Duties and related matters: An explanation of taxation liabilities

Taxation in South Africa is levied according to specific “residence principles”. These principles apply to incorporated, unincorporated and natural taxpayers. The South African Income Tax Act (the Act) contains certain “source” deeming principles in relation to passive income such as interest, royalties, dividends and certain other kinds of income, e.g., the imparting of or rendering of specific technical, industrial or commercial knowledge or information for use in South Africa, including related assistance. The actual source principles apply to non-residents deriving income from a source or deemed source in South Africa. The income tax legislation is significantly integrated with the South African Companies Act No. 71 of 2008, and thus there is a substantial interrelationship between terms, phrases and definitions in the Companies Act and those of the income tax legislation.

Limited Liability

For company law purposes, a company is a separate legal entity, distinct from its shareholders. The implications of this are:

• A company bears the liability and risks relating to its actions, dealings and business transactions;

• The company’s liability is separate from that of its shareholders; and

• The liabilities of shareholders for the debts of a local company are, save for exceptions relating to reckless trading, limited to the amount of the issued share capital of the company. There are generally no legal restrictions on the percentage of foreign shareholding in a South African incorporated company. Once incorporated, the company is subject to the provisions of the Companies Act. Black Economic Empowerment considerations in respect of shareholding are typically borne in mind when incorporating a company in South Africa.

Requirements Relating To Financial Records

undefined The Companies Act sets out which types of companies are required to be audited or be independently reviewed.

An audit of the annual financial statements is required if the company is:

• A public company; or

• Any other profit or non-profit company, taking into account whether it is desirable in the public interest based on the economic or social significance of the company, as indicated by any relevant factors, including its annual turnover, the size of the workforce, and the nature and extent of its activities.

All other for-profit or non-profit companies can be either voluntarily audited if stated in the Memorandum of Incorporation or by shareholders’ resolution or independently reviewed.

The Companies Act requires that, each year, a company must prepare annual financial statements within six months after the end of its financial year, or such shorter period as may be appropriate.

Taxation

As stated above, South Africa has adopted a residence basis of taxation in terms of which residents are taxed on their worldwide income. The Act defines a tax resident of South Africa in relation to natural persons and persons other than natural persons inter alia as follows: for natural persons, a subjective test is initially applied. Enquiry is made as to the place a taxpayer considers to be his real home, i.e. where the taxpayer would return to after travelling abroad. Case law confirms that all surrounding evidence of the person’s ties to South Africa should be considered.

Second, residence can be triggered in terms of the so-called “physical presence test”, which is a day-count test over six tax years. Under this test, a person will be a resident on March 1 of their sixth tax year in South Africa if they have spent more than 91 days within South Africa during each of the current and preceding five tax years, in addition to 915 days in total over the first five years. Such residence may be broken if the person fails the test in any year, or is absent from South Africa for at least 330 continuous full days. For persons other than natural persons, a resident is defined to be: “[any] person (other than a natural person) which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic, but does not include any person deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation”. A number of exclusions and provisos apply to this rule. Thus, in the absence of the application of a double tax agreement (DTA) that provides otherwise, a company incorporated in South Africa would be subject to tax in South Africa on its worldwide income. The taxable income of a company is calculated in terms of the provisions of the Act. In general, the taxable income is calculated as gross income, less exempt income, less general and special deductions and allowances, plus any taxable capital gains. The corporate tax rate applicable to a company is currently 28%.

Capitalisation & Funding Of Companies

South African companies may be funded by debt and/or the issue of shares.

Dividend Taxation

Dividends declared by a South African-based company are not deductible for tax purposes and are subject to the dividends withholdings tax (DWT) at a rate of 15% and to certain exemptions or reductions in terms of any relevant DTA. Unless the dividend constitutes an asset declared in specie, the DWT is a tax on the beneficial owner of the share and not on the company declaring the dividend. Despite this, the company declaring the dividend must withhold the DWT, unless the beneficial owner of the share is an exempt person and submits a declaration to the company in the prescribed manner by a date determined by the company or the date on which the dividend is paid. The DWT must be paid to the tax authorities by the last day of the month following the month in which the dividend is paid. Exempt beneficial owners include, inter alia, South African-based companies, retirement, pension and benefit funds, various spheres of the government, and specified tax-exempt bodies (i.e. parliamentary budget offices and other similar tax-exempt organisations). Companies that are exempt beneficial owners and that form part of the same group as the company declaring the dividend do not have to submit a declaration. The introduction of the DWT on April 1, 2012 has resulted in a number of amendments to the income tax legislation. One significant amendment was the recent rewrite of the dividend definition. The current dividend definition includes, as a dividend, any amounts transferred by a company to a shareholder to the extent that the transfer does not result in the reduction of contributed tax capital (CTC). The CTC of a company is defined in the legislation to include amounts received by or accrued to the company as consideration for the issue of shares by the company and includes the share capital and share premium of the company immediately before April 1, 2012. CTC needs to be determined with reference to each class of shares issued. It is important for a company looking to pay a dividend to determine whether such payment results in the reduction of CTC of the class of shares in terms of which the distribution is made or not. Such a consideration will be relevant in determining the portion of the payment made that will not result in the reduction of CTC. It is that portion that will be subject to DWT, and the company will have a withholding tax liability.

Interest Payments

Interest on loans is deductible, provided the money is used for the purpose of earning income. Interest on money borrowed to generate income that is not subject to tax – e.g., exempt income – is generally not tax-deductible, although special rules apply for qualifying share acquisitions. Any interest received by an offshore holding company from a South African subsidiary company is currently exempt from South African income tax, unless that offshore holding company carries on a business through a permanent establishment in South Africa.

Current tax legislation includes a withholding tax on interest paid to non-residents. However, this legislation is not yet in effect. In terms of the legislation, all interest received by or accrued to a foreign person will become subject to a final withholding tax at the rate of 15%, unless such interest is specifically exempt from the withholding tax or subject to a reduced tax rate as a result of relief provided by a DTA. The expected effective date of this new withholding tax is March 1, 2014.

It should be further noted that, in terms of the Act, the interest on any form of interest-bearing arrangement must, in most instances, be spread over the term of the instrument by applying the compounding accrual (yield to maturity) basis. This has the effect that the interest is incurred or accrued on a day-to-day basis over the period of the funding.

Local companies must bear in mind the transfer pricing rules that have been set out in the legislation and relevant supporting practice or interpretation notes in paying interest to non-resident connected persons.

Tax Treatment Of Specific Items

Payments may be made from a South African-based company to the foreign holding company, inter alia, by way of royalties, management fees or interest on loans. Such payments are, however, subject to South Africa’s transfer pricing rules, which require South African-resident persons to transact on an arm’s length basis with foreign-related parties. These payments are also subject to varying degrees of exchange control approval. The following sections reflect the tax treatment of certain transactions between non-residents and a resident company.

Royalties

Royalties (including know-how payments) derived from a South African source or deemed South African source, are taxable in South Africa in the recipient’s hands. In respect of non-resident recipients, the tax is withheld at source, in South Africa.

Royalty or similar payments that are made by a local company to a foreign-connected person, in respect of intellectual property or know-how made available by the foreign person for use in South Africa are generally tax-deductible in the hands of the South African company. Subject to the successful application of any relevant double tax treaty, the royalty will be subject to a 12% withholding tax in South Africa on the amount that is received by or accrued to that foreign person. This rate is set to increase to 15% on March 1, 2014.

The quantum of the allowable deduction of the royalty payment must also be determined in terms of South Africa’s transfer pricing rules. Payment of the royalty is subject to prior approval from the South African Reserve Bank (SARB) as well as the Department of Trade and Industry (DTI), in certain circumstances in the case of local manufacturing.

Directors’ Fees

Directors’ fees are subject to tax if they are earned by persons residing in the country, or if they are earned by non-residents from a source in South Africa. There is a general presumption in the tax law that the source of directors’ fees is the location of the head office of the company where, typically, directors will exercise their powers.

Interest

As indicated above, a company can deduct interest paid to a foreign holding company in respect of loans made available by a foreign-connected person. The deductibility of the interest will, however, be subject to the transfer pricing rules contained in the Act. Thin capitalisation also needs to be borne in mind, although it is no longer legislated.

The quantum of the interest payment(s) will also be subject to SARB approval. The remittance of interest to a foreign entity by a South African company will, with effect from March 1, 2014, be subject to a 15% withholding tax that is subject to certain exceptions. The rate at which tax is to be withheld may be reduced in terms of a DTA, if applicable.

Transfer Pricing

South Africa’s transfer pricing legislation was introduced in 1995. In August 1999, South African Revenue Service(SARS) issued Practice Note No. 7 (the Practice Note). The Practice Note contains guidelines for the application and interpretation of transfer-pricing rules in South Africa. The Practice Note is based on guidelines from the Organisation for Economic Cooperation and Development.

The overriding principle of the transfer-pricing legislation is that all cross-border intra-group transactions between resident and non-resident connected persons must be reflected, for tax purposes, as being on an arm’s length basis. The onus thus falls on the taxpayer to prove that the price is indeed an arm’s length price. Should a transfer-pricing adjustment be made for tax purposes, a further secondary adjustment applies, in that the difference between the taxable income of the person who derives a tax benefit from any connected person, and the taxable income, had the arrangement been made at arm’s length, is deemed to be a loan that falls within the transfer pricing rules and will therefore attract interest at an arm’s length rate. Only repayment of the deemed loan will eliminate this adjustment and ongoing interest.

Headquarter Company

When considering potential investment in South Africa, with a view to further expansion into various African countries, foreign investors may elect to consider setting up their base in South Africa through what is referred to as a headquarter company. The requirements for a company to constitute a headquarter company include:

• The company must be a resident and each shareholder must have a minimum 10% voting equity shareholding during each year (except before it commences trade);

• At least 80% of the cost of the total assets ( excluding cash or bank deposits payable on demand or if the total market company’s total assets did not exceed R50,000 [$6095]), of the company must represent an interest in equity shares in any debt owed by or any intellectual property that is licensed to the foreign subsidiaries, in which the company must hold at least 10% of the equity shares and voting rights;

• Where the gross income of the company for the year of assessment exceeds R5m ($6.1m), 50% or more of that gross income must consist of any rental, interest, royalty or service fee paid or payable by the foreign subsidiaries, or proceeds from the disposal of any equity shares or intellectual property held ( foreign exchange gains and losses are excluded from this calculation); and

• The company must comply with the abovementioned requirements in respect of each year of assessment.

Consequences

If the above conditions are met: • The holding company may elect to constitute a headquarter company;

• The foreign subsidiaries of the headquarter company are not to be treated as controlled foreign companies;

• Dividends declared by the headquarter company are not to be subjected to dividends tax;

• Interest paid will be deductible to the extent interest is received; and

• The holding company will be seen as a non-resident company from a South African Exchange Control perspective.

South African Branches Of Non-South African Resident Companies

Branches of foreign entities in South Africa are subject to tax on their South African-sourced income at a rate of 28% ( subject to the application of any DTA). Expenditure is apportioned to the branch operations directly or attributed indirectly, e.g., overheads and infrastructure costs. No deductions can be claimed for costs created within the same entity, e.g., royalties paid to head office.

There is currently no withholding tax on repatriation of branch profits to the head office.

Trading Losses

Where, in any year of assessment, the allowable deductions of the taxpayer, as determined by the Act, exceed total income, an assessed loss arises. The loss may be carried forward to subsequent years of assessment to be set-off against future income, provided the taxpayer continues trading. Losses may not be carried back to previous years of assessment. Furthermore, losses generated by foreign branches or foreign-controlled companies are ring-fenced to be offset against other or future offshore taxable income, and may not be offset against South African taxable income.

Group Relief

While theAct contains group relief provisions in defined circumstances, these do not extend to the offset assessed losses of one group company against the income of another. The group relief provisions are limited to specified transactions relating to re-organisations and amalgamations, and provide for a deferral of the tax, subject to certain specific requirements being met.

Capital Gains Tax

In South Africa, all residents are subject to capital gains tax (CGT) on the disposal of their worldwide assets. Non-residents are also subject to CGT, however only in certain circumstances or in respect of specific assets. Non-residents are subject to CGT on gains realised on the disposal of:

• Immoveable property situated in South Africa;

• The assets of a permanent establishment (or branch) in South Africa; and

• The shares in a company where broadly 80% of the market value of the shares is attributable to immoveable property situated in South Africa. CGT is levied for companies (including non-resident companies) on 66.6% of the net capital gain calculated at the company tax rate of 28%, resulting in an effective tax rate of 18.6%.

CGT is levied in terms of the eighth schedule to the Act. Typically, if there is a disposal or deemed disposal of an asset, as defined for proceeds, a CGT liability may arise. The liability determined is at the relevant rate after reducing the proceeds arising on disposal of the asset by the allowable costs (base cost) of the asset. If an aggregate capital loss is determined, this may not be offset against normal taxable income. Aggregated capital losses can be carried forward from year to year to be offset against capital gains. However, in the absence of an available capital loss, capital gains may be offset against an assessed income tax loss.

Administration, Provisional Tax & Returns

undefined A company is required to register as a taxpayer within 60 days of becoming liable for any normal tax or becoming liable to submit any returns to the SARS. An e-filing system is available for the purposes of submitting any relevant tax returns.

A company is required to pay provisional tax in respect of its income tax liability for each year of assessment. Two provisional payments must be made during the tax year. The first payment must be made within the first six months after the commencement of the year of assessment, with a second payment by the end of the year of assessment with a voluntary third “top-up” payment if required. Even if no tax is payable, the form must be submitted to avoid penalties and interest.

The commissioner gives public notice of the submission dates of all tax returns, forms and payments, annually, in respect of the year of assessment specified in the commissioner’s notice.

Value-Added Tax (VAT)

VAT, in terms of the Value-Added Tax Act No. 89 of 1991, is levied in respect of the following categories of transactions:

• The supply of goods or services by a vendor (any person required to be registered for VAT) in the course or furtherance of any enterprise carried on by the person; and

• The importation of any goods and services. For VAT purposes, the term “person” is widely defined and includes any corporate or unincorporated person, whether they are a resident of South Africa or not.

Thus, where a foreign entity owns a company or runs a branch (or, in fact, is involved any activity in the course of which VAT able supplies are made) in South Africa, the company will be liable for VAT registration where the total turnover in respect of its taxable supplies exceeds the threshold of R1m ($121,900) for a 12-month period. A company may also voluntarily register for VAT if its taxable supplies exceed the threshold of R50,000 ($6095) for a 12-month period. Upon registration, a company may be registered to have a one-month or two-month VAT period stipulating when the VAT returns and any payments need to be submitted. In additions, a four-month, six-month or annual VAT period may apply in limited circumstances.

As stated above, where a foreign entity (i.e. the main business) conducts its business partly in South Africa through a branch, such main business is, for VAT purposes, deemed to be carried on by a person separate from the South African branch in circumstances where the main business and branch can be separately identified and an independent system of accounting is maintained for the branch in South Africa. Under these circumstances, only the South African branch, and not the main business, may be liable to VAT registration in South Africa. Consequently, only supplies made by the branch, independently from the main operation, should be taken into account to determine whether or not the R1m ($121,900) annual threshold has been exceeded, and only the activities of the South African branch would form part of the South African VAT-registered person.

To register a person who is not a resident of South Africa for VAT purposes, such person must appoint a representative vendor and open a bank account with a South African registered banking institution for purposes of the enterprise carried on in South Africa. Current procedures allow for such person to make use of a third party’s bank account under certain circumstances. Currently, the standard rate of VAT to be levied on the supply of goods or services by a vendor is 14%. There are provisions for the application of the zero rate to the supply of certain goods or services. Most commonly, the zero rate applies in the case of the export of goods or services. Also, certain goods or services are subject to a VAT exemption, such as the supply of certain financial services. The provisions of the VAT Act regarding registration, charging and accounting for output tax, and claiming input tax applies equally to a company and a branch of the foreign entity operated as a “separate person” in South Africa.

The South African VAT law allows for the recovery of VAT on pre-incorporation expenditure in certain circumstances. However, the law does not generally provide for the recovery of VAT that is incurred on pre-VAT registration expenditure.

Therefore, in order to ensure no leakage of VAT, the date of incorporation of a taxable entity should be synchronised with the effective date for VAT registration.

As regards the receipt of services from outside South Africa, to the extent that the services are used for the purpose of making non-taxable supplies, the recipient of the services should account for VAT on such imported services on a reverse-charge basis.

As the services are contracted for the purposes of non-taxable supplies, an input tax credit for the reverse-charge VAT would not be available for recovery. Thus, such amount would become, in effect, a cost to the recipient of the services.

Exchange Control

Regarding the remittance of income, income derived from investments in South Africa is generally transferable to foreign investors, subject to restrictions, described as follows.

Management Fees

The payment of a management fee by a South African resident company to a foreign entity or beneficiary, based on an invoice which sets out the nature of the services rendered, is typically not subject to exchange control scrutiny, and can be authorised for payment by an authorised dealer. If the fees are calculated as a percentage of turnover, sales income or purchases are payable in advance, though approval from the SARB would be required. The SARB may require to be provided with the company's transfer pricing policy in order to determine whether the amount of such fees is at arm’s length.

Royal Ties

Agreements for the payment of royalties and similar payments for the use of technical knowhow, patents and copyrights, require the prior approval of the Financial Surveillance Department of the SARB, as well as of the DTI in certain instances.

Any royalty payment made to the non-resident licensor must be substantiated by an auditor’s report confirming the basis of calculation of the royalty and the existence of a valid agreement between the licensor and resident licensee. Exchange control is not in favour of minimum payments should the royalty not reach a certain amount during a specific period. The royalty payable should therefore be in proportion to the production or sales achieved.

The royalty payments are usually calculated as a percentage of the manufacturing cost or a percentage of the net ex-factory selling price, excluding any taxes such as VAT. However, a distinction is made by the DTI between royalty agreements covering consumer goods and those for intermediate and capital goods. For consumer goods, a royalty of up to 4% of the ex-factory selling price may generally be regarded as acceptable. In the case of intermediate and capital goods a payment of up to 6% may be considered favourably.

Dividends

Dividend distributions are freely remittable abroad. However, a letter of representation from the director, an auditor’s covering letter and financial statements that have been authorised by the SARB must be provided to the bank. LOANS TO RESIDENT COMPANIES FROM ABROAD: The following considerations apply:

• The acceptance of foreign loan funds by a local entity requires the approval of the exchange control authorities at SARB;

• There is a minimum period of approximately six months for the holding of a foreign loan; and

• No repatriation guarantees will be given by exchange control. For exchange control purposes, different restrictions and procedures apply, depending on whether the loan financing from overseas is from a non-resident branch, from non-resident shareholders or from any other nonresident. Interest in respect of foreign loan funding can be remitted abroad, provided the exchange control authorities of the SARB have previously approved the loan facility, the repayment terms and the interest rate charged on the loan. Generally, an interest rate calculated at prime, if rand-denominated, or the relevant interbank rate, if denominated in a foreign currency, is acceptable by the SARB.

In addition, SARB may consider requests to borrow from non-shareholders and forward cover can be obtained for foreign loan repayment.

Foreign Direct Investments (FDI)

In terms of a circular issued by the SARB in August 2010, authorised dealers may approve upon application outward FDI up to R500m ($60.95m) per company per calendar year. The guidelines and limitations set out below will, however, apply to outward FDI. Where the FDI is used to establish or acquire a new foreign company, the following guidelines are to be adhered to:

• Passive real estate investments (residential and commercial) are excluded from the dispensation;

• At least 10% of the foreign target entity’s voting rights must be obtained;

• The proposed investment must be in the same line of business as that of the applicant company;

• An outline of the anticipated benefits must be provided;

• The approved offshore entities (domiciled outside the Common Monetary Area [CMA]) may not acquire any assets or make loans to entities within the CMA thus creating a “loop structure”;

• South African-owned intellectual property may not be transferred by way of a sale, assignment or cession and/or the waiver of rights in favour of nonresidents in whatever form, directly or indirectly, without the prior approval of the SARB;

• Where goods are exported from South Africa, the applicants are obligated to receive the full currency proceeds, in South Africa, within six months from the date of shipment. Furthermore, all fee receipts due to the applicants should be repatriated to South Africa and be accounted for in an approved manner within 30 days of such funds being received by the applicant;

• The applicants may not independently change their approved equity interest in the offshore company, nor may their voting rights in the aforementioned company be diluted below 10%. The nature of the foreign business operations may also not be changed without the SARB’s specific prior approval and the transfer of any additional working capital from South Africa is subject to the submission of a fresh application to the SARB

• Should the applicants wish to dispose of their equitty interest in the foreign company, and for such a disposal to be permissible, the sale of said foreign entity must have been concluded on an arm’s length basis, at a fair and market-related price, (payable upfront and no extended credit terms are allowed) and the net sale proceeds must, within 30 days of receiving same, be sold to a South African authorrised dealer for conversion to rand, after advice to the SARB. A copy of the sale agreement must accompany such advice/application;

• The applicants are allowed, without prior approval of the SARB, to expand their offshore business via an existing or newly established offshore entity, through the acquisition of further assets or equity interests offshore, provided such acquisitions are in the same line of business. The expansion must be financed, with out recourse to South Africa, through foreign borrowings or by the employment of profits earned by the offshore company;

• No recourse to South Africa may occur to fund or guarantee such offshore expansion, and all expansion plans must be placed on record with SARB with in 30 days of such expansion taking place;

• South African corporate entities that receive dividends from approved offshore subsidiaries or associate companies (i.e. dividends declared out of normal trading income of a non-capital nature) may freely retain such dividend proceeds offshore, and may use them for any purpose, provided the application of such dividends does not create any recourse to South Africa. Similarly, any dividends that are later repatriated to South Africa may be re-transferred abroad at any time and used for any purpose, provided that no further recourse to South Africa is created;

• Dividend proceeds may, however, under no circumstances be utilised to fund investments or loans into the CMA via a loop structure, except if invested in approved inward-listed instruments based on foreign reference assets or issued by foreign entities, listed on the Johannesburg Securities Exchange or the Bond Exchange of South Africa;

• The SARB must also, on an annual basis, be advised of all dividends declared by the offshore operation(s), the amounts repatriated to South Africa or, alternatively, the dividend amounts retained abroad, together with an indication of how such funds were utilised offshore;

• Where guarantees from South Africa have been authorised by an authorised dealer and, in the event of such guarantee(s) being called up, full details of the circumstances giving rise to the implementation of such guarantee must immediately be forwarded to the SARB; and

• The original share certificates of the foreign holding company (where applicable) and the foreign target investment company must be lodged with the authorised dealer approving the investment within 30 days of having acquired the offshore shares, and such shares may not be released without the authorised dealer’s prior approval. In instances where the South African applicant needs the foreign shares as collateral for foreign borrowings/debt abroad, the share certificates may be released by the authorised dealer for the specific purpose stated, including the disposal of foreign investments. The audited financial statements of all approved foreign companies, together with an outline of the benefits to South Africa must, on an annual basis, be furnished to the authorised dealer approving the request for onward delivery to the SARB. Where the criteria, as set out above, are not adhered to, the SARB reserves the right to call for the foreign investment to be disposed of, and for the proceeds to be repatriated to South Africa. Where the foreign direct investment is used to establish new foreign branches or offices, the guidelines are, in most instances, similar to those mentioned in relation to recently acquired foreign companies.