South Africa budget almost avoids tax hikes for businesses to plug deficit
Businesses were left almost unscathed in Finance Minister Pravin Gordhan’s 2017-18 budget that announced ZAR 28 billion ($2.16 billion) of revenue raising measures to help stabilise the economy, but there was one concern for MNEs.
Although there were no rate increases to corporate tax, VAT or capital gains tax, the minister announced an increase in the dividend withholding tax rate from 15% to 20% to raise ZAR 6.8 billion in additional tax revenues.
He also announced higher personal income taxes, ‘sin’ taxes, and plans to tackle tax avoidance and introduce the sugar tax.
“Overall, the 2017 National Budget speech was a lesson in balancing the urgent requirement of increasing revenue collection against a number of sensitive political considerations, made more acute by the looming national election in 2019 and the watching brief that is currently being applied by the ratings agencies,” said Dale Cridlan, director at Norton Rose Fulbright in Sandton.
Dividend withholding tax affects MNEs
On the dividend withholding tax, Michiel Els, a transfer pricing specialist at Deloitte in Johannesburg, tweeted that this will have a “big impact” for MNEs.
“Secondary transfer pricing adjustment used to be 15% and it will now be 20%. Therefore, on a transfer pricing adjustment you will pay tax of 28% on the primary adjustment and then 20% as secondary adjustment on the adjusted amount,” Els told International Tax Review.
Cridlan explained that the tax increase will “decrease the after-tax return received by MNEs thereby making South Africa a more expensive investment destination.”
“However, for those MNEs who are located in jurisdictions with which South Africa does have a favourable double tax treaty, the increase in the dividends tax rate will have little to no effect,” he continued. “As there is no withholding tax which applies to the remittance of branch profits it can be expected that one will see a bias towards setting up a South African branch operation in South Africa as opposed to a South African subsidiary, that is, a branch will pay South African income tax at 28% (with no branch remittance tax) as opposed to a foreign shareholder who risks being taxed at an effective rate of 42.4%.”
Dan Foster, director at Webber Wentzel, agreed that the higher dividend rate “is very disappointing as it discourages all the kinds of economic behaviours that the government should in fact be encouraging”.
“Interestingly, South Africa renegotiated many of its tax treaties ahead of the introduction of the dividend withholding tax in 2012, so those countries with a treaty rate at or below 15% now look attractive,” Foster said.
“Nobody expected the dividend withholding tax to exceed 15%, so that rate now looks like a good deal,” he continued. “But generally, a high dividend rate on foreign investors further encourages profit extraction by other means – however SARS have transfer pricing firmly in their sights so MNEs must tread very carefully. It certainly does not encourage equity investment either locally or from abroad, which is counter-productive. On the plus side, the corporate tax rate has stayed at 28% which is a huge relief.”
Tax arbitrage opportunities
In addition to the dividend withholding tax, Gordhan confirmed predictions that the top personal income tax rate would be raised. He announced that the rate would be raised from 41% to 45% for those with taxable incomes above ZAR 1.5 million. In addition, the bracket creep relief would be limited, increasing the tax free threshold from ZAR 75,000 to ZAR 75,750. Together, these measures intend to raise an estimated ZAR 16,516 billion from personal taxes.
Mark Goulding, tax market leader at EY Africa said the higher personal income tax rate is a “big jump for” the top income earners, although there are only 100,000 people in that top income bracket.
However these taxpayers, who would collectively pay an additional ZAR 400 billion in tax, tend to own their own companies or have access into their own companies, allowing them some tax planning opportunities. “If they do tax planning by taking their earnings as fully-taxed company dividends, there is still a 5% arbitrage opportunity,” said Goulding. “Fully distributed dividends will now be taxed at 40% through a corporate, so there is still opportunity for tax planning to happen with those individuals.”
“The government very cleverly increased the dividends tax rate from 15% to 20% to account for this arbitrage gap that would have otherwise been more significant that this 5% that is already there,” Goulding added.
However, Christian Wiesener, associate director of international tax and transfer pricing at KPMG in Cape Town, said the situation is likely to be monitored and if needed, the dividends tax rate may be increased again, if required. “It should be noted that the effective tax paid by both the company and the shareholder after dividends tax is 42.4%, i.e. a difference of 2.6% benefit for those already earning over ZAR 1.5 million, for those earning up to ZAR 1.5 million it would be beneficial to earn income as remuneration,” he said.
Foster said the 45% rate is “somewhat odd in that it will not collect much extra tax, but only punish a few people, who may join the emigration queue in any case”. However, he pointed out that this increase also means that the rate for trust also increases from 41% to 45%. “Perhaps it was merely a symbolic, political move, and may hopefully pave the way for a VAT increase next year rather than more income tax hikes,” he added.
Nazrien Kader, head of taxation services at Deloitte Africa, said that although the tax rate applicable to trusts has been increased to 45%, the inclusion rate stays the same. However, the effective capital gains tax rate will go up to 36% for trusts. Similarly the highest effective CGT rate for individuals with taxable income over ZAR 1.5 million will increase to 18%.
Sin taxes raised
Gordhan also unveiled higher fuel levies and excise duties for alcohol and tobacco, as well as an increase in the road accident fund levy to generate the remaining tax needed to meet the ZAR 28 billion revenue target, based on full adjustment of personal income tax and excise duties for inflation.
As such, the excise duties for alcohol and tobacco were increased by between 6% and 10%, the general fuel levy was increased by ZAR 0.30 per litre and the road accident fund levy was raised by ZAR 0.09 per litre.
The revenue-raising measures confirm Gordhan’s plans announced in his mid-term budget policy statement (MTBPS) in October 2016 to increase taxes over the next two years to raise ZAR 43 billion ($3.1 billion) in tax revenues to help stabilise the economy (ZAR 28 billion in 2017-18 and ZAR 15 billion in 2018-19). The revenue is necessary to plug the deficit in South Africa’s budget during a time of political instability, an ailing economy and the risk of having its financial rating downgraded to junk status.
Sugar tax coming, but carbon tax stalled
South Africa has been planning to introduce carbon and sugar taxes for some time. While the sugar tax many happen this year, proposals for a carbon tax seem unlikely to be introduced in 2017 as planned.
On the sugar tax, Gordhan said that “further consultations are currently taking place on the tax on sugary beverages. Arising from these discussions, and working closely with the Department of Health, the proposed design has been revised to include both intrinsic and added sugars. The tax will be implemented later this year once details are finalised and the legislation is passed.”
However, he did announce that the tax will charge a “health promotion levy” on sugary beverages at 2.1 cents per gram of sugar content above 4 grams per 100 millilitre.
Nazrien Kader, head of taxation services at Deloitte Africa, said that if the government did introduce the sugar tax, it could potentially generate around ZAR 11 billion in tax revenues, based on preliminary research.
On carbon tax, the finance minister said the measure and its date of implementation will be considered further in parliament this year.
Kader said that more details are crucial to held taxpayers to prepare for its introduction. “The carbon tax could make a significant dent in South Africa’s budget deficit, making it more likely that the tax will be introduced sooner rather than later,” he said. “A draft of the bill has already been released with a planned implementation date of January 1 2017. Many comments were made on this bill and a new draft is expected early in 2017 with a view to implement the legislation in 2018. There are several outstanding issues that need to be addressed in the revised legislation. Possibly one of the more pressing of these issues is the emissions threshold for paying carbon tax. It is also unclear who the taxpayer will be. There are some indications that groups of companies would be liable, but tax is normally levied at company level.”
Moving forward on combating tax avoidance
South Africa intends to sign the Multilateral Instrument this year to allow it to update its tax treaties in line with the OECD BEPS initiatives and reduce the scope for aggressive tax avoidance activities.
The automatic exchange of information between tax authorities will also come into operation in September 2017 and multinational companies will be required to file further information with SARS on cross-border activities from the end of the year.
“We will continue to work actively with the international tax community and within government to modernise customs administration and combat cross-border revenue leakages, money laundering and harmful tax practices,” Gordhan said.
“There are once again a slew of anti-avoidance proposals which could by themselves generate significant tax revenue and will require much attention by tax managers over the coming years,” Foster said.
According to Cridlan, an interesting development to watch from an international tax perspective will be the proposed amendment to the South African controlled foreign company (CFC) regime. “The proposal is to introduce rules which will circumvent the current custom of avoiding the CFC rules by interposing a foreign trust between the South African resident beneficiaries and the foreign company.”
Tax amnesty scheme doing well
South Africa’s special voluntary disclosure programme, which aims to bring undisclosed foreign investments held by South Africans into the tax net, could generate significant tax revenue – potentially at least ZAR 10 billion.
Gordhan confirmed that the South African Revenue Service has already received disclosures of ZAR 3.8 billion in foreign assets, which will yield revenue of about ZAR 600 million.
“Although the amount will only be known when the programme ends. The last amnesty in 2003 yielded ZAR 48 billion,” Kader noted.
The programme will be open until August 31 2017.
“In summary, the Minister of Finance has stuck to his guns and has continued on the course which has marked his time in office of conservative and fiscally disciplined budgets,” Cridlan concluded.
Pictures used for this article are from South Africa government/Flickr.com