Covid-19: How to manage 'place of effective management' tax risk during lockdown

Covid-19: How to manage 'place of effective management' tax risk during lockdown

• 06 May 2020
• Corporate Tax
• Webber Wentzel

Covid-19 is only anticipated to peak in South Africa (SA) in September 2020, with international air travel only being permitted once the current lockdown restrictions are reduced to Level 1. This may result in some chief executive officers, or other senior executives/board members of foreign companies being unable to travel from SA to attend board meetings or conduct business in the country where the company is tax resident. Could this put the foreign company at risk of becoming South African tax resident?

Under South African domestic law, a company will be tax resident in SA if it is incorporated in SA or has its "place of effective management" in SA. A foreign company may be incorporated outside SA, but it will qualify as South African tax resident if it is effectively managed from SA.

The term "place of effective management" is not defined in the Income Tax Act. SARS' view on what effective management means has evolved over time, with the current approach as discussed in SARS Interpretation Note 6 (2015) being that an entity's place of effective management will be the place where top level key managerial and strategic decisions that are necessary for its business as a whole, are made in substance.

It is not unusual for foreign companies to have one or more board members who live in SA, especially if the foreign companies are subsidiaries of a group headquartered in SA. If SARS were to take the view that managerial decisions taken in SA during the lockdown by a CEO or other board members of a foreign company have caused the foreign company to become a South African tax resident, then it will be at risk of being taxed here as well as in the country where it is normally tax resident.

Where a company is dual tax resident, i.e. tax resident in both SA and another country under those countries' respective domestic legislation, it is necessary to refer to the double taxation agreement entered into between those two countries, if one exists, to determine which country will have the primary taxing rights over the company's income.

In early April, the Organisation for Economic Co-operation and Development (OECD) issued guidance on the analysis of certain tax treaty provisions in the context of the impact of the Covid-19 pandemic.

The OECD suggests that it is unlikely that the Covid-19 situation will create any changes to an entity’s residence status under a tax treaty, because a temporary change in location of senior executives would most likely be seen as "an extraordinary and temporary situation due to the Covid-19 crisis and such change of location should not trigger a change in residency, especially once the tie breaker rule contained in tax treaties is applied".

Currently, and pending the implementation in South African tax treaties of the Base Erosion and Profit Shifting Multilateral Convention provisions relating to the tax residence tie breaker test, most of South Africa's double taxation agreements also look to the place of effective management of a company to decide the issue of which of the two countries which are party to the treaty will have primary taxing rights. In this context, the OECD guidance states that all relevant facts and circumstances must be examined to determine the "ordinary" or "usual" place of effective management and not only "those that pertain to an exceptional and temporary period such as the Covid-19 crisis".

Please click here to read more.

This article first appeared on webberwentzel.com.

Webinar Commentary

For an update on the latest legislative amendments and court rulings access our next Monthly Tax Update presented by Prof Jackie Arendse here.

0 COMMENTS

LEAVE A COMMENT