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The Davis Tax Committee report on base erosion and profit shifting (BEPS) introduction

Jan 15,2015

On 23 December 2014, the Davis Tax Committee released its first interim report on BEPS for public comment.

In his 2013 Budget Speech, the Minister of Finance announced the creation of a committee, to be chaired by Judge Dennis Davis, referred to generally as The Davis Tax Committee, to review a number of issues relating to the tax system, and the Committee was formally appointed in July of that year, and its terms of reference issued more or less at that time. The terms of reference are fairly wide-ranging with tax avoidance, which includes BEPS among other avoidance aspects to be looked at, comprising but one aspect of the Committee’s brief.

At about the same time that the Committee’s establishment was announced, the OECD commenced its work on BEPS, to a significant extent at the behest of the G20 nations. We would not go so far as to say that the creation of the Committee and the commencement by the OECD to look at BEPS was coincidental, as South Africa is part of the G20 and our Minister of Finance does attend those meetings and is apprised of developments, but the timing could not have been better.

Recognising the wisdom of not reinventing the wheel, the Committee wisely based its investigation into, and report on, the South African aspects of BEPS based on the OECD report, even going so far as to follow its format and headings, and then to adapt same suitably to what exists, and what is required, in this country.

This is clear from reading the Committee’s report which deals with the digital economy (action 1), hybrid mismatch arrangements (action 2), harmful tax practices (action 5), treaty abuse (action 6), transfer pricing work on intangibles (action 8), transfer pricing documentation and country-by-country reporting (action 13) and developing a multilateral instrument to enable jurisdictions that wish to do so to implement (action 15).

The report is exceedingly lengthy, running into some 300 pages, plus a 34 page summary. For the purpose of this publication, however, we will confine ourselves to giving brief information on those recommendations which we believe to be of more widespread interest.


  • There is no urgent need to amend the rules governing the taxation of e-commerce businesses conducted by South African residents.
  • New source rules are required to enable South Africa to tax non-resident suppliers of goods and services supplied via e-commerce.
  • All non-residents receiving South African-source income must submit tax returns, even if they do not have a permanent establishment in South Africa.
  • When VAT vendors purchase services from non-residents, VAT should be paid on import, which can then be claimed as a deduction if it qualifies (much as is the case with goods). Currently VAT is payable on imported services only if the services are not used to make taxable supplies.


This situation refers to entities which are treated differently in different countries, for example, as a company in one country but as a tax-transparent vehicle in another country, the result of which could be that the profits are taxed in neither country.

The following are some key recommendations of the Committee:

  • Our domestic rules on hybrid entities need some refinement.
  • Appropriate anti-avoidance provisions should be included in South Africa’s treaties, with appropriate domestic law amendments.
  • The hybrid debt and hybrid interest rules (sections 8F and 8FA of the Income Tax Act (the Act)) require attention as they are not linked to the tax treatment in the hands of a counterparty. The tax treatment in the foreign countries must be linked to the rules.
  • The rules governing the deductibility of interest must be developed holistically and without introducing too many sections within the Act. The focus should be on deductibility mismatch or other leakage.
  • Currently the anti-avoidance provisions are dealt with in sections 8E, 8EA, 8F, 8FA, 23M, 23N and the transfer pricing rules under section 31 of the Act. It is recommended that South Africa moves away from anti-avoidance sections aimed at particular transactions and establish anti-avoidance principles which can be applied to a broad range of transactions without undue technicality.
  • Our rules should be in line with international best practice. But South Africa must not move too quickly, and undertaking unilateral changes no matter how small, could have knock-on impact for foreign investment.


  • Local companies, especially in regard to the headquarter company regime, must have substantial activity, ie substance, and this must be examined.
  • But there must be a balance between South Africa’s international obligations not to engage in harmful tax practices, with the need to preserve the competitiveness of the economy.
  • The headquarter company regime contained in the Act is actually a holding company regime, and consideration should be given to incorporating minimum levels of substance.
  • The rules relating to special investment zones to attract investments must comply with the OECD substance requirements.
  • Where the SARS issues rulings affecting residents of another country, there should be an automatic exchange of information by the SARS.


This section particularly covers treaty shopping where a company is inserted in a particular jurisdiction merely to take advantage of a more favourable double tax agreement than would exist between the ultimate investor and South Africa. Often these interposed companies are mere conduits, where the dividends, interest or royalties merely “pass through” without the company itself having any substantial activity. The following are some recommendations:

  • The general anti-avoidance rule (the GAAR) contained in sections 80A to 80L of the Act should be applied to prevent tax abuse.
  • Older treaties should be renegotiated or protocols signed to clarify that they are not intended to create opportunities for non-taxation, including through treaty shopping.
  • Limitation on benefit provisions should be included in new treaties (these limit the benefits to a foreign company which can show that it has a close connection to its country of residence, eg a majority of its shareholders are resident there).
  • The principal purpose of the interposed company should not be to obtain tax a treaty benefit.
  • The new treaty with Mauritius should be finalised and brought into effect as soon as possible. The same applies with regard to the new treaty with Zambia.


The purpose here is to prevent transfers of intangibles (essentially IP) which has the effect of eroding the tax base, as royalties or other income will be derived abroad, rather than in South Africa.

It is recognised that there are already certain provisions in place in the Act which prevent abuse, such as the fact that section 23I of the Act will deny a deduction of a royalty on IP licensed to South Africa where the IP was exported; the CFC rules do not exempt income on intangibles in certain circumstances; the transfer pricing rules are present; and, very importantly, exchange control regulations severely limits the export of IP and require approval of royalty rates payable abroad.


This documentation applies when companies within the same group, but operating in different countries, transact with each other in order to justify the prices charged and paid. Currently, while advisable, it is not a requirement that South African companies, subject to the transfer pricing rules in section 31 of the Act, must maintain transfer pricing documentation. The SARS issued Practice Note No. 7 in 1999, which were based on the 1995 OECD Guidelines. Recommendations include the following:

  • Practice Note 7 must be replaced with more up to date interpretation based on more current OECD Guidelines.
  • The more sophisticated and complex, and hence costly, recommendations, including preparing a master file, local file and country-by-country reporting should be compulsory for large multinational businesses, the recommended threshold being businesses with turnover exceeding 1 billion.
  • Disproportionate and costly documentation requirements should not be imposed on SMEs, but they should be obliged to provide information and documents about their material cross-border transactions following a specific request.
  • The master file, the local file and the country-by-country report should be reviewed and updated annually, but database searches for comparables should be updated every three years.
  • SARS needs to establish a highly skilled transfer pricing team to include not only lawyers and accountants but also business analysts and economists, to ensure an understanding of commercial operations.


Even if the report is adopted without change, it is evident that it will be several years before its recommendations can be put into effect, either administratively or through the legislative process. And one must remember that there are a number of other reports on other areas being issued by the Committee, which will similarly have to be dealt with in due course by Treasury and the SARS. Moreover, experience from previous tax commissions shows that only a relatively small proportion of recommendations are actually brought into effect, with the authorities often “cherry-picking” among the recommendations made.

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