The Parliamentary Budget Office released a report (the PBO Report) on 26 June on the potential introduction of a digital tax in respect of the supplies of goods and services by non-residents to South African customers, which are delivered by digital means.
The PBO Report acknowledges the current efforts of the Organisation for Economic Co-operation and Development (OECD) in conjunction with the G-20 countries and several others (137 countries - the OECD/Inclusive Framework) to design changes to the existing international tax system to allow countries to impose such digital taxes . A main objective of the new approach 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.
The PBO Report observes that many countries have opted for unilateral rules to tax the digital economy in view of the relatively slow progress made by the OECD/Inclusive Framework to agree on a new approach, which has become critical in view of the budgetary constraints following the Covid-19 crisis.
The PBO Report concludes that South Africa can learn from those countries, notably France, the United Kingdom, Spain and Italy, which have introduced unilateral measures to tax digital supplies by imposing a flat tax on the supplies by MNEs to customers in their jurisdictions.
The African Tax Administration Forum (ATAF) has also recently released a report (the ATAF Report) containing a suggested approach for members who are considering whether to introduce new rules for the taxation of highly digitalised businesses. The ATAF Report observes that the digitalisation of business often enables MNEs to carry out business in African countries with no or very limited physical presence in those countries. This trend has seen some MNEs with physical presence in a country close their premises and move to online trading. This makes it difficult for countries to establish taxing rights over the profits the MNE is making from those business activities.
The ATAF Report also acknowledges the work being done by the OECD/Inclusive Framework to find a global consensus solution to the tax challenges arising from the digitalisation of the economy. However, it expresses the view that there is a significant risk for African countries to simply wait to see whether the OECD/Inclusive Framework can achieve an international solution since it would significantly delay the introduction of appropriate legislation, which would cost African countries millions of dollars of lost tax revenue.
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. 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. This is most likely the result of the approach of the USA, which has indicated that it would encourage its residents to oppose the imposition of the tax in court.
The OECD/Inclusive Framework has remarked that a multilateral agreement (MLI) amending the relevant DTAs to allow such taxation by the market jurisdictions could be signed by the middle of 2021, which could result in the implementation of the new rules in 2022.
Therefore, it is advisable for the Government to await this international action to ensure cooperation of other states, notably the USA, since most of the targeted MNEs are USA based.
However, in line with the recommendations in the OECD/Inclusive Framework reports, the Government should commence the drafting of the relevant legislation to impose such digital taxes, including provisions to deem income generated by a non-resident from supplies to residents by digital means as South African source income. 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. 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.
