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International Tax Newsletter - Winter 2011-12 - South Africa

A draft Taxation Laws Amendment Bill (the TLAB) was issued in June 2011 which contains significant proposed tax amendments, including the following:
 
DIVIDEND WITHHOLDING TAX 

The long-anticipated replacement of Secondary Tax on Companies (STC) with a dividend withholding tax will be effective from 1 April 2012. This will bring South Africa’s taxation of dividends regime in line with international norms. The withholding tax rate will be 10%, subject to the application of applicable double tax treaty provisions.

CONTROLLED FOREIGN CORPORATION (CFC) PROVISIONS — OVERHAUL OF CFC RULES

The South African CFC regime is in its tenth year anniversary. The regime is being overhauled to close remaining loopholes and to clarify and simplify calculation. In the main, the proposed amendments include:

  • Attribution of income to a foreign business establishment (FBE) can only be done once arm’s length transfer pricing principles are taken into account. Attribution of income to a FBE must account for the functions performed, assets used and the various risks of the foreign business establishment. Mere connection of income to a FBE via legal agreements and similar artifices will not be sufficient.
  • The diversionary income rules will be simplified to avoid legitimate commercial activities falling within its scope whilst still retaining meaningful protection of the tax base. The diversionary rules associated with South African exports to a CFC will be completely removed.
  • Under current law, transfer pricing violations involving a CFC trigger tainted treatment for all amounts derived from the suspect transaction, not just the reallocation of misallocated income. This “all-or-nothing” rule is misdirected and will accordingly be deleted.
  • As a general rule (and consistent with current law), mobile income accruing to a CFC will be automatically taxable unless specific exemptions relevant to that income stream are applicable. As under current law, the FBE exemption will per se not apply even though the mobile income may be attributable to FBE activities. Unlike current law which mixes mobile income into one set of rules, the targeted mobile income will be covered under four broad but distinct categories — income from financial instruments, tangible rentals, intellectual property and insurance.
  • Closure of “control” avoidance through trust and other artifices. The definition of CFC will be extended to specifically cover certain foreign companies that are under the de facto control of South African residents. This additional criterion will apply in the alternative to the general CFC requirements. De facto control will exist where the parent has the power to govern the financial and operating policies of a subsidiary in order to derive a benefit from its activities. This is a facts and circumstances case. Factors such as control over the distribution and reinvestment policies, annual business plans, corporate strategy, capital expenditure, raising finance, winding up of the entity, voting rights or the power to appoint or remove the board of directors will be taken into account on a case-by-case basis. This concept is derived from financial accounting principles. 
  • The ownership thresholds in respect of the dividend and capital gain participation exemptions in relation to foreign shares will be reduced from 20% to 10%. This lower threshold is consistent with the global economic concept of direct foreign investment.

The proposed amendments will apply to the net income of a controlled foreign company relating to the year of assessment beginning on or after 1 April 2012.

CFC RESTRUCTURINGS

In terms of existing law, South African resident companies can restructure their affairs through various transactions falling within the so-called reorganisation rollover rules. In terms of these rules, the transactions themselves are exempt from tax but any gain is deferred until a later disposal. The rollover rules apply to asset-for-share transactions, amalgamations, intra-group transfers, unbundlings and liquidations. These relief measures are not currently available to the restructuring of foreign operations (except in very limited circumstances).

In respect of offshore restructurings, only a capital gains participation exemption currently applies. Under the participation exemption, the gain is wholly exempt when residents and CFCs dispose of equity shares in a 20% held foreign company. However, the exemption only applies if the foreign shares are transferred to a totally independent foreign resident or to a CFC under the same South African group of companies. The restructuring of CFC assets can also qualify for tax relief if disposed of within the confines of the foreign business establishment exemption or if the disposal occurs within a high-taxed country.

In light of the global economic crisis, many South African multinationals are seeking to restructure their offshore operations. The current participation exemption applicable to offshore restructurings is too narrow, resulting in certain restructurings being excluded. In view of the above, the domestic corporate restructuring rollover rules will be extended to fully include the restructuring of offshore companies that remain under the control of the same South African group of companies.
As a result of the extended deferral regime, participation exemption for transfers to CFCs will accordingly be deleted in order to remove the possibility of avoidance.

These amendments will apply in respect of transactions entered into on or after 1 January 2012.

OFFSHORE CELL COMPANIES

Control of a foreign company generally exists if South African residents own more than 50% of the participation and voting rights of the foreign company. Currently, the CFC rules do not apply to foreign statutory cell companies (often referred to as “protected cell companies” or “segregated account companies”). These companies effectively operate as multiple limited liability companies, separated into legally distinct cells. These cell companies are often found in the jurisdictions of Bermuda, Guernsey, Gibraltar, Isle of Man, Jersey, Vermont, Mauritius and Seychelles.

It is proposed that the CFC rules be adjusted so that each cell of a foreign statutory cell company will be treated as a separate stand-alone foreign company for all South African CFC regime purposes. Therefore, if one or more South African residents hold more than 50% of the participation rights in an offshore cell, the cell will be deemed to be a CFC without regard to ownership in the other cells. CFC treatment for the cell will thus trigger indirect tax for the participant cell owners to the extent the cell generates tainted income.

The proposed amendment will apply in respect of foreign tax years of a CFC ending during years of assessment commencing on or after 1 January 2012.

UNIFICATION OF SOURCE RULES

South African residents are taxed on the basis of their world-wide income with foreign sourced income eligible for tax rebates (credits) in respect of foreign tax proven to be payable. Non-residents are only subject to tax on the basis of income derived from sources within (or deemed to be within) South Africa.

The Income Tax Act does not comprehensively define the term “source.” The source of income is instead initially determined with reference to the common law, in terms of which the determination of source generally involves the doctrine of originating cause. The statutory regime relating to source is also scattered throughout the Income Tax Act.

A new uniform system of source is proposed which represents an amalgamation of the common law, pre-existing statutory law and tax treaty principles. The starting point for these uniform source rules will largely reflect tax treaty principles (with a few added built-in protections) so that the South African system is globally aligned. The common law will remain as a residual method for undefined categories of income.

The new uniform set of source rules will eliminate the concept of deemed source. South African sources of income will be fully defined with items of income falling outside these definitions being treated as foreign source income.

SPECIAL FOREIGN TAX CREDIT FOR MANAGEMENT FEES

South African residents are taxed on their worldwide income. However, South African residents are entitled to a tax rebate (i.e., credit) against normal South African tax in respect of foreign taxes proven to be payable. Amongst other requirements, these credits are conditional on the foreign taxes being applied to foreign sourced income. In other words, no foreign tax credits are available in respect of South African sourced income.

A number of African jurisdictions impose withholding taxes in respect of services (especially management services) rendered abroad if funded by payments from their home jurisdictions. These withholding taxes are sometimes even imposed when tax treaties suggest that the practice should be otherwise. African imposition of these withholding taxes in respect of South African sourced services is no exception.

The net result of these African withholding taxes is double taxation with little relief. The South African tax system does not provide credits in respect of these foreign withholding taxes because these taxes lack a proper foreign source nexus. Only partial relief is afforded through the allowance of a deduction in respect of the foreign taxes suffered. The practical implication of this position is adverse to South Africa’s objective of becoming a regional financial centre.
 
In view of the above, it is proposed that a new limited foreign tax credit be introduced. The scope of this foreign credit will be limited solely to foreign withholding taxes imposed in respect of services rendered in South Africa. These tax credits will be limited solely to South African taxes otherwise imposed on the same service income after taking applicable deductions into account. Foreign withholding taxes in excess of the South African tax cannot be carried over (i.e., the excess is lost). Given the introduction of this new foreign tax credit, the current deduction for non-creditable foreign taxes will be withdrawn as ineffective.

The proposed amendment will come into effect in respect of foreign withholding taxes paid in respect of years of assessment commencing on or after 1 January 2012.

More information on these developments can be provided by Eugene du Plessis, Director, PKF Johannesburg, through the EisnerAmper contacts listed on the homepage.

International Tax Newsletter - Winter 2011-12 Issue 

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