South Africa Closes Loopholes In New Dividend Tax

by Lorys Charalambous,, Cyprus

South Africa’s Minister of Finance, Pravin Gordhan, has announced the closing of tax avoidance schemes which have arisen with regard to the operation of the new dividends tax.

The dividends tax came into effect on April 1, 2012 at a rate of 15% and is designed to replace the former secondary tax on companies (STC). The latter applied at the company level, while the new tax is levied on shareholders when they receive their dividend payment.

It has been pointed out that one consequence of the change is the differing rates applicable depending on the shareholder involved. As a result, dividends paid to domestic companies are also generally exempt on the basis that they will be taxed once the profits are eventually paid via further dividends paid to other types of individual shareholders, and dividends paid to certain foreign shareholders may now be eligible for tax treaty relief.

However, the government has become concerned about dividend schemes involving foreign shareholders. The National Treasury and the South African Revenue Service (SARS) have seen, for example, a growing number of advisors advocating tax schemes for the benefit of foreign shareholders that arguably reduces the dividends tax rate to zero (without any reliance on a tax treaty).

In essence, the schemes seek to convert the taxable payment of dividends into exempt compensation, gains or income upon disposal. In most cases, the conversion is attempted on the basis that the scheme allows for the conversion of Rand denominated dividends into amounts denominated in a foreign currency.

In one of the most notable schemes, for example, a listed company declares dividends to its shareholders. After declaration, but before payment, a foreign shareholder who expects to receive dividends from the company sells the right to those dividends to an independent South African company in exchange for a foreign currency equivalent (less a fee).

In another, the listed company declares dividends to its shareholders. A foreign shareholder sells the shares cum dividend to an independent South African company for USD1m, but then repurchases the same shares for USD900,000 (after the dividend is paid to the South African company and after subtracting the fee).

The sale of the shares by the foreign shareholder is viewed as foreign source income (outside the South African taxing jurisdiction). The receipt of dividends by the South African company after the sale is allegedly viewed as an exempt company-to-company dividend.

The stated purpose of all the transactions is to convert the Rand dividend amount to foreign currency, but their real purpose says the government is to eliminate dividends tax.

Furthermore, the government is concerned with the use by some taxpayers of the transitional rules from the STC to the dividends tax, where taxpayers with pre-existing STC credits can carry them into the new dividends tax for a three-year period. STC credits are premised on the notion that profits in the form of dividends were once subject to the STC, and are designed so that the same profits are not subject to tax again if passed along via further dividends.

The National Treasury said that it had previously expressed concerns that the mixing of old and new systems could give rise to unintended revenue losses, but that it proceeded with a limited transition rule at the strong insistence of the private sector. However, schemes have arisen whereby alleged defects in the transitional rules have been exploited with the purpose of generating STC credits even though no STC was ever paid on the underlying profits.

The basic essence of the schemes has been to try and pay exempt dividends between group members during the last dividend cycle before the April 1 effective date of the new dividends tax so as to generate STC credits in violation of the stated intention of the proposed relief.

Given the above, schemes involving the conversion of dividends into other forms of non-taxed income will be closed with immediate effect, and, more specifically, the anti-avoidance rules will apply to eliminate their benefit, while the STC transitional rules will be more closely linked to the old system to make absolutely clear that STC credits cannot arise from dividends never previously subject to the former tax.

In addition, the company paying a dividend with overstated STC credits will become liable for any tax shortfall, as only the company paying the dividend has control over these calculations.

The draft 2012 Taxation Laws Amendment Bills have been amended urgently to introduce the close tax avoidance measures relating to dividend conversion schemes, and the National Treasury and SARS are formally requesting public comments, by September 7, in respect of the proposals, including the revisions addressing the misuse of STC transitional credits.