Steering clear of the general anti-avoidance rule in the Income Tax Act.
The new General Anti-Avoidance Rule in the Income Tax Act
One of the most significant amendments to the Income Tax Act in recent years was the repeal of section 103(1) which contained a GAAR (general anti-avoidance rule) and its replacement by a new Part IIA of the Act (embodying the new GAAR). The new GAAR applies to "impermissible avoidance arrangements" (as defined in the new section 80A) entered into or carried out on or after 2 November 2006.
Where a taxpayer falls foul of the new GAAR, the result is a triggering of the Commissioner's draconian powers to take action to nullify any tax benefit from the arrangement. These powers are now set out in section 80B, which states that:
The Commissioner may determine the tax consequences under this Act of any impermissible avoidance arrangement for any party by-
- disregarding, combining, or re-characterising 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;
- re-characterising 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.
It need hardly be said that these are draconian powers - so draconian in fact, that some may say that they transgress fundamental rights contained in our constitutional Bill of Rights and will be declared invalid by the courts
What constitutes an impermissible avoidance arrangement which will or may provoke SARS into invoking the new GAAR? This crucial term is defined in section 80L read with section 80A.
Let us consider what it means in the context of business (for there is a separate definition which applies outside a business context).
In the context of business an impermissible avoidance arrangement (i.e. one which falls foul of the GAAR) is an arrangement which, but for the GAAR, would result in a tax benefit and which -
- has a sole or main purpose of producing a tax benefit and which -
- was entered into or carried out by means or in a manner which would not normally be employed for business purposes other than the obtaining of a tax benefit; or which
- lacks commercial substance; or which
- has created rights or obligations that would not normally be created between persons dealing at arm's length; or
- would result in misuse or abuse of the provisions of the Income Tax Act.
This is a complicated definition, and the ands and the ors are crucial - that is to say the various combinations of elements that will result in a transgression of the GAAR.
If one looks closely at the ands and the ors, a crucial feature of the definition of an impermissible avoidance arrangement comes to light, namely - a sole or main purpose of tax avoidance is not, in and of itself, sufficient to make an arrangement an impermissible avoidance arrangement. Indeed, such a purpose, on its own, is fiscally irrelevant and has no adverse consequences.
It is only where such a sole or main purpose is coupled with at least one of the other specified features that the arrangement will become an impermissible avoidance arrangement. Those other features are -
- abnormality in the means or manner in which the arrangement was entered into or carried out in that such a means or manner would not normally be employed for bona fide business purposes other than obtaining a tax benefit; or
- a lack of commercial substance in the arrangement; or
- the creation of rights or obligations that would not normally be created between persons dealing at arm's length; or
- that the arrangement would result in a misuse or abuse of the Income Tax.
The converse is also important: abnormality or a lack of commercial substance or a resultant misuse or abuse of the Income Tax Act in an arrangement entered into by a taxpayer does not make an arrangement an impermissible avoidance arrangement unless it was coupled with a sole or main purpose of securing a tax benefit.
There are critical lessons to be drawn from all of this for a taxpayer who wants to ensure that his business deals will not fall foul of the new GAAR. Perhaps the most important lesson is that he must make sure that it appears from the contracts in question that the benefits being sought are ordinary commercial benefits, as distinct from tax benefits, and that any tax benefits are subordinate or merely incidental.
If, to take the extreme case, a businessperson were to enter into a business deal and was unable to point to any ordinary commercial benefits arising from it, and the only conceivable benefits were tax benefits, then the deal would be totally vulnerable to the GAAR, and there would be no defence if SARS were to issue an assessment on this basis and if the Commissioner were to exercise his fearsome powers under section 80B, quoted above.