The Tax Court case of TLD Limited v The Commissioner for the South African Revenue Service raises the issue of the interplay between the imposition of capital gains tax in the context of the Eighth Schedule to the Income Tax Act and the application of a double tax agreement.
At a board meeting held in Luxembourg in 2002, a South Africa-incorporated investment holding company resolved that all future board meetings be held in Luxembourg. Subsequent to this decision, one of the executive directors of the company remained in South Africa until he relocated to Europe in 2003. This sequence of events ultimately led to the company ceasing to be a resident of South Africa in February 2003.The company had exclusively become a resident of Luxembourg in terms of the applicable double tax agreement, as provided for in the exclusion to the definition of a 'resident' in the Income Tax Act.
The commissioner contended that ceasing to be a resident of South Africa had triggered a capital gain in terms of Paragraph 12 of the Eighth Schedule, which contains certain provisions relating to events that are treated as disposals. In this case, Paragraph 12(2)(a) refers to the situation where a person ceases to be a resident as a trigger for a disposal of assets (ie, there is the ability to tax any capital gains which may have arisen during its time as a resident).
However, the court did not consider it necessary to rely on the provisions of Paragraph 12(2)(a) of the Eighth Schedule to reach its decision. Its reasoning, turned on the application of the double tax agreement between South Africa and Luxembourg. The court held that any gains from the alienation of property would be taxable in Luxembourg only on the basis of Article 13(4) of the double tax agreement, which provides that gains from the alienation of any property is taxable only in the state in which the alienator is a resident.
The court did not accept the commissioner's attempt to distinguish between the alienation of any property, as referred to in the double tax agreement, and the deemed disposal of property, as referred to in Paragraph 12(2)(a) of the Eighth Schedule.. It held at Paragraph 14 that:
"I am unable to accept this argument. In terms of para 2(1)(a) of the Schedule, capital gains tax becomes payable in respect of 'the disposal of any asset of a resident'. Subparagraphs 12(1) and (2) of the Schedule provide that upon an event occurring in terms of those provisions 'a person will be treated for the purposes of this Schedule as having disposed of an asset'. I am unable to see any reason why a deemed disposal of property should not be treated as an alienation of property for purposes of article 13(4) of the DTA. I agree in this regard with counsel for the appellant, who argued that it would be absurd if a taxpayer were to be protected in terms of art 13(4) from liability for tax resulting from a gain from an actual alienation of property, but not from a deemed alienation of property."
The case raises the question of whether, in all similar instances, reference will be made only to the relevant double tax agreement to the exclusion of any current legislative provisions. It appears that the basis of the reasoning adopted in the case turns on the determination of the residence of the taxpayer concerned. It has been commented in The Taxpayer, that by shifting the place of effective management, a taxpayer ceases to be a resident and the combined simultaneous effect is that the provisions of the double tax agreement will apply.
The consequences of this approach are interesting from the perspective of understanding the timing of any deemed disposal in terms of Paragraph 12 of the Eighth Schedule. Reference was not made in the judgment to the provisions of Paragraph 13(1)(g) of the Eighth Schedule where it is indicated that a deemed disposal in terms of Paragraph 12(2)(a) will occur on the date immediately before the day that the event occurs. It is possible that in terms of Paragraph 13(1)(g) of the Eighth Schedule, the time of the disposal will be immediately prior to the decision to change residency and that the double tax agreement may not be applicable (ie, on such date the taxpayer concerned is regarded as a resident of South Africa only on the date of the disposal). However, this issue does not appear to be a consideration from a reading of the judgment, where it was emphasised that the double tax agreement will prevail in determining the residency of the taxpayer.
The relative ease with which a taxpayer may change its residence without the negative consequences of any capital gains being triggered, in the context where there is a double tax agreement, is noteworthy. The case confirmed that the place of effective management may be established simply by adopting board resolutions in Luxembourg. This approach was not queried by the commissioner as reported in the judgment.
The judgment may further give comfort to non-residents that when shares are disposed of by a non-resident where there is a prevailing double tax agreement, any taxation consequences will arrive only in the jurisdiction of the non-resident and not in South Africa.
For further information on this topic please contact Natalie Napier at Cliffe Dekker Hofmeyr Inc by telephone (+27 11 562 1000), fax (+27 11 562 1111) or email ([email protected]).