SA’s tax laws have not kept pace with the growth of the digital economy and changes in the way in which business is conducted – they were designed at a time when today’s technology and business models were the work of science fiction and the ability of a company to conduct business in a country required a physical presence in the country.
“We are living in an era of unprecedented digital change – the type of change that is reshaping the relationship between customers and business and prompting forward-looking CEOs to question the very business they are in.
“Currently, multinationals in the digital economy that sell goods and services in the South African market and elsewhere do not have to comply with the same rules as local companies,” says Charles de Wet, Head of Indirect Tax, PwC Africa.
Globally, there have been numerous reports regarding multinationals that pay little or no tax in the markets in which they generate profits. “Not only is this position unsustainable but it distorts competition between companies, as well as placing the multinational at an advantage over local businesses operating in the market,” explains de Wet.
Foreign entities are only subject to tax in South Africa on income derived from a source in South Africa. However, the source rules were developed a century ago before the digital economy existed and do not take into account the way in which the modern economy operates. As a result multinationals can avoid paying tax in South Africa because the source of their income is not in South Africa, notwithstanding that they operate in the local economy.
Multinationals are also accused of exploiting loopholes in the global tax system by setting up structures in low-tax jurisdictions and shifting profits both from the markets in which they operate and those in which they do have a physical presence to these low-tax jurisdictions. By doing this they are able to pay much lower taxes on their global profits. This gives these companies a cost advantage over local businesses that are fully within the South African tax net and have to pay tax on the profits they make at comparatively high rates.
“It is not surprising that the tax laws have not kept up with the digital era and South Africa is not unique in this regard. The pace at which the digital economy is growing will require action from South Africa’s tax authorities, as well as an overall global solution to level the playing fields so that South African companies are able to compete with big multinationals on a level playing field,” says de Wet.
The Organisation for Economic Co-operation and Development (OECD) has taken the lead globally to develop the tax rules and to confront the tax challenges faced in the digital economy. In September 2014 the OECD released its final report on the tax challenges of the digital economy under its Action Plan on Base Erosion and Profit Shifting (BEPS). The report acknowledges that the digital economy has increasingly become the economy itself, it is not possible to ring-fence the digital economy from the rest of the economy and more technical work needs to be done to evaluate the broader tax challenges posed by the digital economy and potential options to address them. Overall, most countries have not yet taken steps to implement legislation targeting the digital economy or have cautioned against unilateral action, usually issuing pronouncements that refer back to the OECD reform efforts.
As the OECD continues its work, there is likely to be increasing action by individual countries in this area over the coming years. Italy took steps to introduce a ‘Google tax’ that would have seen the taxation of on-line advertisements. The tax was subsequently cancelled. More recently the UK introduced a diverted profits tax that addresses the way multinationals shift profits around the world to minimise their tax bills.
Closer to home, South Africa as an observer of the OECD has begun to consider its place in the digital economy and the issues of neutrality associated with it. With this in mind, National Treasury implemented legislation in June 2014 which seeks to levy Value-Added Tax (VAT) on foreign entities providing electronic services to local consumers within the South African market place. In order to achieve this, the VAT Act was amended to require foreign entities providing certain electronic services to South African consumers to register for and charge VAT on their services. Currently, the scope of the tax is limited to a handful of electronic services (e.g. educational services, games, auction services, e-books, audio visual content, still images, music and subscription based services.) However it has been proposed that this list will be expanded during the course of 2015 to include software.
De Wet says: “Yet still many suppliers remain outside the scope of South African VAT and further work needs to be done to ensure that foreign suppliers operating in the South African market place are taxed in line with local businesses. Furthermore, the legislation is, in some instances not clear and opportunities exist for National Treasury to strengthen the effectiveness of the law.”
Kyle Mandy, PwC Head of National Tax Technical, says although a foreign company may be registered as a VAT vendor in South Africa, this does not mean that the company has a physical presence or permanent establishment or even that its income is sourced in South Africa for corporate income tax purposes. Currently, South African companies are taxed at the rate of 28% for corporate tax purposes. Conversely multinational companies selling digital goods and services escape paying corporate tax in South Africa. “This is because they do not fall within the South African tax net, either because their income is not sourced in South Africa in accordance with our domestic rules or because of relief provided by a double taxation agreement entered into between South Africa and the foreign country,” explains Mandy.
Finance Minister Nhlanhla Nene announced in his 2015 Budget that proposed changes would be made to the rules for the digital economy in line with the recent guidance issued by the OECD in its report on BEPS. The changes for South Africa are based on the interim report of the Davis Tax Committee which contends that there is limited scope for South African residents to shift profits to offshore tax haven jurisdictions by way of e-commerce transactions. Conversely, the opposite is true with regard to e-commerce transactions carried out by non-residents with South African consumers. The report proposes a number of recommendations in respect of the proposed design of the new tax legislation relating to e-commerce transactions in order that a level playing field is created so that South African companies can compete with multinationals.
“Significant legislation changes will be required to level the playing fields and provide a solution. However, any domestic rule changes are unlikely to be successful in the absence of a global solution which will entail reforms to the international tax system and tax treaties in particular,” cautions Mandy.
“It is also a risk to transplant a foreign taxation system into a domestic system without proper consideration of local circumstances. A considered approach is favoured but the law needs to be developed so that it is consistent, yet malleable enough for a current and future digital era,” adds Mandy.