A decision by the Zurich Tax Appeals Court in Switzerland on the capital gains tax consequences in respect of the disposal of "land-rich" shares (case GR.2023.22, available in German only) makes for an interesting discussion when considered in the context of the practice of the tax authorities in the City of Zurich and the revised position set out in the South African Revenue Service Comprehensive Guide to Capital Gains Tax (Issue 9) ("Guide").

The Guide, amongst other things, covers the capital gains tax consequences for non-residents on the disposal of so-called "land-rich" shares in South Africa, and the view expressed therein is that non-residents should be subject to capital gains tax in South Africa on the disposal of shares in a so-called "land-rich" company, i.e., where more than 80% of the value of those shares (which equate to an interest of at least 20% in the SA company) are attributable to immovable property situated in South Africa, regardless of the provisions of an applicable Double Taxation Treaty (DTA). In previous versions of the Guide, the position put forward (correctly in our view) was that South Africa only has taxing rights where the applicable DTA makes provision for the disposal of "land-rich" shares, although the threshold under applicable DTAs is generally more than 50% but less than 80%.

In the Zurich case, the court's ruling hinged on the interpretation of the Germany-Switzerland DTA, particularly articles 13(1) and 6(2), which address the taxation rights of gains from the sale of immovable property. The case involved the sale of shares in a real estate company, which under Zurich tax law is considered an indirect sale of the property itself, thus taxable. Article 13(1) of the Germany-Switzerland tax treaty stipulates that gains from the sale of immovable properties can only be taxed in the contracting state where the property is physically located. Additionally, Article 6(2) specifies that the definition of "immovable property" should align with the law of the contracting state where the property exists. Unlike some other tax treaties, Article 13 of the Germany-Switzerland treaty does not explicitly address gains from the sale of shares in a real estate company. The tax authorities argued that domestic tax law should determine whether the indirect sale of properties via shares in a real estate company is taxable. Since Zurich's law treats such transactions as taxable events, they claimed the city had the right to levy real estate capital gains tax under Article 13(1). The court, however, rejected this argument, emphasizing that an asset without a specific connection to a jurisdiction cannot be considered immovable property. Interestingly, much like the position in previous versions of the SARS Guide, the historical practice in Zurich was that gains on the disposal of "land-rich" shares, in the absence of the specific clause in Article 13, were not taxable in Switzerland. However, the City of Zurich recently changed its practice and denied treaty protection, culminating in the case at hand.

This ruling provides useful insight into how the sale of shares in a "land-rich" company should be treated in the absence of a specific clause to that effect in an applicable double tax treaty and underscores the importance of treaty interpretation. The court's interpretation aligns with the academic consensus and the Vienna Convention on the Law of Treaties, which emphasizes the need for clarity and consistency in the application of treaties. The ruling also highlights the evolving nature of tax law, as different jurisdictions may have varying definitions and tax implications for similar transactions.

In the South African context, South Africa has a number of DTAs in place, with some containing the specific clause in Article 13 and others that do not. For example, the DTA with the Netherlands does not contain such a clause, whereas the DTA with the United Kingdom does. Now, while it is noted in the Guide that the views expressed therein are not those of SARS, it does create uncertainty in the market, especially in the absence of the specific clause in Article 13 of South African DTAs. The approach noted in the Guide contrasts with the Zurich court's decision, which could have significant implications for cross-border transactions and tax planning strategies. It raises questions about the harmonization of tax laws and the treatment of capital gains in an increasingly globalized economy.

Now, while the Zurich court's decision is not yet legally binding and may be subject to appeal, it provides valuable insight into the interpretation of tax treaties and the principle of relying on domestic definitions. It also serves as a reminder of the complexities involved in international tax law, where each case can significantly impact the tax obligations of individuals and companies across borders. The outcome of this case will be closely watched by tax professionals and multinational corporations, as it may influence future tax policies and treaty negotiations going forward. The full implications of this decision remain to be seen, but it undoubtedly adds a layer of complexity to the understanding of "immovable property" in the context of international tax law.

Written by Denny Da Silva, Director Designate, Tax, Baker McKenzie Johannesburg