People going to file their tax returns at Sars in Long Street, Cape Town. Tax guru Willem Oberholzer has elaborated on tax arbitrage in this interview with the Business Report editor.Photo: Supplied
CAPE TOWN – Former president Thabo Mbeki addressed the African Union in 2015 where he chaired a high-level panel on illicit financial flows.
He then said: “Large corporations are by far the biggest culprits responsible for illicit outflows, especially given their ability to retain the best available professional legal, accountancy, banking and other expertise.”
Mbeki’s words were on point. The current Steinhoff alleged corporate corruption case is loaded with tax avoidance and/or tax evasion examples.
I recently wrote about it. Another term arose: tax arbitrage.
I called one of the tax experts I met many years ago, Willem Oberholzer, to explain this “corporate tax trick”.
Adri: What is tax arbitrage?
Willem: Recently I was asked a question as to what tax arbitrage means with reference to Steinhoff International. Now, the question was asked in a manner that reminded me of someone that thought they were getting a jelly tot and realised they received a sourball.
Tax arbitrage is the practice of profiting from differences that arise from the ways transactions are treated for tax purposes.
The complexity of tax codes often allows for many incentives, which drive individuals to restructure their transactions in the most advantageous way in order to pay the least amount of tax. (https://www.investopedia.com/terms/t/tax-arbitrage.asp)
Adri: Give me examples of tax arbitrage.
Willem: An example of tax arbitrage is that an investor would prefer to take his money and invest it in listed shares to earn dividends as opposed to putting the same amount of money into an interest-bearing money market account.
Under the Dividend Taxation regime dividends are taxed at a rate of 20percent and after a minimum holding period of five years, should the investor choose to dispose of the shares, his/her profit on the sale will be subject to capital gains tax at a rate of 18percent.
So the total income (dividends) and gains (profit on the sale of shares) are taxed at 20percent and 18percent.
The interest earned on a money market account is taxed at 45percent for individuals that earn more than R1.5million per annum.
Tax arbitrage is being savvy with your investments, and you not only consider the returns that an investment will yield, but also what the tax implications will be.
So who among us would rather pay 45percent tax as opposed to 18percent and 20percent?
If a share investment returns a divided of R100 and a cash investment returns interest of R100 then the investor in the shares would put R80 in this pocked and the conservative cash investor would put R55 in his back pocket?
That is what tax arbitrage is in the life of us mere mortals, it means that you pick transactions (investments) that will result in the lowest tax rate and give you the more cash in your pocket – more bang for your buck. In its broadest sense, any form of transactional planning (tax planning) is tax arbitrage.
If you give something a big name like tax arbitrage, something as simple as considering the outcomes of alternative investments becomes a mysterious thing – a Moulin Rouge.
Some of us are attracted to the more exceptional things in life and would pay top dollar for some tax arbitrage.
Our conservative brethren would consider talking to their auditors about how much tax they will pay – guess what – it’s the same thing.
Adri: Will you pay R45 in tax when you can, for instance, only pay R20?
Willem: It is a sad day for us all if we have become so indoctrinated in our country that if you were to decide to invest in something where your returns are subject to a lower tax rate, your actions are morally questionable.
It is our right to structure (plan) our affairs in a legal manner as to ensure that you pay a fair amount of tax. “Give unto Caesar what is due to Caesar.” Maybe I missed the verse that said “though shalt not plan”.
Adri: Do we not all (well most of us) have a deeply rooted desire to maximise our wealth?
Willem: You may well still frown upon those devious scoundrels in their suits and ties that practise tax arbitrage and you have every right to do so. But let me give you a different view of the same coin.
If you compare prices between two stores selling sugar, and you decide to buy from the store with the lowest price – I hate to break it to you, but you just engaged in the practice of price arbitrage – you little deviant consumer you.
Adri: Is tax arbitrage a morally questionable practice?
Willem: You decide what is wrong and what is right, based on your set of morals. Our country’s tax morals hinge on the socio-economic health of the country. Let’s call it our tax morality.
There is, and here I will caution investors, a very fine line between tax planning and tax evasion. Our tax legislation is complex, as is the tax legislation in the various countries around the world, and investors should take care in that what they are doing is legal and is in effect not a scheme to evade taxation.
Tax evasion is a criminal offence, tax arbitrage is not – well, not if it is done with a clear understanding of what the income tax legislation entails – and transactions are structured in terms of the myriad of complex tax sections, schedules, memorandums and agreements, etc.
Adri: Is tax evasion criminal?
Willem: Tax evasion is a criminal offence, and in order to ensure that the “structure” that is being presented to you as an investor does not constitute a form of tax evasion, it is better to be safe than sorry. So go and ask your friendly CA on the corner to give you his opinion.
The difference between tax arbitrage and tax evasion is precisely the same as paying less for a cup of coffee at one store and just not paying for the coffee at all.
Adri: Closing remarks?
Willem: All South Africans (well, most of us) understand that we have to pay tax to ensure that we can keep enjoying the little things that we take for granted, like running water, hospitals, a police service, nurses, tarred roads and a national carrier. I will, however, refrain from mentioning some instances where potholes, hijackings and robberies have left me somewhat irritated.
Now be it the luxuries that we enjoy and the annoyance and frustrations when they disappear! We should remember that nothing in life is ever perfect, neither is the Income Tax Act. Income Tax, Dividends Tax, Capital Gains Tax, Estate Duty, Transfer Duty, VAT all have different rates, and then there are rate differentials between companies and individuals and pension funds. This leaves us with a cookbook full of ingredients for tax arbitrage in South Africa, let alone International Tax Arbitrage.
As the world gets “smaller” the plan gets bigger!
There once was a country that pursued a perfect Utopia, where all will earn the same income, pay the same tax, and there was to be peace and no war.
We all know how that wall came tumbling down. In closing, the day that we can eradicate the Devil, capitalism, the strive for wealth and survival, is that day that tax arbitrage will end.