On June 19 2013 the South African Revenue Service (SARS) published Binding Private Ruling 148.
The ruling dealt with whether the dividends tax rate applicable to dividends paid on shares held by a local branch of a foreign company can be reduced by a relevant double tax agreement. The facts were briefly as follows.
The applicant was a company that was part of a global group with its headquarters in Japan. The applicant had a local branch through which it operated in South Africa. The branch mainly acted as agent for the applicant in respect of purchasing and selling commodities. Where the branch acted as buying agent, it earned commission based on the value of the commodities procured.
The applicant (together with the branch) held a 49% equity stake in a local private company. Of the 49%, 2% was held by the branch. The branch had a right to dividends and capital gains in respect of its 2% shareholding in the local company. The branch also shared in the funding obligations relating to its 2% shareholding. In turn, the local company held a significant interest in a major supplier of commodities to the applicant (presumably through the branch).
Therefore, from time to time the branch received dividends in respect of its 2% shareholding in the local company. In principle, dividends tax had to be withheld on such dividends.
Section 64G(3) of the Income Tax Act (58/1962) provides that a company paying a dividend may reduce the rate at which dividends tax is withheld in accordance with an applicable double tax agreement, provided that the beneficial owner of the dividend submits the relevant declaration and undertaking to the company paying the dividend.
Article 10(2) of the double tax agreement between South Africa and Japan provides for such a reduction of the dividends tax rate to 5% in circumstances where the beneficial owner (being a company) holds at least 25% of the voting shares in the company paying the dividend.
However, under Article 10(4) of the double tax agreement, this reduced rate does not apply to a beneficial owner that carries on business in South Africa through a permanent establishment where the shareholding in respect of which the dividends are paid “is effectively connected with such permanent establishment”.
Therefore, the question that arose was whether the 2% shareholding of the local branch of the applicant was ‘effectively connected’ to its permanent establishment in South Africa.
SARS ruled that based on the particular facts, the branch’s 2% shareholding in the local private company was not effectively connected to the branch and Article 10(4) therefore did not apply. The applicant (and the branch) could therefore rely on Section 64G(3) of the act and Article 10(2) of the double tax agreement in order to reduce the rate of dividends tax in respect of dividends paid on the full 49% shareholding, inclusive of the 2% held by the branch.
Unfortunately, the ruling was not entirely clear as to SARS’s reasoning, but it appears that since the 2% shareholding of the branch related to the procurement or purchasing of goods in South Africa from the local supplier company, Article 5(4) of the double tax agreement excluded or disconnected the 2% shareholding from any permanent establishment of the applicant.
For further information on this topic please contact Heinrich Louw at DLA Cliffe Dekker Hofmeyr Inc by telephone (+27 11 562 1000), fax (+27 11 562 1111) or email (heinrich.louw@dlacdh.com).