Tax avoidance – is it OK?

In this series of articles, Cameron Kotze – the Tax Partner at Ernst and Young – discusses some topical tax issues for our readers.

THERE have been many debates and tax court cases on tax avoidance. Our Income Tax Act has a specific anti-avoidance provision that spells out the Receiver of Revenue’s powers very clearly if all the requirements of the section can be answered in the affirmative.Where transactions, operations or schemes have been entered into which have the effect of avoiding or postponing the liability for income tax, the Receiver may very well be interested in the transactions entered into.If the sole or main purpose for entering into or carrying out the transactions are to avoid tax and, given the circumstances, the transactions are entered into or carried out in a manner that would not normally be used in similar circumstances or, have created rights or obligations that would not normally exist between parties acting at arm’s length in similar transactions, the Receiver has the right to ignore the transactions when determining the taxpayer’s tax liability.The courts have interpreted the section that where the transacting parties are genuinely independent from each other in a commercial arrangement, it can hardly ever apply.Similarly, where the taxpayer has the option to invest in a taxable interest-earning investment or one which is tax free and chooses to invest in the tax-free investment, the section cannot apply because the taxpayer’s intention was to avoid tax – the taxpayer has made the investment normally and cannot get into trouble.Where a complex transaction has been entered into and contains an element which has been inserted solely for its tax effect, the taxpayer must expect the Receiver to challenge the purpose for entering into the transaction.As a general rule, the form a transaction takes will determine its tax effects.Where a particular commercial result can be achieved in one of two or more ways, the way which carries the least exposure to tax can safely be used without running into problems with the Receiver of Revenue.The fact that the transaction’s end result is the same as the more heavily taxed alternative is not relevant.There may of course be cases where there is not complete clarity as to the form of the transaction.In such a case the effect of the transaction will be examined to determine its tax consequences.Transactions where a particular form has been used in an abnormal manner will be challenged by the Receiver of Revenue and agreements which do not reflect the true intention of the parties (commonly referred to as sham transactions) will be ignored and they will be taxed according to their real intent.The onus to disprove the intent to avoid tax or the abnormality of the transaction is on the taxpayer.This is not an easy task and you should therefore think and plan very carefully before you enter into transactions, operations or schemes which have the effect of avoiding or postponing the payment of income tax.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.Our Income Tax Act has a specific anti-avoidance provision that spells out the Receiver of Revenue’s powers very clearly if all the requirements of the section can be answered in the affirmative.Where transactions, operations or schemes have been entered into which have the effect of avoiding or postponing the liability for income tax, the Receiver may very well be interested in the transactions entered into.If the sole or main purpose for entering into or carrying out the transactions are to avoid tax and, given the circumstances, the transactions are entered into or carried out in a manner that would not normally be used in similar circumstances or, have created rights or obligations that would not normally exist between parties acting at arm’s length in similar transactions, the Receiver has the right to ignore the transactions when determining the taxpayer’s tax liability.The courts have interpreted the section that where the transacting parties are genuinely independent from each other in a commercial arrangement, it can hardly ever apply.Similarly, where the taxpayer has the option to invest in a taxable interest-earning investment or one which is tax free and chooses to invest in the tax-free investment, the section cannot apply because the taxpayer’s intention was to avoid tax – the taxpayer has made the investment normally and cannot get into trouble.Where a complex transaction has been entered into and contains an element which has been inserted solely for its tax effect, the taxpayer must expect the Receiver to challenge the purpose for entering into the transaction.As a general rule, the form a transaction takes will determine its tax effects.Where a particular commercial result can be achieved in one of two or more ways, the way which carries the least exposure to tax can safely be used without running into problems with the Receiver of Revenue.The fact that the transaction’s end result is the same as the more heavily taxed alternative is not relevant.There may of course be cases where there is not complete clarity as to the form of the transaction.In such a case the effect of the transaction will be examined to determine its tax consequences.Transactions where a particular form has been used in an abnormal manner will be challenged by the Receiver of Revenue and agreements which do not reflect the true intention of the parties (commonly referred to as sham transactions) will be ignored and they will be taxed according to their real intent.The onus to disprove the intent to avoid tax or the abnormality of the transaction is on the taxpayer.This is not an easy task and you should therefore think and plan very carefully before you enter into transactions, operations or schemes which have the effect of avoiding or postponing the payment of income tax.* Should readers have queries, they are invited to send them to cameron.kotze@za.ey.com.