South African tax laws and rules need to be rewritten to capture the digital economy, as they have not kept pace with its growth or the changes in the way business is conducted globally.

Speaking during a panel discussion in Johannesburg on Tuesday, advisory firm PwC national tax technical head Kyle Mandy said these guidelines 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 that country.

Further, PwC corporate international tax associate director Cor Kraamwinkel explained that South Africa was by and large “actually quite sophisticated” in its legislation, but noted that in the e-commerce industry, technology “moved so fast”, legislation was struggling to keep up with how to address issues.

“Sophisticated legislation is one thing, but inflexible legislation or outdated legislation is perhaps a bigger concern. How do you address the balance between South Africa protecting its basis and getting its fair share versus providing the flexibility and freedom to South African business to become – and remain – relevant in this [digital] economy?” he asked.

The question of how to go about writing future-proof legislation was also raised during the panel discussion, with Mandy noting that the local tax legislation could, much like the Constitution, set the global standard.

“Like the Constitution, the country would want tax legislation to be flexible and principles based, rather than [be] very strict, narrow [and] rule based. The problem is two-fold – the first part of the problem relates to our domestic source rules from a corporate tax perspective, which were developed 100 years ago, when the economy was completely different,” he quipped.

Essentially, in terms of “source rules”, a company needed to identify what the originating cause of income was and, secondly, where this income originated from. With regard to services, historic rules say that  the provision of the services was located where the services were provided.

“If you are providing services digitally, you could be providing them from anywhere in the world. That’s the reason why companies fall outside the local tax rules,” Mandy explained.

He added that this mind shift regarding the source rules had already been proposed and that it was one of the recommendations made by the Davis Tax Committee in its interim Base Erosion and Profit Shifting (BEPS) report. “We expect that it will be on the radar screen to be addressed this year.”

The second problem Mandy highlighted was the provision of appropriate taxing rights to source countries, insofar as the digital economy was concerned. “Unfortunately, there is nothing South Africa can do in isolation and that’s a global issue that needs a global solution.”

Kraamwinkel added that the “solution does not lie exclusively in the hands of the South African legislature. [The country] can make laws as it sees fit, to address BEPS concerns, but in isolation that does not get us [anywhere]. If you were to apply tax treaties as they are written at the moment – even if South Africa were to introduce these new source rules – there would be many foreign multinationals that will, nevertheless, escape South African tax.”

“The solution lies not only in South African legislation, which is a must-have, but also in a multilateral [approach], whereby the harmonisation of rules globally are addressed.”

Further, Mandy highlighted that “we are living 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”.

TAX GAP
Also speaking at the panel discussion, PwC indirect tax head Charles de Wet pointed out that multinationals in the digital economy, that sell goods and services in the South African market and elsewhere, currently did not have to comply with the same rules as local companies.

Globally, there were numerous reports regarding multinationals that paid little or no tax in the markets in which they generated profits. “Not only is this position unsustainable but it distorts competition between companies, as well as places the multinational at an advantage over local businesses operating in the market,” explained De Wet.

Multinationals were also accused of exploiting loopholes in the global tax system by setting up structures in low-tax jurisdictions to shift profits from the markets in which they operated and those in which they had a physical presence to these low-tax jurisdictions. By doing this, companies were able to pay much lower taxes on their global profits. This gave these companies a cost advantage over local businesses that were fully within the South African tax net and had to pay tax on the profits they made 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,” advised De Wet.

INTERNATIONAL PERSPECTIVE
Hot on the heels of the Australian unilateral decision to subject the digital economy’s income to tax, through the implementation of its Goods and Services Tax on e-commerce on Tuesday, the panel agreed  that there was no doubt that other countries would follow suit.

The Organisation for Economic Cooperation and Development (OECD) had 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 BEPS. The report acknowledged that the digital economy had increasingly become the economy itself and it was not possible to ring-fence the digital economy from the rest of the economy and that more technical work needed to be done to evaluate the broader tax challenges posed by the digital economy and potential options to address them.

Overall, most countries had not yet taken steps to implement legislation to target the digital economy or had cautioned against unilateral action, usually issuing pronouncements that refer back to the OECD reform efforts.

As the OECD continued its work, there was 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 online advertisements. The tax was subsequently cancelled. More recently, the UK introduced a diverted profits tax that addressed the manner in which multinationals shifted profits around the world to reduce their tax bills.

Closer to home, South Africa, as an observer of the OECD, had started 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 sought to levy VAT on foreign entities providing electronic services to local consumers within the South African marketplace.

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 was limited to a handful of electronic services, including educational services, games, auction services, e-books, audio-visual content, still images, music and subscription-based services.

However, it had been proposed that this list would be expanded during the course of the year to include software.

“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 local marketplace are taxed in line with local businesses. Further, the legislation is, in some instances not clear and opportunities exist for National Treasury to strengthen the effectiveness of the law,” De Wet commented.

Mandy added that although a foreign company could be registered as a VAT vendor in South Africa, this did not mean that the company had a physical presence or permanent establishment or even that its income was sourced in South Africa for corporate income tax purposes. Currently, South African companies were taxed at the rate of 28% for corporate tax purposes.

Conversely, multinational companies selling digital goods and services escaped the payment of 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,” Mandy explained.

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.

“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,” cautioned Mandy.

It was also a risk to transplant a foreign taxation system into a domestic system without proper consideration of local circumstances, he added. “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.”