South Africa: Residence Based Taxation System
South Africa has always used a source-based taxation system, although the numerous deeming provisions mean that in effect the system is a hybrid of source and residence base. Earlier this year the Minister of Finance announced his intention to move to a fully residence-based system, the first step of which was the introduction of tax on foreign dividends with effect from 23 February 2000.
Foreign dividends accruing to residents have formed part of their gross income since that date, unless they emanate from one of a list of 27 "designated" countries (see below) and the shareholding of the resident in the company paying the dividend exceeds 10%. If the income of the paying company is itself taxable in the Republic, provisions are in place to ensure that double tax does not occur. Any foreign taxes paid on the dividend will be allowed as a credit, up to the amount of the South African tax on the dividend.
The Revenue Laws Amendment Act passed recently by Parliament constitutes the next step in the process. Effective from 1 January 2001, its effect will be that residents will be taxed on their worldwide income, while non-residents will be taxed on their income from South African sources, subject of course to the many DTAs South Africa has with other countries. The change has necessitated a definition of "resident", which has not been required before.
For natural persons, two tests apply:
- the ordinary residence test;
- the physical presence test.
A person who is ordinarily resident is deemed to be a resident for tax purposes regardless of whether or not he or she was actually resident in the Republic at all during the year. The meaning of "ordinary residence" has been extensively considered by the courts, and the most succinct summary of its meaning is that it is the location of the principal or permanent home of the person, "the country to which he would naturally and as a matter of course return after his wanderings".
If the person is not ordinarily resident, the physical test must then be applied. In contrast with the subjective test for ordinary residence, physical residence is objective, being entirely numerical. The person must be physically in South Africa for more than 91 days in the current year AND each of the preceding three years AND must have been physically present for a period or periods exceeding 549 days in aggregate during those preceding three years.
Then if the person, having become a resident under this paragraph, is outside the Republic for at least 330 days, he will retrospectively be deemed not to have been a resident from the date of departure.
Expatriates in South Africa
Employees seconded to RSA for periods of less than 4 years will, in terms of the provisions set out above, not be deemed to be residents. They will, however, be taxed on their RSA earnings in terms of the source rules, which remain in operation.
If an expatriate moves assets and family to RSA and buys fixed property here, he is likely to be deemed ordinarily resident in terms of the definition supported by the general rules.
An emigrant who was formerly ordinarily resident will have to take care during the first year or so after leaving the Republic.
He cannot be deemed to be resident during the year of departure ("E"), because the first requirement of the definition of "resident" is that he not be ordinarily resident at any time during the year. Presumably he will be taxed as ordinarily resident until the date of departure. For the rest of E he will be neither ordinarily resident nor resident.
In the first full year after emigration ("E+1"), the time rule applies. If he had emigrated later than 91 days into the year, and had satisfied the 91-day rule in each of E-1 and E-2, he would have to ensure that he did not return to the Republic for more than 91 days in E+1. If he did return for more than 91 days in E+1, he would be deemed to be a resident for that year.
For entities other than individuals, the criteria for being deemed to be a resident are whether the entity is incorporated OR was established OR formed in the Republic, OR whether it has its place of effective management here. This is wide range of tests, and effectively overrides the well-established legal principles in terms of which a crucial test was where the entity carried on its activities. So, for example, a company registered in South Africa but which operates a mine in Zimbabwe would be taxable in South Africa on its profits.
An interesting exemption from the definition of resident is a new concept, the "international headquarter company (IHC)". This new entity has been introduced into the Act by means of a definition. An IHC is a company the entire equity share capital of which is held by persons who are not residents or trusts. Two further conditions are:
- that any indirect interest of residents or trusts does not exceed 5% of the equity; and
- that 90% of the value of the assets of the company represents interests in the equity and loan capital of non-resident subsidiaries. (One assumes that the intention is that at least 90% of the equity must be so held, and not exactly 90% as the Act reads).
Because the new definition of "resident" excludes any IHC, these will enjoy three attractive benefits as compared with resident companies:
- they will not be taxed on foreign dividend income;
- they will not be taxed on their proportion of the net income of their controlled foreign entities;
- they will not be liable for the Secondary Tax on Dividends (STC) in respect of dividends declared by them.
- Predictably, relief is provided in respect of foreign taxes payable in respect of income taxed as set out above. This will be discussed in more detail later in this article.
The Act provides for several exceptions:
- residents earning income from foreign employment will not be taxed on their earnings, provided they are outside the country for at least 183 days during any 12 month period of which at least 60 days are continuous;
- pensions received from foreign sources in respect of services rendered offshore will not be taxed, at least not for the next three years or so. If this concession is changed in the future, which by no means certain, it is hoped that social pensions at least will enjoy permanent exemption;
- the income of any resident company from a foreign branch will be exempt provided it is taxed in a "designated" country at a rate of at least 27% (90% of the South African corporate rate). The list of 32 designated countries, set out below, includes most of South Africa’s main trading partners. Absentees are tax havens such as Cyprus and Malta, and countries that use low tax rates to attract investment, such as Ireland, Mauritius, India and Botswana;
- the income of any controlled foreign entity, provided it is a business establishment as defined. The definition is based on the OECD definition of "permanent establishment";
- where the funds may not be remitted to South Africa on account of exchange control limitations in the country of origin, for so long as the limitations apply.
Algeria, Australia, Austria, Belgium, Canada, Croatia, Czech Republic, Denmark, Egypt, Finland, France, Germany, Israel, Italy, Japan, Republic of Korea, Lesotho, Malawi, Namibia, Netherlands, Norway, Poland, Romania, Slovakia, Swaziland, Sweden, Thailand, Tunisia, United Kingdom, United States of America, Zambia, Zimbabwe.
Controlled Foreign Entities (CFEs)
Only the passive income of CFEs is imputed to the controlling entity in terms of the present legislation. This is now being extended to include active income, subject to certain exceptions in respect of the active income (in other words, passive income will continue to be imputed):
- where the controlling entity has an interest of less than 10%;
- where the CFE is situated in a designated country;
- where the income of the CFE is taxed at a rate of at least 27%; or
- where the CFE is a business establishment.
The Act contains an anti-avoidance provision to counter what are described as "diversionary transactions" aimed at exploiting the South African tax base. An example common to South African businesses would be the interposition of a Mauritian company between a manufacturing company in the Republic and its offshore customers. The sale of goods via the Mauritian company, with a small markup from South Africa to Mauritius and a substantial one from there to the customers would be seen as a diversionary transaction. The net income of the Mauritian company would be imputed to the South African company.
Foreign dividends are already taxable in the hands of residents. However, if such dividends emanate from companies whose profits have been imputed to South African residents under the new provisions, the dividends will not be taxed again.
In respect of foreign dividend income there is now a significant concession, following representations by the business community. The Minister may waive the application of section 9E to such extent as he may deem "necessary in the national interest" in respect of any project and subject to such conditions as he may prescribe. In making such a decision, he will have regard to:
- the economic benefits for the Republic; the extent to which goods and services for the project will emanate from the Republic;
- the potential effect on the tax base; any other state assistance granted to the project;
- any other criteria he may prescribe.
The practical effect of such a concession is that the taxpayer will be able to repatriate the benefits of the tax incentives enjoyed in the foreign country. Previously such benefits would have been lost when the dividends were brought onshore.
Foreign Currency Adjustment
Where foreign income accrues to a resident, it must be determined in the relevant currency and then converted into Rands at the rate ruling on the last day of the year of assessment.
The section dealing with royalties payable to non-residents has for many years provided for the deduction of a provisional tax of 12% of the amount. The effect of this was that the recipient had to register as a taxpayer and was subject to tax on 30% of the amount. The 12% deducted would then be set off against the tax owing. This untidy situation has been deleted and replaced with a simple withholding tax of 12% of the amount of any such royalty, deductible by the person paying the royalty.
Relief In Respect Of Foreign Taxes Paid
Having subjected to tax the various categories of income from foreign sources accruing to a resident, the Act then provides for relief in respect of any foreign taxes paid on such income. In general, all foreign taxes payable on income from foreign sources may be set off against South African tax on such income to the extent of the South African tax payable, with any surplus being carried forward for a maximum of seven years. In respect of foreign dividends, these will be rebated to the extent that the income from which they have been paid has been included in income under the imputing provisions.
The conversion rate is the rate applicable on the date the foreign tax is paid; if it is unpaid at the end of the year, the year end rate; in the case of foreign dividends, the same rate as that used to convert the dividends.
The foreign income is aggregated, as are the foreign taxes. Only if the total taxes paid exceed the total income is the balance carried forward to the next year as if it were an assessed loss.The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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