By Mike Betts, Tax Partner Grant Thornton Cape
From 1 January 2015, the interest paid or due to non-residents from a source within South Africa (SA) will be subject to a 15% withholding tax, according to sections 50A to 50H of the Income Tax Act (‘the Act’). These provisions do not affect interest paid by, amongst others, any sphere of government, or any SA bank and will most likely affect loans from foreign shareholders and from other group companies located beyond the borders of SA.
The effect on non-resident persons
The withholding tax doesn’t apply in respect of interest paid to a non-resident natural person who has been physically present in SA for more than 183 days in aggregate during the twelve month period preceding the date of payment. It is also not applicable if the loan in respect of which the interest is paid exists to establish that foreign person in SA permanently and that the person is a registered SA taxpayer. In these instances however, the foreign person will not enjoy the exemption in terms of section 10(1)(h) of the Act and will be subject to normal income tax on the interest.
To benefit from the withholding tax exemption, the non-resident person will need to submit a prescribed declaration confirming that the person qualifies for the exemption before the date of payment or another date that can be determined by the person paying the interest. If the foreign person is entitled to a reduced rate of tax through the application of a double taxation agreement (DTA), then a prescribed declaration, within similar time limits, is required together with a written undertaking to advise the borrower of any subsequent change in status.
If the DTA concerned prohibits the withholding of tax in SA, the provisions of the newly introduced Section 23M will require a specific calculation which is likely to result in the deferral of at least portion of the interest deduction in the hands of the borrower where this person is in a controlling (connected person) relationship with the non-resident lender.
In order to comply with these requirements in full by 1 January 2015, consider the following advice:
- Make the foreign lender aware of these requirements;
- If the foreign lender is a natural person, ensure the time he or she spends in SA is properly monitored and that procedures are put in place to ensure the necessary exemption declaration is received timeously if the 183 day threshold is breached;
- If the loan is effectively connected with the permanent establishment of the foreign lender in SA, ensure the necessary exemption declaration and proof of registration as a taxpayer in SA are in place;
- Examine any DTA between SA and the foreign jurisdiction and if relief from the withholding tax is stipulated or provision is made for a reduce rate of tax, ensure the necessary declaration and written undertaking to advise the borrower of any change in status are in place;
- If full relief from the withholding tax is stipulated in the DTA, determine whether the foreign lender is a connected person and, if so, understand the calculation of the interest deduction that will be required;
- Formalise the loan arrangements if no loan agreement exists and obtain exchange control approval;
- Review any existing loan agreement and consider all amendments that may be appropriate to:
- Regulate the timing of interest payments. Monthly interest payments may result in excessive administrative work to meet withholding tax payments that fall due at the end of the next month after the interest is paid. This will also require continuous calculations for determining periods of physical presence in SA, if the foreign lender is a natural person. In the case of annual interest payments with an anniversary arising after 31 December, consider making an early payment on or before 31 December 2014 to minimise exposure to the withholding tax.
- Comply with the revised transfer pricing and thin capitalisation rules for which purpose an arm’s length character needs to be demonstrated for both the level of funding and the interest charged thereon.
- Comply with all current exchange control regulations. These include a maximum interest rate equivalent to the prime lending rate in the case of shareholder loans. This may not necessarily coincide with an arm’s length rate of interest for transfer pricing purposes.
- Seek our expert advice to ensure compliance and minimise administration problems.