Principles of double taxation relief (Part 1)

In cross-border transactions, an amount may be taxable either in South Africa or in the foreign country – but usually not in both.

If there is one thing that bothers taxpayers and practitioners alike, it’s the whole question of international taxation.  More specifically, taxpayers are concerned as to where the tax should be paid.  For instance, suppose you have money invested in the United Kingdom (UK), but you live in South Africa.  Where would the interest income be taxed?  In the UK, or in South Africa?

Astute tax planners would naturally want the income to be taxed in the country that has the lower tax rate, and if one can get the income to be “taxed” in a country that does not impose any income tax at all (such as in the many so-called “tax havens” around the world), all the better.  The worst-case scenario, on the other hand, would be one where the tax authorities in both the foreign country and in South Africa want their slice of the pie. Differing tax systems around the world make it difficult to determine just exactly when, where, and how much tax should be paid on a particular income stream.

For instance, various countries formulate their tax laws to impose tax in one of the following ways:

••         Tax is imposed based on which country the taxpayer regards as being “home” – this is residence-based taxation; or ••         Income arising from an investment domiciled within a particular country (eg, immovable property or investments) is taxed in that country – this is source-based taxation; or ••         Tax is imposed on a particular economic activity that takes place in a particular country – this is also regarded as source-based taxation.

The writers of “Notes on South African Income Tax”, Professors Keith Huxham and Phillip Haupt, define international double taxation as “the imposition of comparable taxes in two or more states on the same taxpayer in respect of the same subject matter”.  Fairness dictates that any income received by a single person should only be taxed once. However, the problem arises where Country A imposes source-based taxation, while Country B imposes residence-based taxation.  For example, suppose that a taxpayer living permanently in South Africa earns interest income from a country that has a source-based taxation regime.  If the rules of each country are applied to the interest income in question, the taxpayer will end up being taxed both in the foreign country and in South Africa.

Because South Africa is truly part of the global village, more so since becoming a democracy in 1994, it would be impossible to formulate a complete set of rules covering every possible type of transaction involving well over 200 countries, this is where certain principles aimed at eliminating double taxation come in.  Such relief is granted in two ways, namely unilateral relief and bilateral relief.

Unilateral relief This is where one particular country decides to set in place rules designed to provide its own taxpayers with relief from double taxation.  Such relief is however usually subject to certain conditions – the first of which being that the taxpayer concerned must actually become liable for tax in both jurisdictions, were it not for the relief provisions.  In other words, income that is subject to South African taxation must also, by its nature, be subject to taxation in a foreign tax jurisdiction.

Such relief is also limited, firstly to specific taxes, and secondly to a certain level. Usually it is only income tax and Capital Gains Tax for which relief is granted, and not indirect taxes such as VAT, stamp duty, or customs duty (although many countries, including South Africa, provide for VAT to be refunded at border posts in respect of goods purchased and physically leaving the country).

Furthermore, the tax relief is usually limited to the amount of tax that would have been paid on the foreign income concerned, in the home country.  For instance, if a foreign country taxes a particular income stream at 40%, but South Africa’s tax rate applicable to such income stream is only 30%, the relief granted by South Africa to the taxpayer in respect of any tax paid to the foreign tax jurisdiction will be limited to 30%.

The manner in which actual relief is provided is usually by allowing a credit to the local taxpayer in respect of any foreign taxes paid.  In South Africa, for instance, Section 6quat of the Income Tax Act provides that any tax paid to a foreign tax jurisdiction in respect of foreign income that becomes taxable in South Africa by virtue of the taxpayer’s residence in South Africa, can be claimed as a tax credit (in the same manner as PAYE or provisional tax would be credited), limited to the amount of the South African tax liability on such income.

Another method of providing unilateral relief is to exempt certain foreign income from domestic tax.  Section 10(1)(k), for instance, exempts certain foreign dividends from South African taxation.