Court victory over tax exit charges ? Tax Talk

Distributed on behalf of Garlicke & Bousfield Inc

A recent Supreme Court of Appeal judgment has provoked a response from the Minister of Finance, raising the possibility of amendments to the Income Tax Act to prevent a similar outcome in other cases. The judgment was in the matter of Commissioner for the South African Revenue Service v Tradehold Ltd. It deals with the so-called capital gains tax ?exit charge?, in the context of a double tax agreement.

Tradehold is a South African incorporated and listed company. In 2002, Tradehold moved its place of effective management to Luxembourg. In terms of the Income Tax Act, as it stood at the time, Tradehold remained tax resident in South Africa. In 2003, amendments to the Income Tax Act resulted in Tradehold ceasing to be tax resident in South Africa. This was because it was deemed to be tax resident in Luxembourg for purposes of that country?s double tax agreement with South Africa.

If a taxpayer ceases to be tax resident in South Africa, it is deemed to have disposed of all of its assets at market value immediately prior to such cessation (with some exceptions that did not apply in this case). This effectively realises all capital gains which have accrued to the taxpayer while it was tax resident in South Africa. The resulting tax liability is what is known as the exit charge. In Tradehold?s case, SARS sought to levy the exit charge in respect of shares in a subsidiary company, which resulted in a deemed capital gain of R405 million.

Tradehold relied upon the double tax agreement between Luxembourg and South Africa, to argue that it was not subject to the exit charge. The double tax agreement states that capital gains from the alienation of property are taxable only in the country of which the alienator is tax resident. For purposes of the double tax agreement, Tradehold had been tax resident in Luxembourg since 2002, when it moved its place of effective management.

SARS argued that this provision of the double tax agreement, giving the country of the alienator?s tax residence sole taxing rights, did not apply in the context of deemed disposals. The Supreme Court of Appeal saw no reason to distinguish between actual and deemed disposals. Tradehold was therefore successful and the exit charge will not be applicable.

The Minister of Finance has expressed the view that this judgment may disturb the balance that has been achieved regarding the taxation of capital gains attributable to a period of South African tax residence.

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