Constitutional Court Gives A New Reach To The GAAR In Absa Case

The Constitutional Court’s judgment in Absa Bank Ltd and Another v C:SARS  is one of the most important tax judgments delivered in South Africa in recent years. The case concerned Absa Bank Ltd’s (“Absa”) investment of approximately ZAR1.9 billion in preference shares issued by PSIC3 as part of a broader structure associated with the Macquarie Group. The Commissioner for the South African Revenue Service’s (“SARS”) case was that through a number of downstream entities and Brazilian government bond transactions, taxable interest income was “converted” into returns that came back to Absa as exempt dividends. SARS therefore invoked the General Anti-Avoidance Rules (“GAAR”) and re-characterised the dividend income as taxable interest.

Two issues came before the Constitutional Court. The first was whether Absa could be regarded as a “party” to the avoidance arrangement under section 80L of the Income Tax Act, 58 of 1962 (“Act”), despite its contention that it did not know about the downstream steps. The second was whether Absa obtained a “tax benefit” for purposes of the GAAR.

The majority judgment, written by Majiedt J, answered both questions against Absa. On the first issue, the majority adopted a broad reading of the concept of being a “party” to an arrangement. The court held that participation is assessed objectively. The question is not what the taxpayer knew, but what the taxpayer did and what role it played in the overall arrangement. On that approach, a taxpayer may be a party to an avoidance arrangement even if it does not know every step or feature of how the structure worked downstream. The majority considered that a narrower interpretation would weaken the GAAR and create room for what it saw as deliberate ignorance or wilful blindness.

Concept of a “tax benefit”

On the second issue regarding the concept of a “tax benefit,” the majority also found against Absa. It held that the enquiry requires the court to strip out the avoidance features of the arrangement and ask what remains. The court held that the “correct ‘but for’ test to determine if a tax benefit arose requires assessing whether, but for the tax avoidant features and dressing up of the transaction, a tax liability would have occurred.” The court held that “[i]f one strips away avoidance features, it converts what Absa received into interest, and then Absa did obtain a tax benefit. The avoidance steps caused the return to be dressed up as a dividend.”

The majority also held that section 80B empowered SARS to assess “any party” to the arrangement, including Absa as the ultimate economic beneficiary, rather than being confined to pursuing intermediate entities that may have had little or no independent commercial substance.

Sole or main purpose test

The court was required to consider the jurisdictional requirement relating to an “impermissible avoidance arrangement” as set out in section 80A of the Act. The jurisdictional requirement is the existence of an avoidance arrangement whose sole or main purpose is to obtain a tax benefit and which is abnormal. The court held that this is an objective enquiry.

The court held that the finding that the jurisdictional requirement (i.e. the existence of an “impermissible avoidance arrangement”) entails an objective enquiry is fortified by the provisions of section 80G of the Act. This section requires a party obtaining a tax benefit to prove that, reasonably considered in the light of relevant facts and circumstances, obtaining a tax benefit was not the sole or main purpose of the avoidance arrangement. The court held that this wording is indicative of an objective test as the focus is not on the taxpayer’s stated intentional purpose, but rather on the reasonable prevailing facts and circumstances. The court held that this is a fundamental change from the provisions of section 103(1) (i.e. the previous GAAR provisions) which the courts interpreted to relate to a taxpayer’s subjective purpose. The court held that the relevant facts constitute the “type of impermissible avoidance arrangement that falls under the GAAR provisions”.

Dissenting judgment

Rogers J delivered the sole dissent, but it is a careful and substantial judgment that is likely to remain influential in future GAAR litigation. On the “party” issue, Rogers J took the view that one cannot sensibly be a party to an arrangement one does not know exists. In his view, knowledge is inherent in the ordinary meaning of participation. He illustrated the point by analogy: a person who gives someone a lift to a location where that person later commits a murder is not, without more, a party to the murder. For Rogers J, the notion of an “arrangement” also carries with it some understanding or meeting of minds between those said to participate in it. He raised the concern that the majority’s approach stretched the concept too far and introduced unfairness and legal uncertainty by exposing taxpayers to adverse consequences in respect of arrangements of which they were unaware. He also observed that there may be legitimate commercial reasons why participants in institutional finance do not disclose all downstream features of a wider structure to every counterparty. On his reasoning, Absa’s alleged ignorance was not in itself unusual or suspicious. He accepted that wilful blindness could, in an appropriate case, bridge the knowledge gap, but pointed out that SARS had not advanced the case on that basis.

On the tax benefit issue, Rogers J drew a distinction between a tax benefit and an economic advantage. In his view, Absa received exempt dividends on preference shares, which is the tax treatment ordinarily provided for that instrument in the Act. The real tax benefit, if there was one, was obtained elsewhere in the structure. For Rogers J, even if the downstream Brazilian swap transactions were removed, that would not convert Absa’s dividend income into taxable interest, because the character of Absa’s return was determined by the legal instrument it held, not by downstream arrangements it did not know about. He therefore considered it problematic to tax Absa on the basis that it had received an economic advantage flowing from a wider arrangement of which it said it was unaware. That reasoning led Rogers J to a different conclusion. In his view, SARS was seeking to tax a party who may have received an economic advantage, but not the tax benefit targeted by the GAAR. He considered that approach troubling, both as a matter of legal principle and as a matter of fairness. He also noted that SARS had other possible remedies, including pursuing the entities that directly obtained the tax benefit.

Conclusion

This is a landmark judgement in many respects. It will have a profound impact on South African law in relation to the interpretation of “tax benefit” as well as in relation to the objective enquiry relating to the sole or main purpose requirement in section 80A of the Act. It also adopts a broad interpretation of whether a taxpayer constitutes a “party” to a particular arrangement.

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