There is not so much of a fine line between tax evasion and tax planning as there is a giant grey superhighway dissecting the two named tax avoidance, says Mark Diuga, regional wealth manager in Cape Town at Overberg Asset Management.
The South African Revenue Services (SARS) crackdown on non-compliant taxpayers in recent months is well documented. The National Prosecuting Authority (NPA) is issuing summonses to taxpayers with outstanding tax returns as part of a continued compliance drive by the tax body.
“The tax we pay to the government is our contribution to South Africa’s welfare. We need it to build roads, schools and hospitals. We need it to ensure our safety and security as citizens of this country. Without it, we must borrow from other countries and institutions such as the IMF on terms that are not necessarily favourable, SARS noted.
“SARS will make it hard and costly for any taxpayer who willfully and intentionally seeks to break the law as we expect every taxpayer to meet their obligations and pay their fair share of tax,” it said.
Diuga highlights the difference between evasion, planning and avoidance:
- Tax Evasion: using unlawful methods to pay less or no tax. Usually, this constitutes fraud, i.e., falsifying statements or presenting false information to the South African Revenue Service (SARS) with penalties including imprisonment.
- Tax Planning: legally, you may arrange your financial affairs in such a way as to reduce your tax liability; a commonly used approach would be to make contributions into a retirement annuity to receive a tax refund and, by doing so, you can use the funds to build long-term wealth whilst deferring an income tax liability until the point of receiving a benefit.
- Tax avoidance: is everything in between which constitutes you paying less tax than SARS would like.
Tax avoidance is, on the face of it, lawful, and some would even suggest that an individual is duty-bound to pay as little tax as is lawfully permissible, said Diuga.
“Lord Tomlin in Duke of Westminster V IRC 1953 (UK) famously held that ‘Every man is entitled, if he can, to order his affairs so that the tax attaching under the appropriate act is less than it otherwise would be’.”
Global Revenue Services disagree, however.
Enter General Anti-Avoidance Rules (GAAR) – ever-changing rules and efforts, locally and internationally, designed to push the lawful, yet undesirable, tax avoidance practices into extinction and turn that superhighway into a one-way street travelling to fines and punishments, said Diuga.
“I have had many a dinner party conversation about the unjust nature of a ‘Starbucks’ or ‘Amazon’ potentially using a myriad of jurisdictions, ownership layers, transfer pricing, base erosion and profit shifting with the net outcome of paying less tax.
“These conversations usually end with a hypothetical, but yet contradictory, statement in that people would, generally, like to pay SARS less, if possible – and legal,” he said. Many begrudge others achieving a perceived advantage which is unavailable to us, tax or otherwise.
Impermissible avoidance arrangement and updated GAAR (80 A-L)
Tax avoidance is typically described as the use of ‘impermissible avoidance arrangements.’ Overberg Asset Management noted that the 2006 amendments to the Income Tax Act 1962 set out four requirements that must be established to determine whether an impermissible avoidance arrangement exists:
- The existence of an avoidance arrangement.
- The arrangement must have been entered into on or after the effective date, 2nd November 2006.
- The sole or main purpose was to obtain a tax benefit.
- The arrangement must include an ‘abnormality’ element.
“Without getting bogged down by the legalese; there must be some form of transaction, which has taken place after November 2006 whereby the main purpose was to obtain a tax benefit, and the arrangement lacked personal/business or commercial ‘substance’ – essentially was it a natural transaction which would have occurred had there not been any tax benefit,” said Diuga.
He said that demonstrating the economic ‘substance’ of an entity and a transaction is becoming increasingly important globally.
“You can see how this can become a minefield for advisors and their clients. You may legally reduce your tax liability – and may be morally justified in doing so – but you must not do so in a manner that is ‘undesirable’ or was simply done so to reduce tax liability,” Diuga said.
As a result, he said that many financial advisors stick to tried and tested vanilla financial products such as retirement plans, tax-free savings accounts and endowments.
South African legislation, and in particular financial regulation, has had a history of following UK law. As GAAR provisions were last specifically amended back in 2006, the question is: could South Africa be due an upgrade?
The Tax Administration Act 2011 started to shift the conversation to the promoters of financial arrangements/ schemes with inherent tax benefits and the requirement for the promoters themselves to disclose the arrangement to SARS.
Diuga questioned whether this could go a step further.
He noted that the UK’s Finance Act 2021 recently received Royal Assent, meaning the bill will soon be enacted.
Among other provisions and amendments, the bill provides new powers to HMRC – the UK’s Revenue Service – to clamp down on the promoters and enablers of tax avoidance by disrupting their activities and doing more to support customers to steer clear of leave tax avoidance arrangements.
New powers under the Act enable HMRC to:
- Use freezing orders to ring-fence assets to make sure that promoters and enablers of tax avoidance schemes cannot escape the financial consequences of their non-compliance.
- Levy significant additional penalties to any UK entity which facilitates the promotion of tax avoidance by offshore promoters.
- Present winding-up petitions to the Court for companies operating against the public interest, removing them from the market and reducing the harm they cause to taxpayers and the wider economy.
- Name promoters, details of how they promote tax avoidance, and the schemes they promote, at the earliest possible stage, warn taxpayers of the risks and help those already involved get out of avoidance.
Diuga said that taxpayers will always seek new and innovative ways of avoiding tax, the effectiveness of the South African GAAR remains an area of concern, despite attempts to address its weaknesses.
“Be mindful that your advisor may lack the knowledge, expertise and confidence to help when it comes to navigating tax issues alongside your financial planning, or their business may simply refuse to engage on the topic,” he said.