The tax changes announced for passage into law this year are short on detail. We will have to wait for the publication of the amending Bills. The issues to be addressed are specific tax avoidance schemes and amendments of a technical and clarification nature. A selection of tax issues that are to be addressed are dealt with below, from the perspective of challenges that they could pose to taxpayers, their businesses or any intended transaction.
Responding to International Tax Reform
The overall trajectory of the international business environment, despite the disruptions of COVID-19 and the war in Ukraine, is the continued key role played by Multi-National Enterprises (MNE) in determining production and distribution value chains across jurisdictions. Consequently, they strongly influence the level of tax paid in each country that forms part of their value chains.
Since the erosion of governmental revenues became a key critical issue across the world in the face of the 2008 global financial crises, the Organisation for Economic Cooperation and Development (OECD) embarked on formulating an approach to counter Base Erosion and Profit Shifting (BEPS) or Transfer Pricing and related tax shifting measures.
South Africa is among the countries that have agreed to the introduction of a minimum corporate tax rate of 15% on corporations forming part of a MNE that have taxable revenue presence in the country. This will apply to corporations with an annual turnover above 750 million Euros and in respect of the income that is earned in that particular jurisdiction.
South Africa is also bound to the rules that were agreed between the countries supporting the minimum corporate tax rate. These rules require that each country have in place measures that will enable collaboration between tax authorities to achieve the implementation of the agreed minimum taxing rate. These measures include the exchange of information on taxpayers in virtual time.
The collaboration between tax authorities is likely to be a challenge as the centralised planning capabilities of MNE head offices includes a single view of the tax obligations for the entire group across jurisdictions and tax types. This asymmetry between MNE head offices and the pace and efficacy of inter revenue authority collaboration is likely to inform the tax planning, compliance and dispute resolution landscape in the coming years.
A test of the efficacy of the collaboration will arise where an adjustment is to be made in favour of a taxing authority in a country where the effective tax rate achieved is less than the 15% minimum rate.
International Tax Measures
Foreign dividends from dual listed shares on the JSE are exempt from income tax. They may under certain circumstances be subject to dividends withholding tax. Currently a scheme exists whereby South Africans invest in non-resident companies listed on the JSE. These companies in turn invest in interest bearing financial instruments in South Africa. There is a deduction for the interest expense whilst not being concomitantly liable for tax on the foreign dividend received. The mismatch is to be addressed by taxing the foreign dividend where the funding of the dividend was directly or indirectly achieved as a result of the tax deduction of the funding in South Africa.
Tax rate differences that arise in two scenarios are to be addressed in the forthcoming legislative programme. In the first case, a rate difference arises where a participation exemption (the exemption from tax of a shareholder in a company from which dividends are received or on the gain made on the sale of these shares) is permitted to the recipients of foreign dividends; where a portion of the dividend is tainted because of an expense having been deducted in South Africa. Secondly, if a foreign dividend is taxable in the hands of a South African resident, the rate applicable is 20% as against the corporate tax rate of 27%.
A further amendment is intended to address the situation where a group of companies is restructured and the shareholders in substance remain the same. If the proceeds from the sale of the shares in a foreign company are not repatriated, the basis for the current participation exemption having been granted is not achieved.
The effect of the tax rules relating to Controlled Foreign Corporations (CFCs) is that only their net income is taxed in South Africa. There is a level of indulgence as to what constitutes the income to be recognised in regard to these CFCs. This is to assist their international competitiveness. The indulgence is only permitted if the CFC has business operational integrity and is not a letterbox company. Should the CFC be sub-contracting the execution of its operations, then the latitude permitted the CFC in the recognition as to what constitutes its income will not be available.
Non-resident beneficiaries of a trust are taxed on their vested income. However, it is the trust that pays the tax on any capital gain that accrues to the non-resident beneficiary. The issue is the ability of SARS to recover the income tax from the non-resident beneficiary. The proposed amendment is to permit the trust to suffer the tax as a matter of convenience in the recovery of the tax. It is assumed that the matter of a difference in tax rates applying to individuals and trusts will be taken into account when this amendment is made, otherwise it could have inequitable results.
Other measures
There are a host of areas where clarification amendments are to be passed to address problem areas in the law on those aspects. These include:
- the clarification of what constitutes a primary residence in the context of an interest free or low interest loan made to a trust for the acquisition of such a residence. Currently low and no interest loans to a trust for any other purpose are regarded as a continuous stream of donations subject to tax on the difference between the official rate of interest and the interest charged;
- the cash equivalent of an employer’s contribution to a retirement fund on behalf of an employee is to be included in the income of the employee. This is prior to permitting the employee a deduction in respect of contributions to all retirement funds. The current fringe benefit exemption provision for amounts paid by an employer on behalf of an employee permits only the inclusion of the cash equivalent of the tax benefit in the income of the employee. This matter is pertinent to the contributions made to employer arranged group benefits where the retirement and risk contribution components of the premiums may have differing tax implications.
Corporate Tax Measures
Ordinarily any dividend or foreign dividend is taxed as income in the hands of the recipient of a ‘third party backed share.’ This does not apply where the funds derived from the issuance of these shares results in the acquisition of equity shares in an operating company. A new measure is to be introduced to tax dividends received by the subsequent acquirer of the ‘third party backed shares’ in the operating company.
Contributed Tax Capital (CTC) is the amount of capital received from shareholders for the shares issued by a South African resident company after it becomes a resident either through incorporation or by change of tax residence to South Africa. Additionally, CTC includes the market value of all shares immediately prior to assuming South African residence. This is diminished by any capital distributions made to shareholders.
In order to overcome a scheme that manipulates the application of ‘contributed tax capital (CTC),’ measures are to be introduced to amend the definition The scheme involves a non-resident intermediary holding company changing its tax residence to South Africa, and receiving dividend distributions from the South African operating company. These dividends are tax exempt. The contributed tax capital of the newly South African tax resident intermediary holding company is recognised as the market value of its shares.
In turn, the intermediary holding company makes capital distributions to its non-resident ultimate holding company free of dividends withholding (at either the 20% rate or a lower ‘treaty rate’ where such a treaty exists), and capital gains tax. Both these tax avoidances are achieved as a result of the manner in which CTC is regarded for the particular transaction.
The general rule is that a dormant company within a group should be exempt from any tax consequences in the context intra group debt being waived or forgiven. The issue is pertinent to the two rules that bring debt relief into the tax net. Firstly, where the debt incurred was to fund tax-deductible operating expenditure, or enjoyed a deduction for trading stock or an allowance against the value of an asset. This would have an income tax impact.
As to the debt being utilised to fund a capital asset or allowance assets, a capital gain is triggered when the debt is forgiven. The exemption for dormant companies does not apply where there is a corporate reorganisation transaction and the asset is disposed of within this context. The measure being proposed in the Budget is to clarify that the non-applicability of the dormant company exemption should not in any way be influenced by the timing of the disposal under the corporate reorganisation rules.
Within the context of any asset for share transaction, the base cost of the asset is crucial to determine the consideration and how it is satisfied. The anti-avoidance measure in these transactions is to ensure that no value shifting arrangement is achieved, free of capital gains tax.
The deemed base cost approach was extended to corporate reorganisation transactions more widely in 2020. The issue to be addressed in the intended amendment is how to have an allowance previously permitted against the asset that is exchanged for the shares in the company, follow the deemed base cost.
Unbundling transactions that have been used to distribute shares of unbundled companies to tax exempt or non-resident recipients were addressed in 2020. The effect has been to have an apportioned approach to the application of the unbundling rules, with not all of the transaction value enjoying rollover relief.
In 2021 a measure was introduced to enhance the base cost of the shareholders who are prejudiced in the value attributed for rollover relief. The coming tax year will see measures introduced to apportion tax paid to the different categories of shareholders, and to address the situation where the unbundling company is in an assessed or capital gains loss position.
The above are the most crucial proposed areas for legislative intervention as announced in the 2023/24 Budget. These measures indicate a tax base preservation approach adopted by SARS currently in the face of a declining business revenue environment.
Ahmed Jooma
