place of business.

In addition to the above, the Commissioner may treat parties who are connected persons in relation to each other as one and the same person or disregard any accommodating or tax indifferent party or treat any accommodating or tax indifferent party and any other party as one and the same person.

How can a taxpayer rebut SARS’ presumption of an anti-avoidance agreement

As stated above, a presumption is made that an anti-avoidance agreement has been concluded where the above indicators are present, and the obligation is on the taxpayer to rebut the presumption. 

The substantive trigger for the exercise of GAAR, as provided by the Tax Court, arises where SARS forms an opinion that there is an impermissible avoidance arrangement.

To summarise the above, for an impermissible avoidance arrangement to exist, the following four requirements must be met:

  • first, there must be an “arrangement”. An arrangement is defined in section 80L of the Income Tax Act as any transaction, operation, scheme, agreement or understanding (whether enforceable or not), including all steps therein or parts thereof, and includes any of the foregoing involving the alienation of property;
  • second, the arrangement must result in a tax benefit. If the arrangement results in a tax benefit, then it constitutes an “avoidance arrangement”;
  • third, the “avoidance arrangement” must have characteristics of abnormality and/or lack commercial substance as set out in section 80C and 80D; and
  • fourth, the “avoidance arrangement” must have had as its “sole” or “main purpose” the obtaining of a “tax benefit.

The onus to rebut the presumption on the taxpayer and the onus is discharged on a balance or preponderance of probability. Below we outline cases where taxpayers attempted to rebut the presumption.

 In ITC 1388 (1983) the taxpayer bought two companies with assessed losses. The Court extracted the essence of section 80D in stating that the Commissioner may disallow an assessed loss. The taxpayer’s dominant motive in acquiring the first company was to acquire its goodwill and to continue trading in its name. In fact, no mention was made of its assessed loss in the negotiations for its purchase. The assessed loss accordingly survived. As far as the second company is concerned, however, the assessed loss was clearly visible in its financial statements; it had ceased trading three years earlier (it had been collecting its book debts since then), it had no goodwill or premises, and the only advantage it seemed to have was its assessed loss. This assessed loss was accordingly forfeited.

Ordinarily, the purchase of a company which has assessed losses would lack commercial rationale. The reason being that:

  • the  transaction would result in a significant tax benefit for a party (i.e. that party would be allowed to set off the assessed loss against their current income, result in less tax liability); but 
  • the purchase of that company does not have a significant effect on or net cash flows of that taxpayer;
  • apart from any effect attributable to the tax benefit that would be obtained (i.e., the setoff).

In the above case the taxpayer was able to rebut the presumption in respect of the first company on account that the taxpayer was not aware of the assessed loss and, on a balance of probabilities, bought the company to continue trading using its good will as submitted by the taxpayer. 

However, the taxpayer was not able to rebut the presumption in respect of the second company because the taxpayer was aware of the assessed loss prior to the sale and purchased the company solely for the purpose of obtaining a tax benefit. 

In the case of Mariana Bosch and Ian McClelland v Commissioner for the South African Revenue Service wherein the appellants were employees of the Foschini group of companies and participants in an employee share incentive scheme run by that group. The type of scheme was what is referred to as a ‘deferred delivery scheme’. 

In essence, employees were granted options to purchase shares, which they had to exercise within 21 days. Once the option was exercised, delivery and payment in respect of the shares were delayed and would take place in three tranches, each two years apart. 

Before delivery and payment, the employees could not dispose of or encumber the shares, were not entitled to dividends and could not vote the shares. 

The risks and benefits did not pass to the employees until delivery and payment. 

The scheme was subject to a stop loss provision, which provided that employees could sell their shares back to the employer if the share price fell below the consideration that was payable on delivery. 

Further, employees were also obliged to sell their shares back to the employer for the same consideration payable on delivery if they terminated their service for any reason other than sequestration, death, superannuation, or ill health.

The scheme was subject to a stop loss provision, which provided that employees could sell their shares back to the employer if the share price fell below the consideration that was payable on delivery. Further, employees were also obliged to sell their shares back to the employer for the same consideration payable on delivery if they terminated their service for any reason other than sequestration, death, superannuation, or ill health.

The effect of the scheme was that the provisions of section 8A of the Income Tax Act were bypassed. Only gains arising within the 21-day option period would be caught by section 8A and be taxable as income in the hands of the employees, as opposed to the full gains over the longer periods until delivery and payment.

The appellants were assessed by SARS for income tax in respect of shares received in respect of the scheme. One of the arguments raised by SARS was that the scheme was a simulated transaction and that there was no real unconditional sale at the time of exercise of the option, but that the parties actually intended that the sale be subject to the suspensive condition that the employees remain employed until the date of delivery and payment. This was evidenced by the fact that an obligation to sell the shares back to the employer arose where an employee’s employment is terminated.

On assessment of the evident the Court found that there had been no simulation. The Court laid down the rule that “any transaction which has at its aim tax avoidance will be regarded as a simulated transaction irrespective of the fact that the transaction is for all purposes a genuine transaction.”

Tax consequences of impermissible tax avoidance arrangements

The Commissioner may determine the tax consequences under this Act of any impermissible avoidance arrangement for any party by –

  • disregarding, combining, or recharacterizing any steps in or parts of the impermissible avoidance arrangement;
  • 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;
  • deeming persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;
  • reallocating any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;
  • recharacterizing any gross income, receipt or accrual of a capital nature or expenditure; or
  • 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.

In essence, the Commissioner has the power to restructure or ignore transactions that amount to impermissible tax avoidance agreements. 

Conclusion

Taxpayers are permitted to structure their affairs in such a way that they avoid or minimise tax payable. Provided that in structuring their affairs, taxpayers do not breach of any tax Act – this would amount to tax evasion which is illegal. 

The legislature does however place restrictions on the right of taxpayers to structure their affairs in the most tax efficient manner. Taxpayers are not allowed to enter into transactions for sole or main purpose of obtaining a tax benefit. 

Where SARS is of the opinion that a taxpayer has concluded an impermissible tax avoidance arrangement, the onus is on the taxpayer the rebut the presumption on a balance of probabilities. 

Should the taxpayer fail to rebut SARS’ presumption, SARS may, inter alia, disregard, combine, or recharacterize any steps in or parts of the impermissible avoidance arrangement.

References

1. Commissioner for South African Revenue Service v NWK Ltd (27/10) [2010] ZASCA 168; 2011 (2) SA 67 (SCA) ; [2011] 2 All SA 347 (SCA) (1 December 2010)

2. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1135

3. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1136

4. (27/10) [2010] ZASCA 168; 2011 (2) SA 67 (SCA) ; [2011] 2 All SA 347 (SCA) (1 December 2010)

5. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1135

6. CIR v Conhage (Pty) Ltd 1999 (4) SA 1149 (SCA), 61 SATC 391; Pienaar Brothers (Pty) Ltd v C:SARS (87760/2014) [2017] ZAGPPHC 231 (29 May 2017)

7. (1953) (at 520)

8. SARS Practice Note 5 stamp duty, income tax, secondary tax on companies, tax on retirement funds, value added tax and uncertificated securities tax implications of lending arrangements in respect of marketable securities (14 APRIL 1999)

9. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1136

10. Such as the Income Tax Act 58 of 1962, the Value Added Tax Act 89 of 1991 and the Tax Administration Act 28 of 2011

11. Section 234 and 235 of the Tax Administration Act 28 of 2011

12. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1135

13. The tainting elelments are discussed from paragraph 18 below

14. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1135

15. Section 80A of the Income Tax Act 58 of 1962

16. Section 80G of the Income Tax Act 58 of 1962

17. Section 80C (1) of the Income Tax Act 58 of 1962

18. Section 80D (1) of the Income Tax Act 58 of 1962

19. Section 80D (1) of the Income Tax Act 58 of 1962

20. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1151

21. Section 80C (1) of the Income Tax Act 58 of 1962

22. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1141

23. Section 80C (2)(a) of the Income Tax Act 58 of 1962

24. 2011 (2) All 347 (SCA); In this case NWK entered into a series of complicated transactions with First National Bank. NWK had a loan from FNB and had to pay interest. NWK was claiming for deduction for the expenses incurred when paying this interest. The Commissioner disallowed the claim for deductions and raised further assessment on the basis that the agreements concluded between NWK, FNB and its subsidiary did not reflect the true substance of the agreement

25. 1999 (4) SA 1213 (C) at 1224H–I

26. Roshcon (Pty) Ltd v Anchor Auto Body Builders CC and others [2014] 2 All SA 654 (SCA)

27. Section 80D (1) of the Income Tax Act 58 of 1962

28. Section 80D(2) of the Income tax Act 58 of 1962

29. M Stiglingh (editor), AD Koekemoer & L Van Heerden et al SILKE: South African Income Tax 2022 (2021) 1142

30. Section 80E(1) of the Income Tax Act 58 of 1962

31. Ibid

32. Section 80E(2) of the Income Tax Act 58 of 1962

33. Section 80E(3) of the Income Tax Act 58 of 1962

34. Section 80F of the Income Tax Act 58 of 1962

35. Mr X v The Commissioner for the South African Revenue Service (Case No IT24502) and Mr Y v The Commissioner for the South African Revenue Service (Case No IT24503) (as yet unreported).

36. An assessed loss is any amount by in terms of which the allowable deductions exceeded the income relevant to those deductions in terms of the Income Tax Act.

37. (394/2013) [2014] ZASCA 171; [2015] 1 All SA 1 (SCA); 2015 (2) SA 174 (SCA) (19 November 2014)

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