On 16 September 2014, the OECD published a slew of discussion documents giving a head’s up of anticipated changes in the global tax system. Although it will be a few years before the proposed changes become effective, they will significantly impact groups that have structured their digital service offering / intellectual property (IP) holding for tax purposes. Not only will these changes impact existing companies considering tax structuring in future. They extend to groups that previously implemented a tax-efficient structure.
Historically, many groups placed their patents, trademarks, copyright, know-how and design registrations in an IP holding company registered in a low-tax jurisdiction. Alternatively, intellectual property has been licensed to a company in a low-tax jurisdiction, which company in turn offered a digital service to users worldwide.
The OECD intends to tackle these tax arrangements from all angles:
- Categorising income earned from the remote sale of digital goods and services as “passive income” and thereby to catch this income under controlled foreign company (CFC) legislation. This will significantly impact “services companies” in which South African residents hold more than 50% shareholding.
- Broadening the definition of “permanent establishment” to recognise “significant presence” in a market (as compared to physical presence). For example: warehousing, logistics, marketing and support by an independent contractor within a country may suffice. So too may using local data to make local sales. Creation of a permanent establishment will cause profit to be attributed to that permanent establishment, which profits would be subject to tax in the country of establishment.
- Creating a new category of payments that are subject to withholdings tax, e.g. the “sale of digital goods and services”. Since no double tax agreements specifically cater for this category, this could circumvent obstacles posed by existing double tax agreements (which frequently zero withholdings tax on certain payments, such as royalties). This category is expected to include payments under infrastructure-as-a-service, software-as-a-service, platform-as-a-service, content-as-a-service, and data-as-a-service transactions.
Once these changes have been incorporated into the South African tax law, restructuring companies to yield a significant tax benefit will be extremely difficult. And, existing groups will need to revisit their structures to ensure that the tax benefit continue to justify the cost.