Withdrawal of foreign tax credits for South African-sourced income

Budget 2015 NewsJohannesburg, 23 July 2015 – The 2015 Budget announced by Finance Minister Nene included a number of measures to bolster tax revenues from an international perspective.

According to David Warneke, a Director and Head of Tax Technical with BDO South Africa, these measures include potentially removing tax relief currently afforded to South African companies on service income received from outside South Africa. This could negatively impact foreign direct investment into South Africa.

“This was originally introduced to relief South African companies of withholding taxes (sometimes in contravention of the Double Taxation Treaties) imposed by foreign entities that became unrecoverable,” says Warneke.

“The Income Tax Act currently provides for a rebate with respect to foreign taxes withheld by a foreign government on income sourced in South Africa. It is understood that certain companies were abusing the relief measure, which inevitably led to the proposal to remove the provision. However, the removal of this relatively unique provision will result in increased costs for South African companies as they will no longer be able to claim this rebate.”

In addition, Warneke advises that the controlled foreign company rules which apply transfer pricing provisions are likely to be extended to include the sale of goods by a controlled foreign company to connected parties that are South African resident. “The rules could be extended to also include companies owned by offshore trusts which have South African resident beneficiaries. The first interim report of the Davis Tax Committee on Estate Duty recommended that it be investigated to make it a criminal offence where South African taxpayers do not disclose direct or indirect interests in foreign trusts. Extending the transfer pricing rules as a mechanism to protect South /Africa’s tax base is welcomed.”

“Furthermore, the interest withholding tax that applies from 1 March 2015 imposes a 15% withholding tax on certain interest paid or due and payable to non-residents. The 15% can be reduced where a double taxation agreement applies” says Warneke. “Interest deductions are limited where the interest is paid to a non-resident who is directly or indirectly in a controlling relationship with the borrower or debtor. The limitation is done through a formula and applies where an interest withholding tax does not apply, for example in case a double taxation agreement or where the interest is not otherwise taxable in South Africa.”

“This does not aid foreign direct investment into South Africa, especially into the manufacturing sector where investment is really needed. Hopefully National Treasury will re-examine the financial consequences to South Africa,” concludes Warneke.