tax paid method. The nominal rate method is defmed on the basis of comparison of nominal rates.66 According to Deak and Sandler67 the nominal rate method does not take into account the use of fiscal incentives. For example, a company may have a high tax rate but offer incentives such as tax holidays for new businesses, accelerated depreciation, investment tax credits and other similar incentives, all of which reduce the CFC's effective tax rate to considerably below such statutory nominal rate.
The effective tax rate approach involves calculating the effective tax rate paid by the CFC in its country of residence and determining on this basis if the country is a tax haven.68The effective tax rate approach appears to eliminate the flaw caused by the nominal tax rate approach as discussed by Deak and Sandler above, however, as pointed out by the OECD69, this method involves calculating the effective tax rate of each CFC in each foreign country on an annual basis and as such is compromised by its tediousness and complexity.
The actual tax paid method involves comparing the actual foreign tax paid by the CFC to what it would otherwise have paid had it been resident in the domestic country. According to the OECD,7° this is the most effective method of the three methods discussed. However, like the effective tax rate method, an annual calculation has to be done to determine the tax payable in the domestic country. Macheli71 comments that because of the complexity of the calculations and the uncertainty for taxpayers and revenue authorities in determining whether a particular foreign country is a tax haven within the meaning of a country's definition, most countries have tended to adopt the list or designated jurisdiction approach independently or to supplement the tax rate approach.
2.7.2 Characteristicsoftax havens
66 The nominal rate is the rate of tax specified in a country's tax legislation that is applied to a company's taxable income to determine the tax payable.
67 Deak and Sandler 'Hungary: CFC Legislation Introduced' (1997) 37 European Taxation 402.
68 Amold The Taxation ofControlled Foreign Corporations: An International Comparison (1986) 424 -430.
69 Sandler Controlled Foreign Company Legislation (1996) (OECD) 42.
70 Ibid.
71 Macheli A Critical Legal Analysis ofthe Regimefor the Taxation ofControlled Foreign Entities in Terms ofSection 9D of the Income Tax Act No. 58 of 1962 (Unpublished PhD dissertation, University of Natal Pietermaritzburg)
(2000) 234. '
The Gordon Report (Gordon 1981), prepared by the U.S. treasury on the use of tax havens, lists a number of characteristics of tax havens:72
• low or no taxes on all or certain types of income and capital;
• bank and commercial secrecy;
• lack of exchange controls;
• relative importance of banking;
• excellent communication facilities;
• effective tax treaties; and
• political and economic stability.
The 1998 OECD report Harmful Tax Competition: An Emerging Global Issue (1998 OECD Report) lists the following factors to identify tax havens:
• no or nominal taxes on income;
• lack of effective exchange of information about taxpayers benefiting from the low tax regime;
• lack of transparency in the operation of legislation, legal or administrative provisions; and
• the absence of a requirement that a qualifying activity needs to be substantiated (1998OEeD Reportop cifpara 52).
As can be deduced from the above, there is common ground with regard to the characteristics of tax havens as viewed by different authors and authorities, especially with regard to secrecy, lack of information exchange and low or no taxes on income.
2.7.3 Motivation to use a tax haven
According to Ginsberg, the most common factors motivating the use of a tax haven are:73
• high taxes in the country of residence, particularly where a progressive system of taxation applies;
• inheritance provisionsinthe country of residence;
• overseas employment contracts, particularly if overseas income is free of tax unless remitted to the country of domicile;
• anonymity and secrecy with regard to bank accounts, nominees and bearer shares;
• political considerations74;
• re-routing of export sales75;
72 Anin-depth analysis of each of these characteristics falls outside the scope of this dissertation. For such an in-depth analysis of the characteristics refer to Sandler Tax Treaties and Controlled Foreign Company Legislation 2nded (1994) 5.
73 GinsbergInternational Tax Havens (1990) 7.
74 This refers to political considerations such as those which inhibit wealthy individuals (or companies) from holding their fortune in the country of residence.
75 For example in the case of an author or investor, or of overseas purchasing in the case of an individual entrepreneur.
• depositing surplus funds76;
• accumulation of income prior to emigration or retirement;
• geographical expansion needed for multinational corporations; and
• couples intending to divorce, to protect their estates from greedy ex-spouses.
Arnold and McIntyre in International Tax Primer (2002)77 ascribe the increase in the use of tax havens over the last two decades to the following additional factors:
• the elimination of exchange controls in high-tax countries;
• improved communications and financial services;
• flexible commercial regimes and strict confidentiality requirements; and
• aggressive marketing by tax havens.
As pointed out above, there is also common ground of agreement with regard to the reasons for using tax havens, especially that of flexible commercial regimes and confidentiality requirements.
During the last 10 years, there have been specific anti-tax haven initiatives taken by the OECD. The 1998 OECD Report78
suggests a number of measures that countries may take to counter the abuse of tax havens and harmful tax practices. These include enacting unilateral legislative provisions like CFC legislation to more effective exchange of information provisions in double taxation agreements.
2.7.4 South African legislative provisions regarding tax havens
To date South Africa has not enacted any specific legislation regarding tax havens. As a result there is no identification or 'blacklisting' of countries as tax havens by the South African revenue authorities. According to Brincker, Honiball and Olivier (2003)79 the only country-specific anti-tax avoidance legislation is the 2002 amendment to s 9E (8)80, in terms of which the Minister of Finance may exclude specific forms of income derived by designated countries by notice in the Gazette. Section 9E can be regarded as an example of domestic legislation which attempts to curb harmful tax practice in another country.
76 This could be, for example, in a family trust.
77 Amold and Mclntyre International Tax Primer (2002) 137.
78 OECD Report Harmful Tax Competition: An Emerging Global Issue (1998)
79 Brincker, Honiball and Olivier International Tax: A South African Perspective (2003) 102.
80 Section 15 of the Revenue Laws Amendment Act 74 of 2002 with effect from 13 December 2002.
Apart from section 9E(8) above, the general anti-avoidance provision of section 103(1) is wide enough to apply to the abuse of tax havens. Section 103(1) applies both to residents and non-residents and provides that:
,... where the Commissioner is satisfied that any transaction, operation or scheme has been entered into or carried out which has the effect of avoiding or postponing liability for the payment of any tax, has created rights or obligations which would not normally be created between persons dealing at arm's length, was entered into in a manner which would not normally be employed for bona fide business purposes or in any abnormal manner, and was entered into or carried out solely or mainly for obtaining a tax benefit, the Commissioner may determine the tax liabilitY as if the transaction had not been carried out.,81
As a result, section 103(1) can serve as general anti-tax haven legislation, as the Commissioner may use the power bestowed upon him in this section to curb the abuse of tax havens by residents.
81 Section 103(1) of the Income Tax Act 58 of 1962.
CHAPTER 3
AN ANALYSIS OF THE RECENT CONTROLLED FOREIGN COMPANY LEGISLATION IN SOUTH AFRICA WITH EMPHASIS ON CURRENT
UNCERTAINTIES
3.1 INTRODUCTION 35
3.2 THE STRUCTURE OF SECTION 9D 36
3.3 THE TERM 'FOREIGN COMPANY' 37