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South Africa

Bernard du Plessis and Peter Dachs
Edward Nathan Sonnenbergs
South Africa

Shareholders dividend tax will replaced secondary tax on companies as soon as legislation is enacted. Bernard du Plessis and Peter Dachs of Edward Nathan Sonnenbergs explain what the change will mean for taxpayers

South Africa exempts the receipt or accrual of local dividends and certain foreign dividends from income tax. Dividends declared by companies which are residents of South Africa would qualify for the domestic exemption. A company which is incorporated or effectively managed in South Africa would qualify as a resident if the company is not deemed to be a resident of another jurisdiction in terms of a double taxation agreement (DTA). Dividends declared by companies which do not qualify as South African resident companies would qualify as foreign dividends and be subject to tax in South Africa in the hands of a resident recipient at the rate of 28% for corporates, a sliding scale for individuals of which the highest is 40% and in the case of trusts, 40%.

Legislation exempts foreign dividends, among other things, if:

• the profits from which the foreign dividend is distributed have been subject to tax under the Income Tax Act (the Act), unless a DTA has reduced the rate in South Africa or the profit arose directly or indirectly from dividends declared by a South African resident company (the loop structure exemption);
• the foreign dividend has been declared by a dual listed company (which is listed on the Johannesburg Stock Exchange, as well as a foreign stock exchange) (the dual listing exemption);
• the recipient holds at least 20% of the equity share capital and voting rights and certain other anti-tax avoidance provisions do not apply.

Secondary tax on companies (STC) is levied at the rate of 10% on resident companies declaring dividends and calculated with reference to the net amount of dividends declared.

During the 2008 budget speech the finance minister announced that STC will be replaced by a shareholders dividend tax (DT). The purpose of the proposed change is to align the system of taxing distributions by companies with international practice as the STC regime which forms part of the South African tax system is uncommon to the majority of tax systems in other countries. Where STC is a tax which is imposed on the company declaring a dividend and the dividend generally accrues to the ultimate beneficial owner of the dividend without any further deductions or withholding of tax due to the STC credit mechanism, DT will differ in that DT will be a withholding tax which is borne by the shareholders.

The DT legislation was promulgated in late 2008, however it has not yet come into effect. It is envisaged that the provisions will only enter into force during the latter half of 2010. Further changes to the existing legislation have been proposed in terms of the recently released draft Taxation Laws Amendment Bill (the draft Bill).

Subject to what is set out below, DT will not have an impact on the income tax treatment of dividends. In other words, local dividends and certain foreign dividends will still qualify for an exemption from income tax. Dividend tax will levy a withholding tax on local dividends and certain foreign dividends received by shareholders. This will be a final withholding tax. Although DT will be borne by the shareholder, the withholding obligation would be either on the company declaring the dividend or certain defined intermediaries.

Before the details of the proposed DT are analysed, it is relevant to note that the draft Bill also contains amendments to the foreign dividend exemptions. In particular, it proposes to delete the loop structure exemption referred to above. The reason for the deletion is likely to be the focus by both the South African Revenue Service (SARS) and the South African Reserve Bank on so-called loop structures where South African residents invest in a non-resident which in turn invests in a South African company. This focus is explained in a media statement released by National Treasury earlier this year regarding funnel finance schemes, which specifically referred to schemes which artificially shift income outside the South African taxing jurisdiction and the creation of tax benefits by using split incorporation or effective management. The media statement specifically referred to structures where the incorporation of a company is in South Africa but the effective management is located in a foreign tax haven treaty country.

In addition, the draft Bill contains certain amendments to the dual listing exemption referred to above. The amendments, once promulgated, will result in dividends paid on a dual listed share still being exempt from income tax, but such a share will be subject to the new DT. This is different from the regime now in terms of which the companies declaring such dividends are not subject to STC. As such, foreign dividends on dual listed shares will be taxed more heavily once DT has been introduced.

If the proposed DT provisions as introduced in 2008 and the changes proposed by the draft Bill are analysed, DT will be imposed on any dividend which is paid by a South African resident or a dual listed company.

Although the company which declares and pays a dividend is required to withhold the DT from the payment of such a dividend, in certain instances the dividend will be exempt from DT. The exemptions include, among other things, dividends paid to a beneficial owner if such beneficial owner is a company which is a resident or a portfolio of a collective investment scheme in securities. The beneficial owner is defined as the person entitled to the benefit of the dividend attaching to the share.

To claim the exemption from withholding, the certain written declarations have to be obtained by the company from the beneficial owner of the dividend.

The draft Bill also contains deemed dividend rules by which certain shareholder transactions will also be subject to DT. Dividends are deemed to be declared by a company in relation to the provision of any financial assistance to connected persons, transfer pricing adjustments by virtue of transactions with connected persons, where companies cease to be resident of South Africa or where any amounts paid by the company through a hybrid debt instrument are disallowed as a deduction.

Specific DT exemptions relating to deemed dividends will be introduced. For example, in relation to the provision of financial assistance, such financial assistance will not be deemed to be a dividend to the extent that it bears interest at a rate that is not lower than the prescribed rate of interest and where such rate is not lower than the rate which would be granted to a member of the general public. Financial assistance will also not be deemed to be a dividend where the company carries on business as a money lender and the provision of the financial assistance arises in the ordinary course of business of the company and the terms of the financial assistance are not more favourable than the terms which would be secured with a member of the general public.

Companies with existing STC credits would be able to use such credits against DT for a period of five years from the date which the DT legislation comes into effect.

It is important to note that DTA relief against the DT may be claimed by a recipient that qualifies as a resident of a DTA country and for a DTA that reduces the rate to a minimum of 5%.

Although STC did not fall within the provisions of the dividend article in DTAs, the new DT will fall within the dividend article and would be subject to DTA relief. Where a DTA has reduced the rate of the DT, a company may withhold tax at the reduced rate if the beneficial owner submitted to the company a declaration that the dividend is subject to a reduced rate of tax as a result of the application of a DTA.

Where a DT liability arises, the tax must be paid to SARS on or before the last day of the month after the month during which the dividend is paid. Should an amount of DT be withheld incorrectly by a company paying a dividend, the beneficial owner is entitled to a refund of the tax within three years of the payment of the dividend, if the necessary declarations are submitted.

Specific provisions will be introduced to deal with the refund mechanism and in certain instances the company which withheld the DT would be obliged to pay the refund to the beneficial owner. In such an instance the company will be able to offset the refund against DT due on a subsequent dividend.

It should be noted that the draft Bill is still subject to change as it has not yet been promulgated. In addition, due to the extent of the period still remaining before implementation, further amendments to fine-tune the process may be expected. As such, foreign shareholders should keep an eye on future South African legislation to ensure they are aware of the DT implications which impact on them in respect of their shareholding in South African resident or dual listed companies.

Bernard du Plessis (bduplessis@ens.co.za) and Peter Dachs (pdachs@ens.co.za), co-authored by Magda Snyckers (msnyckers@ens.co.za) and Michael Reifarth (mreifarth@ens.co.za)