South Africa: Proposed international tax amendments
Proposed changes to the Income Tax Act, contained in the 2017 draft Taxation Laws Amendment Bill (draft TLAB), were released for comment on July 19 2017. This article discusses some of the international tax related proposals. The amendments discussed below, other than the last one, will, if enacted, apply in respect of tax years starting on or after January 1 2018.
Broadening of CFC rules
Encouraged by the OECD's BEPS Action 3 report, the South African Revenue Service (SARS) is seeking to widen the controlled foreign corporation (CFC) net. Proposed changes aim to bring into the South African tax net income derived by foreign companies held by non-South African tax resident trusts or foundations with South African resident beneficiaries. If implemented, these will have the effect of putting South African tax resident beneficiaries of foreign trusts that hold foreign shares in a worse tax position than if those South African residents had held the foreign shares directly.
The CFC rules apply where South African residents hold directly or indirectly more than 50% of the total "participation rights" or exercise more than 50% of the voting rights in a foreign company. "Participation rights" are defined as the right to participate in the benefits of the rights (other than voting rights) attached to a share or any interest of a similar nature in a foreign company.
Where a foreign discretionary trust is interposed between South African residents and a foreign company, the foreign company will typically not constitute a CFC even if the trust holds a majority of its participation or voting rights. This is because the South African resident beneficiaries have no unconditional "participation rights" (or voting rights) in the foreign company. SARS is consequently concerned that trusts are being deliberately interposed in offshore structures to avoid CFC implications. Various proposals have been made in the past to curb this perceived abuse, none of which has been successfully implemented to date.
The draft TLAB proposes to broaden the definition of a CFC to include a foreign company in which foreign trusts or foundations with South African resident beneficiaries hold more than 50% of the total participation rights or voting rights. The South African resident beneficiaries (unless they are companies) must then include "any amount" derived by them from that trust or foundation in their income for South African tax purposes. There will be no possibility of the amount being treated as exempt, or not subject to tax, or subject to tax at a reduced rate, as might be the case under existing tax law.
The term "any amount" implies that the trust does not need to have derived the amount vested in the South African beneficiary from a CFC, although this is presumably the intention. It also ignores how small any distribution to the South African tax resident beneficiary may be, relative to distributions to other beneficiaries. The proposed provision will catch many structures that are in no way abusive or tax driven, which is likely to generate intensive lobbying.
The CFC definition will also be expanded to include a foreign company, the financial results of which are included in the consolidated financial statements as contemplated in IFRS 10 of any company that is a South African tax resident. The percentage of the income to be imputed to South Africa will correspond to the percentage of the financial results of the CFC that is consolidated by the South African resident holding company in the relevant year.
Cross border payments for use of intellectual property
South African taxpayers cannot claim deductions for certain royalties paid to non-residents in respect of intellectual property (IP) which was originally developed in South Africa. The limitation does not apply to payments made to CFCs if the royalty income is fully imputed to a South African resident shareholder under the CFC provisions. The limitation is also influenced by whether and at what rate the payment in question is subject to withholding tax on royalties.
The 2017 budget announced that the regulatory framework regarding cross-border IP transactions is to be relaxed, for both tax and exchange control purposes. In this context, the draft TLAB proposes that a deduction will be allowed if the royalty payments are made to a CFC which is resident in a 'high tax' jurisdiction. To qualify, the CFC must be subject to an aggregate amount of foreign tax that is at least 75% of the amount which would have been payable had the CFC been tax resident in South Africa.
Foreign earnings exemption repealed
It has been proposed that, from March 1 2019, all South African individual tax residents will be subject to South African income tax on foreign employment income earned in respect of services rendered outside South Africa. Currently, South African tax residents who are outside the country rendering services for their employer for a period exceeding 183 days (60 days of which must be continuous) during any period of 12 months, enjoy an exemption from South African income tax on their foreign employment income.
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