BEPS in the Budget?

Johannesburg, 16 February 2024 – Very soon all eyes will be on Finance Minister Enoch Godongwana as he delivers his Budget Speech in Parliament on 21 February 2024.

The big question is of course whether the Minister of Finance will possibly give some tax relief considering that he will need to balance Government expenses and Revenue collections.

Expenditure and revenue collections

It is estimated that Government spending in the 2023/2024 financial year amounts to R2.262 trillion, up from R2.205 trillion in 2022/2023. It will be interesting to see if the expenditure for 2024/2025, which was estimated at medium term, to be R2.352 trillion will be maintained, or if this already significant estimate will grow further.

Several aspects such as the need for investment in order for South Africa to be able to control the current energy crisis, the deteriorating Rand exchange position, and the upcoming elections are making it unlikely that expenses will be reduced, and therefore, a focus should be on what could possibly be done to increase revenue.

The SARS Tax Statistics 2023 confirm that SARS’ revenue collections have grown, and in the fiscal year 2022/2023, SARS collected R2.07 trillion in gross tax revenue, which is almost 10% more than in the prior fiscal year. This increase was largely due to a recovery in tax bases and above-average commodity prices. In addition, increased effectiveness of the tax system also helped improve collections. However, more needs to be done to address the budget deficit, because it will be difficult to cut expenditure.

Budget Tax Proposals

In an environment where taxpayers are already under extreme pressure caused by high interest rates, inflation and a deteriorating currency, and where it is of great importance to attract foreign investment, increasing tax rates will be very unpopular, particularly in an election year. Thus, other areas for revenue growth would likely be considered.

One area that comes to mind relates to the Organisation for Economic Cooperation and Development’s (OECD) global initiative to ensure that certain large Multinational Entities (MNE) are subjected to a minimum tax rate of 15% in each jurisdiction in which they operate. Following the initial 2016 Base Erosion and Profit Shifting (BEPS) 15 Action Plan to revise existing international tax principles, to make the global system fit for purpose for the increased global trade, the OECD, in a second step engaged with over 140 countries to agree further changes to the tax system. This was mostly to also ensure fair taxation of businesses and transactions involving the digital economy.

The new BEPS Initiative follows a two-pillar approach. Pillar One, which relates to the re-allocation of profits globally to ensure a fairer distribution of these profits, is still widely under discussion. Pillar Two, which is to ensure the 15% minimum tax, has already been implemented in many jurisdictions for fiscal years commencing 1 January 2024 and rules in this regard are quickly implemented across the globe.

South Africa is one of the members of the Inclusive Framework on BEPS and has committed to the implementation of the Pillar Two rules. The Minister of Finance indicated in last year’s Budget Speech that a discussion paper would be released for interested parties to be able to comment on the proposed legislation. Similarly, other African countries have indicated that they will pass legislation in line with the Pillar Two rules. In this regard, Mauritius announced the intention to introduce laws while Zimbabwe has already introduced legislation from 1 January 2024.

The implementation of Pillar Two rules in South Africa may help increase revenue collections in certain circumstances.

The Pillar Two rules broadly apply to MNEs with consolidated group revenue in excess of Euro 750 million in at least two of the four past years. This is the threshold that also applies to Country-by-Country Reporting, which was implemented in terms of BEPS Action 13 in 2016.

As indicated, Pillar Two of the initiative focuses on ensuring that qualifying MNEs achieve a global minimum tax rate of 15% in each jurisdiction in which they operate, based on the concept of allowing jurisdictions to “tax back” where other jurisdictions have not exercised their primary taxing rights. The so-called Global Anti-Base Erosion (GloBE) Rules are complex and provide a mechanism for calculating the effective tax rate of an entity, which may require adjustments based on GloBE Rules (e.g. the exclusion of certain accruals or depreciation, or based on covered tax, the use of certain tax credits, or certain R&D credits may be excluded or certain items may be reallocated). Thus, the calculation of the GloBE effective tax rate is more complex than it appears.

Three methods have been developed for levying the Top-up Tax, each with a view to achieving a global minimum tax of 15% for each entity:

The Qualified Domestic Minimum Top-up Tax (QDMTT) provides for a possibility for low tax jurisdictions to levy Top-up Tax due to themselves.

The Income Inclusion Rule (IIR) then imposes a Top-up Tax on one or more Parent Entities of an MNE Group in respect of its Constituent Entities in Low Tax Jurisdictions, unless these jurisdictions have a QDMTT regime.

The Undertaxed Profits Rule (UTPR) provides a so-called “Back-stop”; thus, it will be applicable if not all Top-up Tax is levied under the QDMTT and the IIR. It applies regardless of the UPE’s ownership in a Low-Taxed Constituent Entity and there is a reduction for Top-up Tax levied in terms of the application of the IIR. The Top-up Tax is levied via a denial of tax deductions, equivalent adjustments, or as a separate tax.

A further, but conceptionally different rule is the Subject to Tax Rule (STTR) which is a treaty-based rule that applies to intragroup payments from source jurisdictions that are subject to low nominal tax rates in the country of the payee. The STTR applies to intra-group interest, royalties and a defined set of other intra-group payments (so-called covered income). If covered income is subject to a nominal corporate income tax rate below the minimum STTR rate of 9%, and applicable tax treaties limit the rate at which a jurisdiction in which the income arises can tax that income, the STTR provides that that jurisdiction may tax the income at a rate up to the difference between 9% and the nominal corporate income tax rate.

The impact of the initiative on “source” countries (i.e. countries with inbound MNEs meeting the Pillar Two requirements) and countries that have high tax rates (i.e. with an effective tax rate in excess of 15% like South Africa) is often considered to be minimal. However, the African Tax Administration Forum concluded that a mechanism for African (developing) countries to balance expected negative implications of the GloBE Rules could be to implement a Domestic Minimum Tax (QDMTT) in their domestic tax legislation.^[1] In addition, even though a country’s corporate tax rate may be above 15%, taking into account the impact of tax holidays, special dispensations, super-deductions and incentives, etc, may well reduce the GloBE Effective Tax Rate (ETR) of an entity to below 15%.

While South Africa does not have many MNEs headquartered in the country that meet the Euro 750 million threshold, many foreign inbound MNEs have operations in South Africa.

Choosing the best methodology wisely and implementing the right BEPS Pillar Two Legislation could certainly assist SARS’ collection efforts and it will be interesting to see what the Minister of Finance will announce on 21 February 2024.

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[1] Refer African Tax Administration Forum Publication at page 2: https://events.ataftax.org/index.php?page=documents&func=view&document_id=191&thankyou (accessed 12 August 2023).