Clarifying the translation for hyperinflationary currencies
The net income of a controlled foreign company (CFC) is determined in the currency used by that CFC for financial reporting (the functional currency) and is translated into rand at the average exchange rate for that foreign tax year. An exchange item, as defined in the Income Tax Act, is treated as not attributable to any permanent establishment of the CFC if the currency used for financial reporting is that of a country with an official rate of inflation of 100 per cent or more throughout the foreign tax year. However, in contrast to the intention that a hyperinflationary functional currency not be used for translation purposes, section 9D(2A)(k) of the Income Tax Act requires the local currency to be used. It is proposed that the rules be changed so that section 9D(2A)(k) does not allow the use of a hyperinflationary functional currency for translation purposes.
Clarifying the 18‐month period in relation to shareholdings by group entities
In 2023, tax legislation was amended to require an 18‐month holding requirement for the participation exemption on the foreign return of capital similar to the participation exemption relating to the disposal of shares in a foreign company. However, the test for the holding period for a foreign return of capital does not cover the situation where more than one company in a group of companies was holding the shares during the 18‐month period. It is proposed that the holding period rules be amended to cater for this situation.
Clarifying the rebate for foreign taxes on income in respect of capital gains
South African tax residents are subject to income tax on their worldwide income. The Income Tax Act provides relief to them from double taxation where the same amount is taxed by more than one tax jurisdiction. Section 6quat of the Income Tax Act provides that a taxpayer should get credit for the taxes paid in the relevant foreign jurisdiction but limits this to the South African tax on the amount taxed in South Africa. According to the foreign tax credit rules dealing with foreign dividends, the tax‐exempt portion must not be taken into account when determining the allowable foreign tax credit. However, the rules dealing with capital gains have no corresponding provision for the non‐taxable portion of the capital gain.
It is proposed that section 6quat be amended to explicitly allow for a full foreign tax credit against tax payable in South Africa on a capital gain for taxes payable in the relevant foreign jurisdiction on the disposal of an asset. This will ensure a similar treatment as for foreign tax credits for taxable foreign dividends.
Aligning the section 6quat rebate and translation of net income rule for CFCs
Foreign taxes payable by a CFC must be translated to rand at the average exchange rate for the year of assessment, of the resident having an interest in the CFC, in which an amount of net income of the CFC is included in the income of that resident. However, the net income of the CFC must be translated by applying the average exchange rate for the foreign tax year of the CFC. A mismatch arises when the year of assessment of the resident and the foreign tax year of the CFC are different. To address this anomaly, it is proposed that the Income Tax Act align the years used to translate net income and foreign tax payable by referring to the foreign tax year of the CFC.
Refining the definition of exchange item for determining exchange differences
Certain financial arrangements that include preference shares are eroding the tax base due to a mismatch because some elements of the arrangement result in an exchange loss for tax purposes, while gains on the preference shares are not being taken into account for tax purposes. Government
proposes to address the tax leakage associated with these financial arrangements by extending the definition of exchange item to include shares that are disclosed as financial assets for purposes of financial reporting in terms of IFRS.
Reviewing the interaction of the set‐off of assessed loss rules and rules on exchange differences on foreign exchange transactions
When determining taxable income, the Income Tax Act enables taxpayers to set off their balance of assessed losses carried forward from the preceding tax year against their income, provided that the taxpayer continues trading. The interaction between the assessed loss set‐off and exchange differences rules mean that a foreign exchange loss on an exchange item may not be set off in future years against gains from the same exchange item if the trading requirement is not met. It is proposed that consideration be given to ring‐fencing all foreign exchange losses on exchange items from a future year of assessment.