South Africa’s digital tax plans face a major hurdle

South Africa’s digital tax plans face a major hurdle

The South African government has expressed interest in the introduction of new digital tax laws which would see the likes of Netflix and Facebook being forced to pay tax locally.

These international companies operate across a number of jurisdictions, and government advisory bodies have argued that these companies should be compelled to pay tax on their local operations.

Bowmans head of tax Wally Horak has said the introduction of a digital tax may be likely in future, but it faces a significant obstacle in the form of double taxation agreements (DTA).

A DTA only allows the source jurisdiction to impose tax on a resident of the other contracting state if that resident carried on business via a permanent establishment in the source state, he said.

“The main obstacle to such a unilateral digital tax is the basic, existing rule of double taxation agreements (DTAs) which only allows the source jurisdiction to impose tax on a resident of the other contracting state if that resident carried on business via a permanent establishment in the source state,” Horak said.

“Several of the countries which have threatened to impose the new digital tax have decided to suspend the effective date of the new tax in view of the uncertainty whether the tax may be declared invalid by the relevant courts.”

He said this is most likely the result of the approach of the United States, which has indicated that it would encourage its residents to oppose the imposition of the tax in court.

This means that if South Africa were to unilaterally implement a digital tax on a service like Netflix, the international company would be able to combat the taxation in US courts, relying on the protection of double taxation agreements.

Global framework under development

Horak noted, however, that the Organisation for Economic Co-operation and Development (OECD), in conjunction with the G-20 countries, has developed a new framework which proposes changes to the existing international tax system to allow countries to impose such digital taxes.

A main objective of the framework is to grant a right to market jurisdictions to tax part of the profits of multinational enterprises (MNEs), with reference to the income generated from customers in that jurisdiction, irrespective of whether the MNE has physical presence in that country, he said.

“Therefore, it is advisable for the Government to await this international action to ensure the cooperation of other states, notably the USA, since most of the targeted MNEs are USA-based.”

Once a global standard and framework is developed for the taxation of multinational digital companies, this will be easier to implement as it will most likely have the cooperation of major countries these digital service providers are based in.

In line with the recommendations in the OECD framework, Horak said that the government should commence the drafting of the relevant legislation to impose such digital taxes.

“Government should also consider amending the foreign tax credit provisions to allow a tax credit for foreign digital taxes imposed on digital supplies by South African companies to foreign customers,” he said.

“The current foreign tax credit provisions would generally not provide such relief since the source of the supply would generally be regarded as in South Africa where all the inputs for the website in question are provided and where the products or services sold via a website may originate.