Author: Gary Moore

Date: 30 June 2017

The income-tax statutes’ general anti-avoidance provisions have all violated the Rule of Law:

The current statute’s[1] predecessor, the Income Tax Act, 1941,[2] in its anti-avoidance provision[3] had originally stipulated that, if the Commissioner[4] was satisfied that “any transaction” had been entered into[5] to avoid liability for tax,[6] then liability for the tax[7] “may” be determined[8] as if it “had not been entered into.”[9]

This on the face of it hit legitimate[10] tax-avoidance arrangements,[11] gave the Commissioner discretion to ignore offending transactions or not, and authorised tax to be determined based on a notional alternative situation.[12] The provision violated the Rule of Law principles that laws should be clear and liabilities should not be determined by discretion.[13]

(The courts cut down the provision’s literal meaning[14] by restricting it to transactions to escape liability for tax which a taxpayer “ought to pay” on income “in reality his” and transactions to reduce the amount of tax from “what it ought to be,”[15] and held that the provision conferred no discretion on the Commissioner.[16])

The provision[17] was then substituted[18] by the legislature to state: If a transaction[19] was entered into[20] before or after the statute commenced that had the effect of avoiding[21] liability for[22] income tax,[23] and that (in the Commissioner’s opinion, having regard to the circumstances in which it was entered into) was entered into by means[24] not normally employed in entering into transactions of that nature (or created rights[25] not normally created at arm’s length in such transactions), and if the Commissioner was of opinion that avoiding liability for[26] income tax was the transaction’s sole[27] purpose, then the Commissioner had to determine liability for[28] income tax as if the transaction was not entered into, or in such manner as he deemed appropriate in the circumstances for preventing or diminishing such avoidance.[29]

This[30] hit transactions entered before the statute commenced, created a test of abnormality in the circumstances, and authorised the Commissioner to determine tax liability as he deemed appropriate.  It was thus retrospective, left determination of whether tax had been improperly avoided to be determined factually and in the circumstances of each case,[31] and allowed the Commissioner to determine tax liability in his discretion. It violated the Rule of Law principles that the legislature should abstain from retroactive legislation,[32] that laws should be clear and predictable,[33] and that liabilities should not be determined by discretion.[34]

The current Income Tax Act, 1962’s[35] anti-avoidance provision stated previously[36] that,[37] whenever the Commissioner was satisfied that a transaction[38] entered into[39] before or after commencement of the Act—

Had the effect of avoiding[40] liability for the payment of a tax[41] imposed by the Act;[42] and

Having regard to the circumstances under which it was entered into—

was entered into, in the case of —

a business transaction, in a manner not normally used for bona fide business purposes other than to obtain a tax benefit; or

any other transaction, by means[43] not normally used;[44] or

created rights[45] not normal at arm’s length in transactions of that nature; and

was entered into solely[46] for the purpose of obtaining a tax benefit,

the Commissioner had to determine liability for tax[47] as if the transaction had not been entered into, or in such manner as in the circumstances he deemed appropriate.[48]

The provision reproduced weaknesses of the 1941 statute (as originally enacted[49] and as amended[50]) in hitting transactions entered before the Act commenced, using a test of abnormality in the circumstances, and authorising the Commissioner to determine tax liability as he deemed appropriate. It was thus retrospective, left determination of whether tax had been improperly avoided to be determined factually[51] and subjectively[52] in the circumstances of each case, and conferred a discretion on the Commissioner. This violated the Rule of Law principles that the legislature should abstain from retroactive legislation,[53] that laws should be clear and predictable[54] and that legal liability should not be resolved by discretion.[55]

The 1962 Act’s anti-avoidance provisions[56] currently[57] stipulate that an avoidance arrangement is impermissible, if its sole[58] purpose was to obtain a tax benefit, and if—

In business contexts, it was entered into[59] by means[60] not normally employed for bona fide business purposes other than obtaining a tax benefit, or lacks commercial substance;[61]

in other contexts, it was entered into[62] by means[63] not normally employed for a bona fide purpose other than obtaining a tax benefit; or

in any context, it created rights[64] not normally created at arm’s length, or would result[65] in the “misuse or abuse” of the Act’s provisions.[66]

The Commissioner may determine the tax consequences of an impermissible avoidance arrangement for any party, by[67] treating the arrangement as if it had not been entered into,[68] or in such other manner as in the circumstances of the case the Commissioner deems appropriate for prevention or diminution of the tax benefit.[69]

These provisions, albeit objectively framed,[70] nevertheless violate the Rule of Law:

The provision that an avoidance arrangement is impermissible if it would result[71] in the “misuse or abuse” of the Act violates the Rule of Law in being insufficiently clear[72] for a course of action to be based on it.[73]

The provision that the Commissioner may determine tax consequences by treating an arrangement as if it had not been entered into, or in such manner as in the circumstances he deems appropriate,[74] is ambiguously broad[75] and gives the Commissioner discretion to determine tax liability, violating the Rule of Law principles that laws should be clear and predictable and liabilities should not be determined by discretion.[76]

The Income Tax Act, 1962 since 1989[77] also[78] provides[79] that, where under any transaction[80] a taxpayer has ceded the right to receive any amount in exchange for the right to receive any dividends, and in consequence the liability[81] for tax of the taxpayer or any other party to the transaction[82] has been reduced or extinguished, the Commissioner must determine the liability for tax of the taxpayer and any other party “as if that cession had not been effected.”

This likewise violates the Rule of Law, in being ambiguously broad[83] and giving the Commissioner discretion to determine tax liability.

Laws should be predictable. Liabilities should not be determined by discretion.[84]

[1] Income Tax Act, 1962. See fn 35.

[2] Income Tax Act 31 of 1941.

[3] Income Tax Act, 1941 s 90.

[4] Of Inland Revenue.

[5] Or operation has been carried out.

[6] Or reducing the amount thereof.

[7] And its amount.

[8] And payment of the tax chargeable may be required and enforced.

[9] Or operation had not been carried out.

[10] Every man is entitled to order his affairs so the tax is less than it otherwise would be. If he succeeds he cannot be compelled to pay an increased tax. Inland Revenue Commissioners v Duke of Westminster [1936] AC 1 [HL] 19, per Lord Tomlin.

[11] Such as selling investments which produce income subject to tax and instead buying shares which produce no income but may increase in value, or selling company shares which pay high dividends and investing in securities which return a lower but safer and more certain income, or securing deductions from gross income by taking out life insurance. Commissioner for Inland Revenue v King [1947] 2 All SA 155 (A) 160–161.

[12] The problem of deciding what a taxpayer’s income would have been if he had not carried out the offending operations would appear insoluble in some cases, if the countless possibilities of what he might otherwise have done with his capital or labour are borne in mind. Commissioner for Inland Revenue v King ibid 161 per Watermeyer CJ.

[13] Lord Bingham, “The Rule of Law.” Sixth Sir David Williams Lecture, 2006. Centre for Public Law, University of Cambridge: first and second sub-rules.

[14] In effect rewriting the provision.

[15] Commissioner for Inland Revenue v King ibid 163–164. The section is designed to meet the Commissioner’s objections to the creation of abnormal or unnatural situations to the detriment of the fiscus. Normally the owner of an income-producing asset receives the income and the labourer receives the reward of his labour. A departure from this order of things with the object of prejudicing the fiscus is the subject of legitimate objection by the Commissioner. In such cases alone can it be said that the Commissioner is seeking to tax the taxpayer on what is “in reality his income.” Ibid 169 per Schreiner JA concurring.

[16] Commissioner for Inland Revenue v King ibid 162–163.

[17] Income Tax Act, 1941 s 90.

[18] By Income Tax Act 78 of 1959 s 17.

[19] Or operation or scheme. (In this document, a reference to “transaction” includes “operation or scheme”)

[20] Or carried out. (A reference to “entered into” or “entering into” includes “carried out” or “carrying out”.)

[21] Or postponing. (A reference to “avoiding” or “avoidance” includes “postponing” or “postponement”).

[22] Or reducing the amount of.

[23] Including any such tax imposed by a previous Act.

[24] Or in a manner.

[25] Or obligations.

[26] Or reducing the amount of.

[27] Or one of the main.

[28] And the amount of.

[29] Or reduction.

[30] Income Tax Act, 1941 s 90(1)(a)(i) and (ii) and (2)(a), as inserted by Act 78 of 1959 s 17.

[31] See text at fnn 51 and 52 below.

[32] Declaration of Delhi, 1959. International Commission of Jurists. The Rule of Law in a Free Society (report on the international congress of jurists, New Delhi, 5–10 Jan 1959). Conclusions: Rpt of Ctte I ‘The Legislative and the Rule of Law’ cl III(3)(e).

[33] President of the Republic of South Africa and Another v Hugo 1997 (6) BCLR 708 (CC) para [102].

Bingham, “The Rule of Law” op cit: first sub-rule.

A citizen must be able to have an indication adequate in the circumstances of the legal rules applicable to a given case. A norm cannot be regarded as a ‘law’ unless it is formulated with sufficient precision to enable the citizen to regulate his conduct. Sunday Times v United Kingdom 26 Apr 1979 EHRR (plenary) §49.

[34] Bingham, “The Rule of Law” op cit: second sub-rule.

[35] Income Tax Act 58 of 1962 (the “Act”, “current Act”, “1962 Act” or “Income Tax Act 1962”).

The Act repealed the 1941 Act. Income Tax Act 1962 s 111(1) read with third sched.

[36] Income Tax Act s 103(1) as amended by Act 101 of 1978 s 14(1)(a).

[37] In abbreviated form.

[38] Or operation or scheme (see fn 19).

[39] Or carried out (see fn 20).

[40] Or postponing (see fn 21).

[41] Or reducing the amount thereof

[42] Or a previous Income Tax Act.

[43] Or in a manner.

[44] In entering into transactions of that nature.

[45] Or obligations.

[46] or mainly.

[47] And the amount thereof.

[48] To prevention of the avoidance. Income Tax Act s 103(1) as amended by Act 101 of 1978 s 14(1)(a).

[49] Income Tax Act 31 of 1941 s 90.

[50] By Income Tax Act 78 of 1959 s 17.

[51] Hicklin v Secretary for Inland Revenue [1980] 1 All SA 301 (A) 312.

[52] Clegg et al, Income Tax in South Africa, appendix A6 (anti-avoidance rules up to Nov 2006) at fn 344.

[53] Declaration of Delhi, 1959 (supra), ibid.

[54] President of the Republic of South Africa and Another v Hugo, supra, para [102].

Bingham, “The Rule of Law” op cit: first sub-rule.

[55] Bingham, “The Rule of Law” op cit: second sub-rule.

[56] Income Tax Act ss 80A–80L and s 103(2), (4) and (5), read with Tax Administration Act 28 of 2011 s 235(1)(a)–(e) and (2).

[57] Income Tax Act s 103(1) was deleted. Revenue Laws Amendment Act 20 of 2006 s 36(1)(a).

[58] Or main.

[59] Or carried out.

[60] Or in a manner.

[61] in whole or part, taking in account the provision about lack of commercial substance (s 80C).

[62] Or carried out.

[63] Or in a manner.

[64] Or obligations.

[65] Directly or indirectly.

[66] Income Tax Act s 80A.

[67] Inter alia.

[68] Or carried out.

[69] Income Tax Act s 80B(f).

[70] Silke on South African Income Tax, A P de Koker et al, para 19.35 at fn 241.

[71] Directly or indirectly.

[72] This misuse-or-abuse provision was borrowed from the Canadian income-tax statute, where it has led to conflicting decisions which provide ‘little guidance, other than legal uncertainty and confusion.’ Y van der Westhuizen, “Abusing the Income Tax Act by misusing the letter of the Act,” (2008) 71 Tydskrif vir Hedendaagse Romeins-Hollandse Reg 613 628.

[73] Bingham, “The Rule of Law” op cit: first sub-rule.

[74] For prevention or diminution of the tax benefit.

[75] (To repeat) the problem of deciding what the income of such persons would have been if they had not carried out such operations would appear to be insoluble in some cases, if the countless possibilities of what they might otherwise have done with their capital or their labour are borne in mind. Commissioner for Inland Revenue v King supra. See fn 12.

[76] Bingham, “The Rule of Law” op cit: first and second sub-rules.

[77] Income Tax Act 1962 s 105(5), inserted by Act 70 of 1989 s 19.

[78] In addition to the general anti-avoidance provisions discussed above.

[79] The 1989 provision (s 105(5)) has been amended. Act 32 of 2004 s 42(1); Act 20 of 2006 s 36(1)(c); Act 24 of 2011 s 89(1).  The amendments are not material.

[80] Operation or scheme.

[81] As determined before applying these provisions.

[82] Operation or scheme.

[83] (To reiterate yet again,) the problem of deciding what a person’s income would have been if he had not carried out a transaction can be insoluble, in light of the countless possibilities of what he might otherwise have done. Commissioner for Inland Revenue v King supra. See fnn 12, 75.

[84] Bingham, “The Rule of Law” op cit: first and second sub-rules.

 

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Gary Moore

Gary Moore BA LL.B. (Witwatersrand) LL.M. (UC London) is a South African lawyer and Senior Researcher at the Free Market Foundation.

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