The South African Revenue Service (SARS) issued Binding Class Ruling 41 (Ruling) on 24 July 2013 regarding the question of whether a dividend distributed by a foreign company will constitute a ‘foreign dividend’ as defined in section 1 of the Income Tax Act No. 58 of 1962 (the Act).
The applicant was a foreign corporate partnership limited by shares (Company X). The structure is essentially a hybrid between a partnership and a limited liability company utilised in European countries such as Germany, Belgium, France, Denmark and Poland. The applicant was listed on the London Stock Exchange (LSE) with depository receipts (DRs) listed on the Johannesburg Stock Exchange (JSE).
DRs are negotiable financial instruments that are issued by a bank and represent a foreign companys shares on a local exchange. DRs 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, such as banks, in the local financial sector.
The ruling deals with whether the applicant could be considered to be distributing ‘foreign dividends’ as defined in section 1 of the Act, where it makes distributions to beneficial holders of DRs locally. The class members to which the Ruling applies are these beneficial owners, who would receive foreign dividends associated from time to time with the applicants shares.
Section 1 of the Act provides that ‘foreign dividend’ means 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 (POEM).
- Where there are no laws relating to POEM, laws related to companies in the country in which the foreign company has been incorporated, formed or established.
The definition does not include amounts paid or payable which constitute shares in the foreign company.
On the facts, the applicants shareholders who are resident in Country X, are 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 are to be declared are 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 DRs 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 DRs will qualify as ‘foreign dividends’ in terms of the definition in section 1 of the Act.
Cliffe Dekker Hofmeyr
ITA: Sections 1 (definition of foreign dividend) and 8E(1)