As a student at Unisa currently advancing through the program to obtain my master’s degree in taxation, I was required to review a book on tax strategy, called ‘Broomberg on Tax Strategy’ (5th edition) by Des Kruger, Michael Stein, Peter Dachs and Tony Davey. As a tax practitioner, I am always investigating and assessing various methods to achieve the optimal tax structure for my clients, and this book contained all the possible considerations and angles that one can take in such endeavours. Thus, due to its relevance to effective tax planning, I have decided to publish a series of articles based on chapters in this book to really give taxpayers an inside view of the mechanisms that skillful tax practitioners employ to gain tax savings for their clients.
THE ANATOMY OF TAX PLANNING
This chapter in Broomberg introduces the principles upon which effective tax planning and tax strategy should be based. It includes four factors that determine the liability for tax, which should always be considered by tax professionals when endeavoring to minimise client’s tax liabilities. These four factors conceptualize the foundation from which most of the subsequent chapters in the book draw its value. The reader is regularly reminded of the four factors that determine the liability for tax in subsequent chapters with the view of its application to each specific topic.
Apart from the four factors that determine the liability for tax, the author informs of certain rules and logic that upon reflection, does put the tax system in a position of bringing into being its own controls for anti-avoidance, without reference or drawing on the weight of specific anti-avoidance provisions. To add to that, a brief account of the quandaries that tax law versus tax practice produce is also given.
The fail-safe mechanism and the rules
In the chapter titled ‘’The approach to tax planning’’ explanation is given of a ‘’in-built sort of fail-safe mechanism’’ in the tax system, which does not refer to the anti-avoidance provisions contained in the Income Tax Act (ITA) or Value-Added Tax Act (VAT Act). This fail-safe mechanism can be found in the transactional nature of trade in general and the logic behind the concept is that concomitant to any transaction of any kind there is more than one party that will engage in the trading of an economic commodity which forms the subject of the transaction. In a transaction where a negotiator has structured it so that his or his company yields a tax benefit it will ultimately result in a tax loss for the other contracting party and vica versa. It can even be more disastrous in that the resultant tax loss for the other contracting party may even exceed the financial benefit that the negotiator fashioned. However, the opportunity does infrequently present itself to construct a transaction or contract in such way that all the contracting parties receive a tax benefit therefrom. Unfortunately, an event of this nature is quite seldom. It seems more equitable for contracting parties to rather be transparent about potential tax benefits or losses with the purposes of sharing resulting yields or losses in a contract by amending the price, terms and conditions.
Broomberg states his first rule in tax planning as being to ‘’…not lightly allow tax considerations to distort a sound commercial bargain’’. Over ambitious tax professionals and taxpayers with an appetite for tax risk have numerous times constructed schemes with the purpose of only achieving tax avoidance and even tax evasion. The many anti-avoidance provisions in the ITA and VAT Act (among other) are proof thereof. The overriding reason for engaging in trade or contract must not be because of the resulting tax benefit it may bring. There should be a sound economic basis and reason why taxpayers engage in trade. If an over emphasis is placed on the tax effects inherent to trade, it might be evident of economic inefficiency. According to the Economic Efficiency principle of taxation as stated in (SILKE: ‘’A tax is regarded as economically efficient if it does not unduly influence a person’s’ economic decision making’’. It seems then that there are two causes that influence the propensity of tax practitioners and taxpayers to place undue focus on the tax effects of transactions or dealings. One internal, finding is source from the tax practitioner or taxpayer’s attitude towards tax, and the other external, where the economic efficiency of tax policies and provisions have a bearing on the behaviour of taxpayers.
However, if by careful tax planning a taxpayer can couple the profit that a trade will produce with that of a minimized effective tax rate, it will reflect the shrewdness of his business acumen. Nothing prevents him to arrange his affairs in such a manner. As Hefer JA puts it in Cactus Investments v CIR, as quoted in Broomberg “it is often said that there is no equity in tax legislation (nor, I would add complete rationality) …the taxpayer’s remedy is to arrange his affairs, so far as he is able, so as to not attract these results’’.
As a second rule in tax planning, Broomberg propose that one should never accept the adverse tax consequences as conclusive. ‘’Rather, isolate and identify each of the several factors that give rise to the tax liability; then consider ways and means of neutralizing one or more of those factors’’. It must be borne in mind that an optimal tax position in one tax type might cause an adverse tax situation for another.
Over the period of developing an efficient, equitable and politically acceptable system of taxation a divide between the theory underlying the tax system and the practical application thereof has emerged. And conceivably, the more complex the tax system in theory, the larger the movement away from its practical application. In South Africa a complex tax system is unavoidable due to its history and unequitable distribution of skills, income and assets. This chapter in Broomberg recognise differences ‘’between the tax law applied by the revenue authorities, and the law as it is written in the Income Tax and Value Added Tax Acts’’. The concern is that these differences create room for uncertainty and that taxpayers can never with unerring conviction conclude on a transaction attracting complex tax considerations. This problem has been addressed by publication of guides and practice manuals by the South African Revenue Services (SARS). It is however important to keep in mind that these guides and practice manuals comprise purely interpretations by SARS and that ‘’courts will not hesitate to depart from the SARS’ guides’’ if necessary.
The factors that determine the liability for tax
The taxpayer
By varying the taxpayer upon which the tax liability vest, the incidence of tax is determined. Incidence is the first factor listed by Broomberg that determine the liability for tax and usually the easiest to implement. Incidentally, the incidence referred to here is formal tax incidence as opposed to effective tax incidence. Formal tax incidence ‘’falls on those who have the actual liability to pay the tax’’ whereas ‘’effective tax incidence identifies those who are, in the end, out of pocket as a result of the imposition of the tax’’ as per The Margo Commission Report. Broomberg also refers to capital gains tax and the effective tax rates it imposes on different entities. Further to that, I would suggest that the pragmatic utilisation of Small Business Corporations (SBCs) as defined in section 12E(4)(a)(i) to (iv) of the ITA offers an additional means to reduce overall effective tax rates.
When tax is due
The definition of gross income as per section 1 of the ITA explicitly states that gross income of a taxpayer always relates to ‘’any year or period of assessment...’’. It follows that gross income that is not ‘’received by or accrued to or in favour of...’’ a taxpayer in a year of assessment will not be included in such taxpayer’s gross income and consequently will not result in a tax liability in that year. This may be desirable for many reasons as mentioned by Broomberg: ’’there may not be income tax levied in the following year; tax rates may differ; the status of the taxpayer may alter; the tax rules may change.’’. And apart from these reasons, the natural resistance of taxpayers to contentedly part with their money naturally contribute to the motivation to defer tax liabilities.
Source of income
This factor is more applicable to non-residents as residents are taxed on a worldwide basis and source of income is therefore irrelevant. If non-residents seek to influence their tax liability in a year of assessment, they need to consider whether their situation satisfy a two-tier test to determine source of income as per Broomberg: ‘’First, it is necessary to establish the originating cause of the income – the reason why the income accrued to the taxpayer. Secondly, if that originating cause is located in South Africa, the income is from a South African Source.’’ Succinctly put by the author ‘’…what did the taxpayer do to earn the income; and did he do it in South Africa?’’.
Income or capital
This factor that determines the liability for tax relates to the quality of the amount derived by the taxpayer or expensed by him. Capital receipts are excluded from gross income as per the gross income definition in section 1 of the ITA, but then added back per the provisions of the Eight Schedule of the ITA. It can be advantageous to a taxpayer to have the quality of a receipt classified as capital, and in the same context, have an expense classified as revenue in nature to qualify as a deduction. It is submitted by Broomberg that, whilst all four factors must be considered to achieve an optimum tax result, the factor of quality can become quite complex.
Conclusion
In conclusion, the author appeals to the reader that one must always by cognisant of all three major forms of tax (income tax, VAT and Capital gains tax) and how they interface with each other. I submit that a tax planner’s comprehensive strategic tax objective should be to reduce the overall tax liability of a taxpayer, in other words to reduce the amount payable to the fiscus in total, encompassing all taxes.