A recent decision of the Supreme Court of Appeal of South Africa considered the application of the capital gains article in a double tax convention based on the OECD model to a deemed disposition of property occurring as a result of an "exit tax" imposed on an emigrating corporation. As the Court's decision concerns capital gains exemption language that is similar to that used in most double tax treaties based on the OECD Model, it provides a helpful glimpse into how such provisions may be interpreted in other jurisdictions, including Canada.
In Commissioner for the South African Revenue Service v. Tradehold Ltd [2012] ZASCA 61, the Supreme Court of Appeal of South Africa (the "Court") considered whether Article 13(4) of the Luxembourg-South Africa Tax Convention (the "Convention") applied to exempt a deemed disposition arising under South Africa's domestic "exit tax" from being subject to tax in South Africa.
The taxpayer, Tradehold Ltd. ("Tradehold"), was a publicly-listed holding corporation incorporated in South Africa. Under the domestic legislation, Tradehold was deemed to be a resident of South Africa by virtue of having been incorporated there. On July 2, 2002, the board of directors of Tradehold, at a meeting in Luxembourg, resolved that all further board meetings of the corporation would be held in Luxembourg. As a result, Tradehold became resident in Luxembourg under common law principles. Nonetheless, under South African legislation at the time, the corporation remained resident in South Africa.
As a dual resident corporation, the Convention's "tie breaker" rule provided that Tradehold was deemed to be resident solely in Luxembourg for Convention purposes. A change to the definition of 'resident' under the South African domestic law to exclude a corporation that is "deemed to be exclusively a resident of another country for purposes of the application" of one of South Africa's tax conventions, including the Convention, subsequently took effect on February 26, 2003.
The Commissioner assessed Tradehold on the basis that when Tradehold's seat of effective management was relocated to Luxembourg, or when the domestic legislative change resulted in the corporation ceasing to be a deemed resident of South Africa, Tradehold was deemed to have disposed of its only relevant asset, namely, 100% of the shares of a subsidiary corporation, under South Africa's departure tax. The result was a deemed capital gain in excess of R400,000,000.
At the Tax Court, the taxpayer argued that the deemed disposition was exempt from South African tax pursuant to Article 13(4) of the Convention, which designated the right to tax capital gains on most non-immovable property to the state of residence and not the source state. It was argued by Tradehold that the exemption was available because at the time of the deemed disposition the Convention tie breaker rule applied to deem Tradehold to be resident in Luxembourg only. The Tax Court rejected the Commissioner's argument that the exemption in the Convention, which excluded "gains from the alienation of property" did not apply to a deemed disposition, as a deemed disposition was not an "alienation" for these purposes.
On appeal to the Supreme Court of Appeal, which is the highest court in South Africa for non-constitutional matters, the Commissioner again argued that the Convention did not provide an exemption for deemed dispositions, on the basis that a deemed disposition is not an "alienation". The Commissioner argued that if Article 13(4) of the Convention applied, South Africa's exit tax would be ineffective for corporations that migrate to a country with which South Africa has entered into a double tax treaty; it was argued that this could not have been the intention of the legislature. In addition, the Court considered the Commissioner's argument that since the deeming provision in the domestic legislation provided that it applied "for purposes of this Schedule", it could not apply to the Convention.
The Court held that the Convention modified South Africa's domestic law and, as a result, it was necessary to determine whether the exit tax could be imposed consistently with the obligations entered into by South Africa when it signed the Convention. The Court noted that the Convention did not draw a distinction between capital gains arising from actual or deemed dispositions, despite the drafters of the Convention having been aware that the provisions of South Africa's domestic taxing statute could result in deemed dispositions. The Court also found that there was no reason in principle why the parties to the Convention would have intended that Article 13(4) would apply only to taxes arising on actual capital gains arising from actual alienations of property. Accordingly, the Court found that the language of the Convention covered deemed dispositions and, therefore, the exit tax did not apply to Tradehold upon its ceasing to be resident in South Africa.
This decision has prompted the South African Minister of Finance, Pravin Gordhan, to state that he will consider whether legislative changes are necessary "to further clarify that a DTA does not apply to deemed or actual disposals while a taxpayer is resident in South Africa. Measures such as the immediate termination of a taxpayer's year of assessment on the day before becoming non-resident, as is the practice in Canada, are being explored." It is by no means clear however that the Canadian model would survive the analysis in Tradehold.
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