Retroactive application of a double tax agreement

International Taxation

On 16 October 2015, a Protocol amending the double tax agreement (DTA) between South Africa and Cyprus was published in the Gazette. In normal circumstances, the promulgation of a protocol does not cause much excitement; however, one of the articles in the Protocol raises unusual issues.

Article IV contains two paragraphs:

The first states that each of the states shall notify the other of the completion of the procedures required by its domestic law to bring the Protocol into effect, and that the Protocol shall come into effect on the date of receipt of the later of these notifications. The operative date in that respect was 18 September 2015.

The second states that the provisions of the Protocol shall apply from the date of the introduction in South Africa of the system of taxation at shareholder level of dividends declared, namely 1 April 2012.

The principal amendment wrought by the Protocol was to permit the source state to tax dividends paid to a resident of the other state. Under the original Article 10 of the DTA, prior to its amendment, only the country of residence enjoyed the right to tax the dividends.

How will SARS apply the Protocol?

From 1 April 2012 and prior to 18 September 2015, residents of Cyprus deriving dividends from South African resident companies would have received the dividends free of any dividend tax, provided that they had complied with the formal requirements entitling them to the reduced rate specified in the DTA.

In theory, at least, all of the declarations that were filed are a misstatement of a material fact. The persons making the declarations would have stated that they are entitled to a reduction in the rate of tax in terms of the DTA. However, by a fiction, the entitlement which they had claimed never existed!

This raises questions whether SARS will:

  • pursue the shareholders and claim payment of the tax;
  • levy penalties and interest on late payment;
  • penalise the local withholding agents for failing to withhold the tax; or
  • make the company or regulated intermediary a responsible third party and enforce collection of the tax from subsequent dividend remittances.

It is submitted that any action to recover taxes that were lawfully not payable on the date that the dividends were paid would be unwarranted and reprehensible. In all instances, the shareholders, companies and regulated intermediaries would have acted in strict compliance with the law in force at the time of the payment of the dividends, and, regardless of whether the law recognises the retroactive effect of the agreement, these parties cannot be presumed to have known law which had not yet been promulgated.

There is a presumption in law that retroactive legislation is deemed to have force from the date on which it is deemed to come into effect, and there may be an argument that SARS can fix a shareholder with liability. However, the withholding obligations are administrative provisions and you cannot re-enact the payment, so there would appear to be little expectation that the companies or regulated intermediaries should be held to account.

It would seem that SARS’ only resort would be to pursue the shareholders in Cyprus, which would appear to be a lengthy and costly endeavour.

One is left pondering what the motive for Article IV(2) of the Protocol could possibly have been. If there was nothing to gain from retroactive application, why was it considered necessary?

We await further developments with interest.

This article first appeared on pwc.co.za.

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