Earlier this year, the South African Revenue Service (“SARS”) released issue 2 of Interpretation Note 6 (“draft Interpretation Note”) on the “place of effective management” (“POEM”). Comments were due by 31 July 2015. POEM is often of critical importance in determining the tax residency of an entity.
The interpretation previously put forward by SARS in terms of Interpretation Note 6 issued during 2002 (“IN6”) in this regard, did not accord entirely with international precedent and the approach followed by SARS was that the POEM is:
- the place where the company is managed on a regular or day-to-day basis by directors or senior managers of the company, irrespective of where the overriding control is exercised or where the board meets; and
- management by these directors or senior managers refers to the execution and implementation of policy and strategic decisions made by the board and it can also be referred to as the place of implementation of the entity’s overall group vision and objectives.
2011 Discussion Paper
During 2011, SARS released a discussion paper (“Discussion Paper”) to invite taxpayers and tax practitioners to comment and raise any concerns in relation to the concept of POEM in South Africa, so as to provide a potential framework for possible amendments to IN6.
The Discussion Paper noted that IN6 had been subject to criticism in a number of areas. In particular, the “general approach” followed therein, namely to focus on the place where strategic decisions and policies are executed and implemented, as opposed to the place where those decisions are taken or adopted, was criticised. It was acknowledged in the Discussion Paper that IN6 had caused uncertainty by “adopting an approach that appears to conflict with the weight of international authority insofar as the general approach focuses on the place where strategic decisions are ‘executed and implemented’ rather than on the place where the decision-making, in substance, takes place” (our emphasis).
Draft Interpretation Note
The draft Interpretation Note provides that since POEM is not defined in the Income Tax Act, 58 of 1962, the ordinary meaning must be ascribed to the phrase, taking into account international precedent and interpretation. The draft Interpretation Note purports to be in line with the Organisation for Economic Cooperation and Development (“OECD”) principles and guidelines for the determination of the POEM when used as a tie-breaker rule in a double taxation agreement (“DTA”).
The draft Interpretation Note confirms that a company may have more than one place of management, but it can only have one POEM at any one time. The POEM will be at the place where key management and commercial decisions affecting its business as a whole are primarily or predominantly made. In our view, this approach is consistent with the OECD’s guidance provided in paragraph 24 of the Commentaries on the Articles of the Model Tax Convention on Income and on Capital (“OECD Commentary”).
In determining a single dominant POEM, the draft Interpretation Note provides for certain facts and circumstances that need to be taken into account. The determination looks at where the key management and commercial decisions are regularly and predominantly made. According to SARS, some of the facts and circumstances that should be considered on a case-by-case basis include the following:
- The place where a company’s head office is located (i.e. the place where a company’s senior management and support staff are predominantly located) is often representative of the place where key company decisions are made and forms an important consideration in determining where the POEM is located.
- Where a company’s board has chosen to delegate some or all of its authority to a committee, the location where the members of the committee are based will be considered in establishing the POEM.
- SARS states that the location where the company’s board meets and makes decisions may be indicative of a company’s POEM, depending on the role of the board in the key management and commercial decisions of the company. Where a board delegated authority to senior management, the POEM will ordinarily be where those senior managers are located.
- With advances in technology, the physical location of a board meeting may not be where the key management and commercial decisions are in substance being made. Therefore, no undue focus should be placed on the location of board meetings without considering the facts and circumstances such as who was physically present and who joined via video-conference.
- Some decisions are reserved for the shareholders of a company, but such decisions generally affect the existence of the company rather than its business and are therefore not relevant in determining the POEM. However, shareholder involvement can influence the POEM where a shareholder may usurp the powers of the directors of a company. This situation normally arises where there is only one shareholder. Usurpation should be distinguished from influence exercised by a shareholder.
- The relevance of operational management decisions (i.e. oversight of day-to-day business operations) are generally limited in determining the POEM and should be distinguished from the key management and commercial decisions (i.e. broader strategic and policy decisions).
- Where support functions are centralised, the managers in charge of those support functions are generally not directly involved in making key management and commercial decisions that affect the company’s business as a whole. Accordingly, the location where the support services are located is generally of limited relevance in determining the POEM of a company.
The move by SARS of its focus away from the execution and implementation of strategic decisions is welcomed. Since determining the POEM of an entity is a fact-specific enquiry, it is useful that there should now only be one test, namely to identify the place where the key management and commercial decisions are in substance made. SARS’ statement that it does not anticipate that the application of the draft Interpretation Note (as opposed to IN6) should result in many, if any, companies previously having had their POEM outside South Africa now being effectively managed in South Africa, or vice versa, is also encouraging.