The South African Minister of Finance delivered his 2013/14 Budget Speech on 27 February 2013. This Alert summarizes the proposals that may impact foreign investors.
South Africa introduced the dividends tax on 1 April 2012. The withholding tax regime also was expanded with the introduction of interest withholding tax (15%) from 1 July 2013. In addition, the rate of withholding tax on royalties was set to increase from 12% to 15% also effective 1 July 2013.
The Minister of Finance announced in the 2013/14 Budget Speech that the effective date for the new interest and royalty withholding tax regimes will be delayed until 1 March 2014. The 2012 draft Taxation Laws Amendment Bill contained certain provisions whereby a deduction in respect of cross-border interest and royalty payments was deferred until the date of payment. These provisions did not form part of the final 2012 Taxation Laws Amendment Bill when it was introduced in parliament for promulgation, and as expected, the provisions were deferred for introduction in 2013/14.
South Africa will also introduce a new withholding tax on services from 1 March 2014. It is expected that this tax will be levied at a rate of 15%, with relief provided where a double tax treaty is available.
It is interesting to note that South Africa’s double tax treaties provides for a withholding tax to be imposed by the source country in limited instances (for instance, the double tax treaty with India and the double tax treaty with Botswana contain such provisions). Accordingly, South Africa will generally not have the right to impose a withholding tax on cross-border services where a double tax treaty does not provide for such taxation. The reason for this is that the non-resident may be provided with relief under the double tax treaty if it does not have a permanent establishment in South Africa.
Debt and base erosion
The OECD released its initial report on base erosion and profit shifting on 12 February 2013. The report discusses the key principles that underlie the taxation of cross-border activities, and focuses, among others on mismatches in entity and instrument characterization (hybrids and arbitrage), and related party debt-financing.
The National Treasury took similar preventative measures. The 2012 draft Taxation Laws Amendment Bill contained certain provisions whereby debt would be reclassified as equity in certain instances (i.e., the instrument when reclassified will pay a dividend and not interest). These new rules were excluded from the final 2012 Taxation Laws Amendment Bill when it was introduced in parliament for promulgation.
As expected, the provisions were deferred for introduction in 2013/14. It is proposed in the 2013/14 Budget that certain debt instruments, such as shareholder loans without a date of repayment or profit participation loans will be reclassified as equity.
It seems that the thin capitalization provisions (dealing with excessive connected party debt) may also be addressed. Under the SARS (South African Revenue Service) Practice Note 2, a debt to equity safe harbor of 3:1 existed. South Africa’s revised transfer pricing rules that came into operation for years of assessment commencing 1 April 2012 and thereafter moved away from the safe harbor to an arm’s length test. It is proposed in the 2013/14 Budget that connected party debt be limited so that the interest on this form of debt does not exceed 40 percent of earnings after interest on other debts is taken into account. It is not clear whether this proposed change may be a new arm’s length test for thin capitalization purposes, or if it will apply to South African transactions only.
Gateway to Africa
The 2013/14 Budget proposes a new cash management gateway regime for African and offshore operations. The new regime should not be confused with the headquarter company regime which was introduced on 1 January 2011, as it serves a different purpose.
In terms of the proposal, a Johannesburg Stock Exchange (JSE) listed company will be entitled to incorporate a South African subsidiary (as an intermediate holding company) to hold African and offshore operations. Although the intermediate holding company is a South African tax resident, it will not be regarded as a resident for exchange control purposes, hence does not need approval to invest offshore. Other conditions for the new regime will be as follows:
- Transfers from the parent company are limited to R750 million, but additional amounts may be applied for.
- Cash pooling, which is generally restricted for exchange control purposes will be allowed – hence, the intermediate holding company may operate as cash management center.
- Intermediate holding company can raise capital offshore, but South African guarantees are not allowed.
Intermediate holding companies may elect their functional currencies and may operate foreign currency accounts. It is also considered that these companies may use a foreign functional currency, hence not being subject to South Africa’s foreign exchange gains and loss rules.
In 2012, mark-to-market taxation was legislatively added to income tax, but the effective date was deferred until 2014. This legislation will be refined based on further consultations. The main refinements are as follows:
- Covered persons will be extended to include most of the companies in regulated banking groups to reduce the potential for mismatches between the new mark-to-market system and the historic system of realization.
- Rules to prevent artificial losses from dividend transactions.
- Assets and liabilities will be disregarded to the extent that they are not recognized under relevant international financial reporting standards (IFRS).
- Different treatment of impairment of financial assets for accounting and bad and doubtful debt for tax purposes are under consideration.
Mining taxation review
The mineral and petroleum royalty regime has broadened the tax base and allowed for increased revenue during periods of high commodity prices, while providing relief to marginal mines when commodity prices and profitability are low. The broader review of the tax system will consider whether this approach is sufficiently robust and assess what the most appropriate mining tax regime is to ensure that South Africa remains a competitive investment destination.
Financial intermediaries and securities transfer tax
Unlike the London Stock Exchange, only brokers can be members of the JSE and receive an exemption from South African stamp duty in the form of securities transfer tax (STT).
Other financial intermediaries, such as banks, do not receive comparable relief. This lack of relief for financial intermediaries inadvertently disrupts intermediary transactions where profits are small, because the STT potentially eliminates (or even exceeds) all intermediary profits. It is accordingly proposed that certain intermediaries be exempt from the STT so that transacting on the JSE remains internationally competitive.
The phasing in of carbon taxes
In line with the Climate Change Response White Paper approved by Cabinet in 2011, it was proposed in the 2012/13 Budget that carbon tax would be implemented in 2013/14 at a rate of R120 (South African Rand, approximately US$13) per ton of CO2 on direct emissions. This rate was to be phased in and increased at 10% per annum until 2019/20. The carbon emissions tax would be percentage-based rather than having emissions thresholds.
The 2013/14 Budget proposes the implementation of the carbon tax effective 1 January 2015 in accordance with the rates previously suggested, being R120 per ton of CO2 on direct emissions, increasing at 10% per annum during the first implementation phase.
During the first phase of implementation between 2015 and 2020, a basic tax-free percentage threshold of 60% is proposed as previously suggested. Off-set percentages of 5-10% aim to incentivize emission-intensive and trade-exposed industries to invest in and develop emission reducing projects outside of their ordinary operations, thus reducing their carbon tax liabilities.
Article 8 of the OECD Model Tax Convention allocates the sole taxing right of international profits to the residence country in which the place of effective management of the enterprise is situated. Under South African domestic law, a fairly similar exemption is available to non-residents in respect of South African sourced shipping income, if the resident country provides a similar exemption under its domestic law.
Although a possible tonnage tax was mooted for international shipping in 2006, as a substitute for the 28% tax on companies, and in order to attract international shipping, relief in the form of an outright exemption for shipping income is proposed.