Protecting offshore ‘income’

How to ensure that dividends from an offshore company are tax-free.

Protecting offshore ‘income’
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Dividends received from an offshore company are free of tax in the hands of a South African holding company provided that:

  • The holding company qualifies for the ‘participation exemption’;
  • The offshore company is not taxed as a controlled foreign company (CFC).

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In layman’s terms, so long as more than 10% of the voting rights and equity of the offshore firm are held by the SA company, the participation of the SA company is sufficient to ensure that the dividends are tax-free. This is in terms of Section 10B of the South African Income Tax Act (SAITA).

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CFC legislation, however, holds that the nett income of the offshore company could be taxable in the hands of the SA company, unless the CFC income is exempted from such treatment under SAITA. Broadly speaking, a ‘controlled foreign company’ is a foreign company subject to control by an SA resident. CFC legislation is promulgated to make it difficult to use an offshore company to avoid taxes in South Africa.

Sub-Section 9D(9) provides for an exemption from this legislation where the offshore company is run through a proper ‘business establishment’. However, the financial results of the CFC must be reported to SARS in terms of Section 76 of SAITA.

Thus, if the SA resident company’s offshore subsidiary is held with the correct amount of shareholding and the offshore company has a proper place of business, dividends declared by the offshore subsidiary will be free of tax in the hands of the SA company.

Further declaration
What is the position with regard to the further declaration of these dividends to the SA shareholders?

Are these tax-free receipts that must then be further declared as dividends subject to withholding tax?

The bad news is that withholding tax is payable if the dividends received by the SA company are issued to the SA shareholders. A rebate is available under Section 64N of SAITA, but this is only for JSE-listed companies that operate offshore.

Section 64F, meanwhile, cites those who would escape the liability for SA withholding taxes. An SA company in receipt of dividends from offshore is not on the list. Looking at the unilateral tax relief provisions of SAITA, it is clear they apply to income – and dividends are not income as such.

It would therefore appear to me that it is much better for SA taxpayers to hold offshore shares in their own name as long as they hold enough shares to qualify for the ‘participation exemption’ as per Section 10B of SAITA. In conclusion, the SA holding company will certainly enjoy tax-free dividends from its offshore subsidiary, but the issue of dividends by it as a private company to its shareholders will result in withholding tax being payable both in the offshore jurisdiction and in South Africa.
SA shareholders, however, will suffer foreign withholding taxes only.