One of the key issues that foreign investors in South Africa (ZA) need to consider is whether their activities in South Africa will create a Permanent Establishment (PE) and expose them to a corporate income tax liability in South Africa. The construction industry is one of the main sectors that may give rise to a PE in South Africa.
Section 1 of the Income Tax Act defines a PE with reference to article 5 of the OECD Model Tax Convention on Income and Capital (Model Convention), being a fixed place of business where the enterprise’s business is wholly or partly carried on, including management places, branches, offices, factories, workshops, mines, and construction sites lasting over 12 months.
According to the Model Convention, a building site, a construction, installation or assembly project constitutes a PE only if it lasts more than 12 months (this time period can differ depending on the particular double taxation agreement in question). Based on the OECD Commentary, the phrase “a building site or construction or assembly project” should not be interpreted restrictively. The OECD Commentary further provides that a project should be regarded as a single unit, even if it is based on several contracts, provided that it forms a coherent whole commercially and geographically. It follows that a site exists from the date on which the contractor begins his work (time spent on mere negotiations excluded), including any preparatory work, in the country where the project is to be established.
If a general contractor which has undertaken the performance of the comprehensive project, sub-contracts all or parts of such a project to sub-contractors, the period spent by a sub-contractor must be considered as being time spent by the general contractor on the project for purposes of determining whether a PE exists for the general contractor.
A site continues to exist until the work is completed or abandoned. The period during which testing is performed by the (sub)contractor should be included in the period during which the site exists. The 12-month test applies to each individual site or project and temporary interruptions do not result in the disregarding of time on site. Once the 12-month threshold is exceeded, the PE is deemed to exist from the date of commencement of the project, and not only from the date of exceeding the threshold.
In addition to the potential income tax liability (at a rate of 27%), other taxes (such as value added tax and employees taxes) and regulatory requirements (such as reportable arrangements and external company registrations) should be considered when evaluating a potential project in ZA. Contractors and sub-contractors involved in cross-border construction projects should therefore carefully monitor the duration and nature of their activities in ZA and seek professional advice to avoid any unintended tax consequences.
If you wish to discuss these topics, please contact:
WTS Renmere
