This article sets out a brief summary of some of the proposed amendments introduced by recent South African draft Tax Bills. The article focuses on amendments in the context of international taxation.
The draft Taxation Laws Amendment Bill, 2015 (“draft TLAB”) and the draft Tax Administration Laws Amendment Bill, 2015 (“draft TALAB”) were released by National Treasury on July 22, 2015.
These draft Bills aim to provide the necessary legislative amendments required to implement most of the tax proposals outlined in the 2015 Budget Review. Specifically, the draft TLAB deals with more substantive changes to tax legislation and the draft TALAB deals with administrative provisions of tax legislation currently administered by the South African Revenue Service (“SARS”). We consider proposed amendments in an international tax context below.
Withdrawal of Special Foreign Tax Credit
Section 6quin of the Income Tax Act No. 58 of 1962 (“Act”) contains a special foreign tax credit regime, which provides for a tax credit in respect of foreign withholding taxes imposed on service fees from a South African source and which are received by a South African resident in respect of services rendered in South Africa to a non-resident.
One of the main reasons for introducing section 6quin was the fact that some treaty countries, although they did not have the right to tax service fees in terms of their tax treaties with South Africa, still imposed withholding tax on services rendered by South African residents to their residents.
The aim of this provision was to provide some relief from potential double taxation on cross-border service fees. However, in terms of the Explanatory Memorandum to the draft TLAB, it effectively encourages treaty partners not to adhere to treaty terms, and consequently erodes South Africa’s tax base, as South Africa is obliged to give credit for foreign taxes levied by the other countries. Accordingly, it is submitted that this regime is not aligned with international tax rules and defeats the whole purpose of tax treaties.
It is proposed that section 6quin be withdrawn from the Act in its entirety with effect from January 1, 2016 and that tax treaty disputes be resolved by the contracting states through mutual agreement procedures.
Reinstatement of the CFC Diversionary Income Rules
Prior to 2011, the controlled foreign company (“CFC”) provisions in the Act contained three sets of diversionary income rules, known as:
- CFC inbound sales, which applied to the sale of goods by a CFC to any connected South African resident;
- CFC outbound sales, which applied to the sale of goods by a CFC to a foreign resident or to an unconnected South African resident where those goods were initially purchased from connected South African residents; and
- CFC connected services rules, which applied when a CFC performed services to a connected South African resident.
In 2011, the CFC outbound sales rules were abolished in their entirety and, in addition, the CFC inbound sales rules were narrowed, the rationale being that the transfer pricing rules could be applied as an alternative. The CFC connected services rules were, however, retained.
The draft TLAB proposes that both the CFC outbound and inbound sales rules be reinstated in their pre-2011 form, with effect from January 1, 2016. In terms of the Explanatory Memorandum to the TLAB, the main reason for such proposed reinstatement is that the removal of the CFC outbound sales rules resulted in the CFC rules being less effective in addressing profit shifting by resident companies, since transfer pricing auditing processes often take a long time to be finalized and consequently leave the South African tax base vulnerable to base erosion practices if transfer pricing is to be solely relied on. Furthermore, the narrowing of the CFC inbound sales rules limited the scope of the effective application of these rules.
Withholding Tax on Interest
The withholding tax on interest entered into force on March 1, 2015. It is levied at the rate of 15% on South African sourced interest that is paid by any person to or for the benefit of any foreign person, subject to certain exemptions. The term “interest” is not defined for the purposes of these provisions. To remove current uncertainty as to whether the common law definition of interest or the definition of interest as contained in section 24J(1) of the Act applies, the draft TLAB proposes that the term “interest” be defined in these provisions with reference to the definition of “interest” as contained in section 24J(1). Section 24J of the Act regulates the incurral and accrual of interest. The definition of “interest” in section 24J(1) extends beyond the common law meaning of interest.
The draft TLAB also proposes to insert an additional exemption from the withholding tax on interest. In terms of the proposed amendment, any amount of interest paid to a non-resident in respect of a debt owed by another non-resident must be exempt from the withholding tax on interest unless the other non-resident (1) is a natural person who was physically present in South Africa for a period exceeding 183 days in aggregate during the 12 month period preceding the date on which the interest is paid, or (2) the debt claim in respect of which that interest is paid is effectively connected with a permanent establishment of that other non-resident in South Africa if that other non-resident is registered as a taxpayer in South Africa. These proposed amendments will be deemed to have come into operation retrospectively from March 1, 2015.
Withholding Tax on Service Fees
In terms of the Act, a withholding tax on service fees will apply with effect from January 1, 2016 in respect of South African sourced service fees which are paid or become due and payable on or after January 1, 2016 to or for the benefit of any foreign person, subject to certain exemptions. In light of the 2015 Budget Speech delivered by the Minister of Finance, where it was indicated that these provisions ought to be reviewed to clarify definitions and remove any anomalies, we expected to see amendments to these provisions in the draft TLAB. The draft TLAB, however, only proposes to postpone the effective date from January 1, 2016 to January 1, 2017. We therefore expect that amendments to these provisions will be introduced in future years.
Sale of Immovable Property by Non-residents
The capital gains tax (“CGT”) provisions are contained in the Eighth Schedule to the Act. In the case of non-residents, the Eighth Schedule applies only to the disposal by a non-resident of any immovable property situated in South Africa or any interest in immovable property situated in South Africa, or assets which are attributable to a permanent establishment of the non-resident in South Africa.
Under tax treaties, the term “immovable property” is generally defined with reference to the meaning it has under the domestic law of the contracting state in which the property is situated. However, the current definition of “immovable property” for CGT purposes is not aligned with the definition thereof as contained in paragraph 2 of article 6 of the OECD’s Model Tax Convention as far as natural resources are concerned.
Since South Africa has an extensive tax treaty network in place, it is important that the definition of “immovable property” contained in the Eighth Schedule be aligned with the definition thereof in the OECD’s Model Tax Convention in order to avoid any anomalies. The draft TLAB proposes that the definition of “immovable property” as contained in the Eighth Schedule be amended with effect from January 1, 2016 to include “rights to variable or fixed payments as consideration for the working of, or the right to work mineral deposits, sources and other natural resources”.
Furthermore, section 35A of the Act imposes a withholding tax on a non-resident seller of immovable property in South Africa, subject to certain exclusions. One of these exclusions provides that the purchaser does not need to withhold tax in respect of any deposit paid “until the agreement for that disposal has been entered into”.
To address the risk of tax being withheld in instances where the sale is subject to suspensive conditions which are subsequently not fulfilled, the draft TLAB proposes that the wording of this exclusion be amended by substituting the phrase “has been entered into” with “has become unconditional”.
Relaxation of CGT Rules Applicable to Cross Issue of Shares
In 2013, paragraph 11(2)(b) of the Eighth Schedule to the Act was amended to provide that the issue of shares by a resident company to any person in exchange for shares in a foreign company, would not be exempt from CGT. This amendment was aimed at the prevention of tax-free corporate migrations, but it has transpired that it is too broad and has led to unintended consequences which, inter alia, undermines the expansion of South African multinationals. It is proposed that the 2013 amendment be reversed retrospectively from the date of its introduction. As such the issue of shares by a South African resident company as consideration for the acquisition of shares in a foreign company will no longer be subject to CGT.
Counter-Measures for Tax-Free Corporate Migrations
As a result of the above amendment, other measures have been proposed to address the concerns which led to the 2013 amendment of paragraph 11(2)(b). Paragraph 64B of the Eighth Schedule currently provides for a so called “participation exemption” in terms of which, a capital gain or capital loss arising on the disposal of equity shares in a foreign company must be disregarded provided certain requirements are met, including that the shares be disposed of to a non-resident other than a CFC. It is now proposed that this participation exemption will also not apply should the interest held be disposed of to a connected person. This is aimed at countering the tax-free disposals of the foreign operations of resident companies to their non-resident connected persons. A further measure proposed is the claw-back of participation exemptions enjoyed by a South African resident as set out below.
The Claw-Back of Participation Exemption Benefits on a Change of Tax Residence
In terms of the claw-back of capital gains benefits, it is proposed that upon a change of tax residence as envisaged in section 9H of the Act, any capital gains benefits enjoyed by a South African resident during the three year period before ceasing to be a South African tax resident will be subjected to tax. As such, capital gains previously disregarded in terms of paragraph 64B of the Eighth Schedule that were determined in respect of disposals by a resident of its shares in foreign companies during the abovementioned three-year period will be clawed back. In this regard, the aggregate of such disregarded capital gains will not be allowed to be taken into account in determining the net capital gain or assessed capital loss of the resident, but will be included in the taxable income of the resident at the companies’ inclusion rate.
Similarly, the participation exemption on foreign dividends enjoyed by a South African resident during the three-year period before ceasing to be a South African tax resident will be subjected to tax upon exit. As a result, foreign dividends that were previously exempt in terms of section 10B(2)(a) of the Act during the abovementioned three-year period will be subject to tax. Such foreign dividends will be subject to tax, at an effective tax rate of 15 per cent.
If promulgated, these amendments would apply retrospectively from June 5, 2015.
In terms of current legislation, when an outright transfer of collateral is executed during a securities lending arrangement, equity securities constituting the collateral are subject to CGT and securities transfer tax (“STT”) on the transfer thereof since it involves a change in the beneficial ownership of the securities.
Accordingly, it is proposed that a similar tax dispensation as applies to securities lending arrangements (i.e. no CGT and STT implications arise upon transfer) be introduced for the outright transfer of listed shares provided as collateral. It is proposed that this dispensation come into operation on January 1, 2016 and apply in respect of collateral arrangements entered into on or after that date.
Automatic Exchange of Information
Section 26 of the Tax Administration Act No. 28 of 2011 (“Admin Act”) deals with third party returns. The draft TALAB proposes to insert an additional subsection to this section authorising the Commissioner to require a person to register as a person required to submit a return under section 26, an international agreement or an international standard for exchange of information.
South Africa is an early adopter of the OECD Standard for Automatic Exchange of Financial Account Information in Tax Matters, and reporting on tax years from March 1, 2016 will begin in 2017.
The proposed amendment is aimed at ensuring that the relevant financial institutions comply with international tax standards such as the above and to assist SARS in the administration and enforcement of such standards. In terms of the Explanatory Memorandum to the draft TALAB, it will ease the compliance burden on reporting financial institutions and would enable these institutions to collect information and report to SARS even in respect of taxpayers that are resident in jurisdictions that have not yet adopted this standard or concluded an international tax agreement with South Africa.
Foreign Information Requests
The draft TALAB proposes to amend section 46 of the Admin Act. Section 46 allows SARS to request relevant material from a taxpayer or another person for purposes of the administration of a tax Act in relation to a taxpayer.
One of the proposed amendments is that a senior SARS official could request relevant material held or kept by a connected group company that is located outside of South Africa. Furthermore, failure to provide such information would bar the taxpayer from producing or using the material in any subsequent proceedings unless a competent court would direct otherwise under exceptional circumstances. Such circumstances would not include an assertion that the material was held by a connected person.
In terms of the Explanatory Memorandum to the draft TALAB, this amendment is aimed at ensuring that taxpayers do not assert that they are unable to obtain and provide relevant material, only to provide it at a later stage, for tactical reasons.