International Tax – Exit charge CGT – Section 9H

The Taxation Laws Amendment Bill 39 of 2013 (the Bill) was tabled by the Minister of Finance on 24 October 2013. One of the interesting amendments in the Bill to the Income Tax Act 58 of 1962 (the Act) relates to the exit charge on interests in immovable property, especially in light of the recent amendments to the double tax treaty between South Africa and Mauritius, concluded on 17 May 2013.

To give some background to the exit charge provisions in the Act we must consider the South African taxation system first.  South Africa taxes persons that are resident in South Africa on their worldwide income.  This includes capital gains tax on the disposal of certain assets.  Non-residents are subject to tax in South Africa on income from a source within South Africa.  Furthermore, non-residents are subject to capital gains tax on, inter alia,the disposal of immovable property situated in South Africa held by them and any ‘interest’ in immovable property situated in South Africa.

Where a company ceases to be a resident, such event is a deemed disposal event in terms of which the company is deemed to have disposed of all its assets for market value on the day before ceasing to be a resident, and immediately reacquired the same assets at the same market value on the day that the company so ceased to be a resident.  The difference between the original cost of the assets (the base cost) and the market value of the assets on disposal is generally subject to capital gains tax (commonly referred to as the exit charge).

The exit charge, however, does not apply amongst others, to immovable property situated in South Africa or an ‘interest in immovable property’ as these assets will remain taxable under the source rules when the company becomes a non-resident.  An ‘interest in immovable property’ refers to a direct or indirect shareholding of a minimum of 20% in a company or ownership or right of ownership in any other entity if more than 80% of the market value of that entity is attributable to South African immovable property held otherwise than as trading stock.  These types of entities are commonly referred to as ‘immovable property rich entities’. The reason for the exit charge not applying is because the interest in immovable property should be subject to capital gains tax in South Africa in future when disposed of by the now non-resident person, subject to double tax treaty relief.  Depending on the relief provided in and the wording of the double tax treaty concluded between South Africa and the new residence jurisdiction of the non-resident, the disposal may ultimately not be subject to South Africa tax. 

Generally, double tax treaties give the taxing rights on the disposal of immovable property to the jurisdiction where the immovable property is situated and the taxing rights on capital gains on movable property are given to the jurisdiction of where the alienator of the movable property resides. Under the older tax treaties concluded with South Africa, an interest in immovable property is treated as a movable asset for South African purposes.  This is because the term ‘immovable property’ is defined in the double tax treaty with reference to the law of the country in which the property is situated.  No definition is currently provided for the term immovable property under the Act and South Africa’s common law definition of immovable property does not include an ‘interest in immovable property’.  For this reason, certain double tax treaties allow for the complete non-taxation of capital gains arising from the disposal of an interest in immovable property situated in South Africa.  This happens firstly because, South Africa does not levy an exit charge upon cessation of company’s residency from South Africa and secondly, South Africa does not tax the company when it disposes of its interest in an immovable property rich entity (i.e. an interest in immovable property) in future due to the narrow interpretation of the concept of ‘immovable property’ that applies for purposes of some double tax treaties. Accordingly, South Africa loses economically under both circumstances. It is this loophole which National Treasury is closing down by introducing the amendments to section 9H of the Act.

The amendment to section 9H of the Act deletes the exclusion from the exit charge of an interest in an immovable property rich entity. A company ceasing to be a resident will therefore be deemed to have disposed of its assets, including any interest in an immovable property rich company at market value and re-acquired the assets at the same market value.

The amendment aligns with SARS and National Treasury’s agenda to tax gains on the disposal of certain shares held in South African companies as can be seen in the newly amended double tax treaty between South Africa and Mauritius.  The amended treaty now provides that the taxing rights on shares held by a Mauritian company in a South African company is conferred on South Africa, if the South African company derives more than 50% of its value from immovable property located in South Africa.

The amendment to section 9H and re-negotiation of the treaty with Mauritius are strong indications that South Africa is serious about securing its taxing rights to gains derived from a South African source.

The amendment will come into operation on the date of promulgation of the Taxation Laws Amendment Bill 2013.

ENSAfrica ITA: Section 9H and Eighth Schedule