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South Africa: Tax exposure in respect of derivative income earned by non-residents

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Peter Dachs

South Africa taxes a resident, as defined in the Income Tax Act, on its worldwide income. A South African resident is defined in section 1 of the Income Tax Act as a 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 who is deemed to be exclusively a resident of another country for purposes of the application of any double taxation agreement entered into by South Africa.

Any person who does not constitute a resident as defined in the Income Tax Act is subject to South African income tax on income which is from a source within South Africa or deemed to be from a South African source, subject to relief provided in terms of the relevant double tax agreement, if any.

As from January 1 2012, the tax code contains a statutory definition of "source" in respect of certain forms of income in section 9 of the Income Tax Act.

However, section 9 of the Income Tax Act does not address the source of derivative income such as manufactured dividends.

If certain items of income are not specifically dealt with in section 9(2) of the Income Tax Act, it is then necessary to consider whether the general principles relating to source apply to such items of income.

On this basis our courts have held that the term source means the "originating cause of income being earned". In CIR v Lever Brothers and Unilever Limited (14 SATC 1) the court stated that that the enquiry into "originating cause" has two steps, namely what was the originating cause of the income and furthermore, where was that originating cause located.

Two aspects which are relevant for determining the source of a non-resident's income are: (i) whether its business is carried out in South Africa; or (ii) whether its capital is employed in South Africa.

A number of factors could contribute to a non-resident earning derivative income. It is therefore possible that income can have more than one source, some of which may be within and others outside of South Africa. Where there appears to be more than one source, the traditional approach has been to seek the real, main or dominant cause of the income (CIR v Black 21 SATC 226).

However, there is also case law dealing with the apportionment of income.

Many items of derivative income do not fall within the ambit of section 9 of the Income Tax Act. It is therefore necessary to test whether these amounts are, in terms of general source principles, derived from a source within South Africa.

In respect of various items of income there is clear case law in respect of the source of such income. This applies in respect of, for example, dividends declared on shares issued by a South African company as well as rental payments, service payments and the source of income from the sale of shares. However in respect of derivative payments there is no applicable case law. To determine whether a non-resident which earns derivative income has an exposure to South African tax, it is therefore necessary to test whether such non-resident carries out business operations in South Africa or employs capital in South Africa.

Peter Dachs (pdachs@ensafrica.com)

ENSafrica – Taxand Africa

Tel: +27 21 410 2500

Website: www.ensafrica.com

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