On July 24 2013 The South African Revenue Service (SARS) issued Binding Class Ruling 41 regarding the question of whether a dividend distributed by a foreign company constitutes a ‘foreign dividend’ as defined in Section 1 of the Income Tax Act (58/1962).
The applicant was a foreign corporate partnership limited by shares. Its structure was essentially a hybrid between a partnership and a limited liability company, which is utilised in European countries, such as Germany, Belgium, France, Denmark and Poland. The applicant was listed on the London Stock Exchange, with depositary receipts listed on the Johannesburg Stock Exchange.
Depositary receipts are negotiable financial instruments that are issued by a bank and represent a foreign company’s shares on a local exchange. Depositary receipts make it easier to buy shares in a foreign company, because the company does not have to be listed on the exchange and the shares do not have to leave the foreign country. They are managed through brokers (eg, banks) in the local financial sector.
The ruling dealt with whether the applicant could be considered to be distributing ‘foreign dividends’ as defined in Section 1 of the act, where it made distributions to beneficial holders of depositary receipts locally. The class members to which the ruling applied are these beneficial owners, which would receive foreign dividends from time to time associated with the applicant’s shares.
Section 1 defines ‘foreign dividend’ as any amount that is paid or payable by a foreign company in respect of a share in that foreign company where that amount is treated by that foreign company as a dividend or similar payment for purposes of:
- the laws relating to income tax on companies in the country in which the foreign company has its place of effective management; or
- the laws related to companies in the country in which the foreign company has been incorporated, formed or established, where there are no laws relating to the place of effective management.
The definition does not include amounts paid or payable which constitute shares in the foreign company.
On the facts, the applicant’s shareholders, which were resident in Country X, were taxed on dividend income on the basis that it is treated as interest. SARS made it a condition that the shares of the applicant in respect of which dividends were to be declared were not ‘hybrid equity instruments’ in terms of Section 8E(1) of the act. SARS ruled that a dividend declared by the applicant to local beneficial owners of depository receipts would constitute a foreign dividend.
It appears that despite the fact that the dividends received by foreign shareholders in the applicant are taxed as interest in the foreign country, SARS ruled that distributions received from the applicant by local holders of depository receipts qualify as ‘foreign dividends’ in terms of the definition in Section 1.