Image: Pexels This follow‑up article by breaks down the court’s reasoning and highlights the key principles and practical considerations arising from the decision.
Absa Bank Limited (“Absa”) (and its subsidiary United Towers) subscribed for preference shares in PSIC Finance 3 and received tax exempt dividends on these preference shares. PSIC 3 then subscribed for preference shares in PSIC 4. PSIC 4 then made a capital contribution to a foreign trust. The foreign trust lent the funds to MSSA, Macquarie's brokerage entity in South Africa.
The foreign trust also invested in Brazilian government bonds and vested and distributed the income arising from the Brazilian government bonds to PSIC 4. Such interest income was exempt from South African tax in terms of the double tax agreement between South Africa and Brazil.
PSIC 4 was therefore not taxed on such interest income. PSIC 4 used the income arising from the interest on the Brazilian government bonds to declare and pay dividends to PSIC 3, which, in turn, declared and paid dividends to Absa Bank. These dividends were exempt from tax.
Absa launched a review in the High Court together with a request for a direction under section 105 of the Tax Administration Act (“TAA”) arguing that assessments by the South African Revenue Service (“SARS”) under the general anti tax-avoidance provisions in the Income Tax Act, 58 of 1962 (“Act”) (“”) in terms of which it re-characterised the tax exempt dividend income received by Absa from PSIC 3 as taxable interest income were flawed due to two legal errors. Firstly, that Absa could not be said to have been a party to the arrangement as it was unaware of the full structure, particularly the parts generating the alleged tax benefit and secondly, that Absa did not obtain a "tax benefit" from the arrangement both of which are requirements for the GAAR.
The High Court found these to be issues of law in respect of which it had jurisdiction and set aside the assessments (Absa Bank Limited v Commissioner for the South African Revenue Service 2021). SARS then appealed to the Supreme Court of Appeal (“SCA”).
The SCA held that the effect, purpose and normality of a transaction are factual questions. The dispute therefore did not constitute the exceptional circumstances required in terms of section 105 of the TAA. The High Court should thus not have granted a direction under that section and should not have entertained the review and therefore set aside the High Court’s orders.
The Constitutional Court granted leave to appeal to Absa and confirmed the High Court's jurisdiction under section 105 of the TAA, finding that the SCA erred in characterising the issues as factual. The remaining issues for determination by the Constitutional Court were whether the assessment should be set aside on review as a result of the alleged legal errors.
The Constitutional Court judgment
The Constitutional Court held that there were two central issues on the merits. Firstly, a twofold enquiry with two interrelated questions, namely, whether the transactions constituted an "impermissible avoidance arrangement" as contemplated in section 80A of the Act and relatedly, what constitutes a "party" under section 80L of the Act and, in particular, whether this requires knowledge of all the steps of an avoidance arrangement (the “party issue”).
Secondly, whether SARS can invoke the GAAR provisions against the taxpayer who is alleged not to have obtained a tax benefit but merely received financial returns from other parties' tax benefits (the "tax benefit" issue).
Impermissible avoidance arrangement
The first question the court addressed was the jurisdictional requirement relating to the existence of an "impermissible avoidance arrangement" as contemplated in section 80A of the Income Tax Act.
The court stated that “The jurisdictional requirement is the existence of an avoidance arrangement whose sole or main purpose is to obtain a tax benefit, and which is abnormal. This is an objective enquiry” .
The court also noted that the amendments to the GAAR provisions in 2006 constituted a “Move away from a subjective approach to an objective analysis by expanding the purpose requirement to include an objective assessment of the purpose of an avoidance arrangement. This objective enquiry occurs through a reasonable consideration of the arrangement in light of the relevant facts and circumstances” .
The court held that the finding that the jurisdictional requirement (i.e. the existence of an impermissible avoidance arrangement) entails an objective enquiry is fortified by section 80G. This section requires the party obtaining the tax benefit to prove that, reasonably considered in the light of relevant facts and circumstances obtaining a tax benefit was not the sole or main purpose of the avoidance arrangement. The court held that this “wording is indicative of an objective test as the focus is not on the taxpayer's stated intent or purpose, but on the reasonable prevailing facts and circumstances.” The court held that this is a “fundamental change” from section 103(1) of the Act, which the courts, and in particular the SCA in the Conhage case, interpreted to relate to the taxpayer's subjective purpose.
The objective enquiry in relation to purpose as enunciated by the court will however necessarily involve an analysis of the subjective intention of the relevant parties reasonably considered in light of the relevant facts and circumstances. As per the statement of the Appellate Division (as it then was) in Secretary for Inland revenue v Gallagher 1978 (2) SA 463 (A), which the court refers to, and quotes from, in footnote 52 of the judgment, if the purpose of a party is treated as an objective matter which is to be analysed as such, there is no need for an “impermissible avoidance arrangement” to have a purpose requirement as contemplated in section 80A, thereby rendering the purpose requirement superfluous. This is so since the effect of a transaction/arrangement, objectively determined, is dealt with in terms of the concept of a “tax benefit” which is distinct from the purpose requirement. It is interesting to note that an analysis which takes into account the subjective intention of a party would not be inconsistent with SARS’ approach that the purpose is test is a now a “more objective” test under the GAAR since SARS’ approach allows for an analysis of the subjective intention of a party against a reasonable consideration of the relevant facts and circumstances.
The court held that the facts in the present instance constitute an impermissible avoidance arrangement.
The concept of "party"
In terms of section 80L, the definition of "party" includes any person who participates or takes part in an arrangement. The definition of "arrangement" means "any transaction, operation, scheme, agreement or understanding... including all steps therein, or parts thereof".
The court held that the question whether a taxpayer is a party to an arrangement requires a broad construction and a purposive interpretation. This is underscored by the deliberate duplication of the synonyms “participates” and “takes part.” The concept of a "party" should thus not be limited to those with full knowledge of all of the various steps to the arrangement as this would frustrate the purpose of the GAAR. The court held that the enquiry is objective, i.e. whether the taxpayer's conduct forms part of the chain of transactions constituting the arrangement.
Tax benefit
The court held that Absa did receive a tax benefit. However, it held that section 80B empowers SARS to determine the tax consequences for "any party". This is not limited to the party which obtains the tax benefit. Therefore, even if a party did not receive a tax benefit, the provisions of section 80B would nevertheless apply to it.
In making this determination the court rejected the argument that the presumption in section 80G indicates that it is only the party obtaining the tax benefit to which liability could be attached and held that the role that the presumption in section 80G plays must be properly understood. That section addresses the evidentiary burden, not the scope of liability. The “party obtaining a tax benefit” merely identifies who bears the onus of rebuttal.
In order to test whether a tax benefit arises, it is necessary that a transaction is “stripped of its avoidance features”. The court held that the correct test to determine if a tax benefit arose requires assessing whether, but for the tax avoidance features and dressing up of the relevant transaction, a tax liability would have occurred. The test is therefore no longer an analysis of whether, but for the transaction, the relevant taxpayer would have incurred a tax liability
The court held that, stripped of the arrangement's anti-avoidance features, the tax benefit accrued to Absa and United Towers. In particular, the court held that Absa received an enhanced yield in respect of its preference share investment.
In this regard, a tax avoidance feature of the arrangement was the “swap” of the taxable income paid by MSSA to the foreign trust for the tax-free interest income arising in respect of the Brazilian government bonds, which was vested and distributed by the foreign trust to PSIC 4. Absent the swap, PSIC 4 would have been taxed on the interest received by the foreign trust from MSSA, which would then have been invested in it. A further avoidance feature may have included the “conduit” nature of the arrangement.
The court held that once the swap and associated conduit steps are removed, “the economic substance of Absa's investment is no longer that of a genuine preference share yielding exempt dividends but of a tax-neutral, yield-protected funding instrument producing a return functionally indistinguishable from interest.” . The court therefore held that if one strips away the avoidance feature (i.e. the swap and, potentially, the conduit nature of the arrangements), this converts what Absa received into interest and then Absa did obtain a tax benefit.
Conclusion
Arrangement
In applying the GAAR provisions, it is necessary to determine firstly whether there is an “arrangement” as defined in section 80L of the Act. As set out above, this definition refers to any transaction, operation, scheme, agreement or understanding including all steps therein or parts thereof.
Avoidance arrangement
In order for an arrangement to constitute an “avoidance arrangement” it is necessary that the arrangement results in a "tax benefit".
In order to determine whether a tax benefit arises, it is necessary to ask whether, but for the tax avoidance features and dressing up of the transaction, a tax liability would have occurred. In this regard, a "tax avoidance" feature constitutes the artificial or contrived elements of the arrangement that serve no genuine commercial purposes beyond securing tax-exempt treatment. In respect of the facts under consideration, the court held that such artificial features constituted both the swap and the conduit nature of the arrangement.
On the basis that there is a tax avoidance feature, there is then a tax benefit and an “avoidance arrangement.”
Impermissible avoidance arrangement
The next question is whether such avoidance arrangement constitutes an "impermissible avoidance arrangement" i.e. whether the avoidance arrangement's sole or main purpose was to obtain a tax benefit and the abnormality provisions are met.
In determining the “sole or main purpose test” (i.e. whether the avoidance arrangement constitutes an impermissible avoidance arrangement) it is necessary to consider, on an objective basis, the purpose of the entire “arrangement” as well as all of the relevant steps in the arrangement. The objective enquiry in relation to purpose as enunciated by the court will however necessarily involve an analysis of the subjective intention of the relevant parties reasonably considered in light of the relevant facts and circumstances.
Party to a transaction
For the purposes of section 80B and section 80G of the Act, it is then necessary to determine whether a taxpayer is a “party” to an arrangement. As set out in paragraph 118 of the minority judgement, the “party issue” is relevant in the context of section 80B(1). In terms of this provision, the Commissioner’s powers to determine the tax consequences of an impermissible avoidance arrangement are confined to the tax consequences “for any party.” It is therefore necessary to determine whether a taxpayer is a “party” to an impermissible avoidance arrangement.
This is also dealt with in paragraph 23 of the majority judgement where the court refers to the fact that SARS invokes section 80G of the Act in submitting that the scheme is presumed to have been entered into or carried out for the sole main purpose of obtaining a tax benefit.
SARS contended that Absa was a party to the arrangement for purposes of section 80G of the Act.
In this regard, it is an objective test as to whether a party's conduct forms part of the chain of transactions constituting the arrangement. It is therefore necessary to determine the entire arrangement, including all parts thereof and any entity which forms part of such “arrangement” will constitute a “party” in relation to such arrangement, regardless of their knowledge in respect of all aspects of the “arrangement” and also whether or not they participated in the entire arrangement or merely one part thereof.
The provisions of section 80B of the Act allow the Commissioner to determine the tax consequences of an impermissible avoidance arrangement by, for example, disregarding, combining or re-characterising any step in or part of the impermissible avoidance arrangement. The court held that the Commissioner may apply this provision to any party regardless of whether such a party obtained a “tax benefit”. This is on the basis that, once there is an “impermissible avoidance arrangement” the Commissioner is empowered to utilise the provisions of section 80B and may do so in respect of any “party”. The court held that in terms of section 80B, SARS is empowered to determine the tax consequences for “any party”. This is not restricted to a party which obtains a tax benefit. DM