Author: Tarryn Spearman(Grant Thornton)
Significant changes were introduced to the way foreign dividends, received by South African residents, are treated for tax purposes. The purpose of these changes is to eliminate the disparity between the tax treatment of domestic and foreign dividends.
Before delving into the changes, it is important to note two points:
- Foreign dividends are not subject to the new dividends tax (DWT) regime (with the exception of dividends paid by dual listed companies) and therefore, with certain exceptions, foreign dividends are included in the recipient’s gross income and taxed at the marginal income tax rates.
- In terms of section 23(q) of the Income Tax Act, deductions in respect of expenditure incurred in the production of income from foreign dividends are no longer allowed. This is because there is no comparable deduction that is allowed for expenses associated with domestic shares.
What has changed?
Section 10B was introduced to clarify the extent to which foreign dividends will be exempt from tax. Section 10B (1) states that, for the purposes of the section, “foreign dividend” means:
- Any foreign dividend as defined in section 1 of the Act or
- A dividend paid by a headquarter company
There are a number of foreign dividend exemptions which apply in terms of section 10B(2):
- The participation exemption, which existed under the previous legislation, remains unchanged
- This section provides that dividends received by a shareholder holding more than 10% of the equity shares and voting rights in the company declaring the foreign dividend, will be exempt.
The exemption in respect of foreign dividends that are received from profits that have already been taxed in terms of section 9D, remains unchanged.
Any dividend received by a foreign company that is resident in the same country as the company paying the dividend, is exempt from tax. In other words, dividends received by a CFC of a South African resident company, from a company that is resident of the same country as the CFC, will be exempt.
The dual-listing exemption contained in sections 10(1)(k)(ii)(bb) has been deleted and a new exemption in respect of foreign cash dividends (i.e. not dividends in specie) has been implemented.
In order to align the amount of tax paid on foreign dividends with local dividends, section 10B(3) sets out a formula for exempting part of a foreign dividend. This section only applies to foreign dividends which are not exempt from tax in terms of section 10B(2). This exemption is calculated in terms of a formula (A = B x C)
A = the amount to be exempted for a year of assessment
B = the ratio 25/40 where the recipient of the dividend is a natural person, deceased estate or insolvent estate, or a special trust; OR
The ratio 13/28 where the recipient of the dividend is not a natural person, deceased estate or insolvent estate, or a special trust
C = the aggregate of any foreign dividends received by or accrued to a person during a year of assessment, that is not exempt under the provisions of section 10B(2).
The section 10B(3) exemption is best explained by means of examples:
Example one: Foreign dividend received by a natural person, deceased estate, insolvent estate, or special trust:
Mr Z, a South African resident, pays taxes at a marginal rate of 40%. Mr Z holds 3% of the total equity shares and voting rights in a Foreign Company. He receives a foreign dividend of R100 000 on shares, which is subject to a dividend withholding tax of 10%. Mr Z incurred an interest expenditure of R 2 000 on a loan to purchase the shares in respect of which the dividend was received.
Gross income R 100 000
Expenditure in the production of income
[R2000 disallowed in terms of s 23q] –
Section 10B(3) exemption
[25/40 x R 100 000] (R 62500)
TAXABLE INCOME R 37 500
TAX @ 40% R 15 000
LESS Foreign rebate [R 100 000 x 10%] (R 10 000)
Tax Payable R 5000
*Note: The rebate (credit) for direct foreign taxes paid in respect of foreign dividends will remain. The rebate is limited to the amount of foreign tax levied on the transaction.
Example 2: Foreign dividend received by companies, trusts, and persons other than those referred to in the example above:
ABC Ltd, a South African resident company, holds 3% of the total equity shares and voting rights in a Foreign Company. ABC Ltd receives a foreign dividend of R1.2 million on shares, which is subject to a dividend withholding tax of 8%.
GROSS INCOME R 1 200 000
Expenditure in the production of income
[R 2000 disallowed in terms of s23q] –
Section 10B(3) exemption [13/28 x R 1 200 000] (R 557 142)
TAXABLE INCOME R 642 858
TAX @ 28% R 180 000
LESS Foreign tax rebate [R 1 200 000 x 8% = R 96 000] Limited to foreign tax paid (R 96 000]
TAX PAYABLE R 94 000
*Note that in both these examples, the tax payable before the foreign income amounts to 15% of the gross dividends received, which aligns the amount of taxation paid on foreign dividends with local dividends.