A major milestone in SA tax law

The newly released South African Income Tax Amendment Bill contains highly innovative material to deal with existing restrictive rules.

It seems that South African fiscal authorities are taking a leaf from Botswana’s book with the new Income Tax Amendment Bill. In Botswana special provisions, called the International Financial Service Centre Regime, have been made for certain regional companies.

These provisions, based upon the Dublin IFSC model, offer special tax benefits to successful applicants. A similar arrangement is being proposed for the South African Bill, but the benefits seem to be more permanent. Head office companies in South Africa with one or many foreign shareholders, will be able to declare dividends free of any dividend tax, among other more technical tax exemptions.

At first glance, the new regime doesn’t seem to boast a special low tax rate, as in Botswana, but the changes will still be effective. This is because a South African head office would receive dividends from foreign subsidiary companies, which would be tax-free due to the exemption contained in sub section 10(1)(k)(11)(dd) of the South African Income Tax Act.

The head office thus has tax-free dividend income coming in and tax-free dividend income being routed through to offshore shareholders. Until now it’s been very costly and prohibitive for international groups to set up a South African head office, as dividends taxed in the country of declaration were again taxed upon declaration to shareholders.

The sensible new rules effectively remove a layer of dividend tax.The proposed amendments would address three sets of South African tax rules that limit investment in Southern Africa through South Africa. These rules are:

The controlled foreign company (CFC) regime causes an effective double-tax situation for the South African company if the foreign-owned company has similar CFC rules.The additional cost layer generated through the dividend taxes raised when a South African firm issues dividends.The rules against “thin capitalisation” or excessive borrowing by foreign firms.

Companies that will benefit from these concessions should have at least 80% of their asset base made up of foreign subsidiaries and at least 80% of the company’s income has to come from its foreign subsidiaries. The company’s minimum shareholding can’t be less than 20% and it’s understood that to qualify, the majority shareholding will have to be non-resident shareholding.

This is a breakthrough in South African tax drafting. It makes sense that South Africa would host head office companies as Johannesburg is the de facto commercial hub of the sub-continent. The proposals appear to have been well thought out with a strong commercial rationale as motivation for the proposed tax exemptions.