Some div­i­dends are no longer ex­empt from tax

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - Peter Dachs & Bernard du Plessis

This in­cludes those that are ceded, shares that have been bor­rowed and funds dis­trib­uted by trus­tees

LAST year there was a ma­jor tax fo­cus on eq­uity fi­nance and in par­tic­u­lar on the na­ture of div­i­dends and the cir­cum­stances in which div­i­dends are ex­empt from in­come tax. Af­ter many leg­isla­tive changes the prin­ci­ple re­mains that div­i­dends are ex­empt from in­come tax in the hands of the re­cip­i­ent. How­ever, there are var­i­ous ex­clu­sions to this gen­eral ex­emp­tion.

For ex­am­ple, div­i­dends that are ceded are no longer ex­empt from in­come tax in the hands of the re­cip­i­ent. Sim­i­larly, div­i­dends on shares which have been bor­rowed are also not ex­empt from in­come tax. Div­i­dends dis­trib­uted by trus­tees of a dis­cre­tionary trust are also not ex­empt from in­come tax in the hands of the re­cip­i­ent ben­e­fi­ciary.

In ad­di­tion, if pref­er­ence shares are en­tered into for less than a three­year pe­riod or are sub­ject to a put/call or sim­i­lar ar­range­ment in terms of which the share­holder does not take eq­uity risk in re­spect of those shares, then the div­i­dends de­clared thereon may not be ex­empt in the hands of the re­cip­i­ent.

This should not be con­fused with the new div­i­dends-tax pro­vi­sions that were re­cently in­tro­duced. Div­i­dends tax is a com­pletely sep­a­rate tax from in­come tax and is im­posed on a with­hold­ing tax ba­sis at the rate of 15%, un­less, for ex­am­ple, the re­cip­i­ent is a res­i­dent com­pany. The sit­u­a­tions de­scribed above re­fer to ex­emp­tions from in­come tax on div­i­dends in the hands of the re­cip­i­ent.

This year the tax fo­cus has shifted from eq­uity to debt. A me­dia state­ment was re­cently re­leased by the South African Rev­enue Ser­vice (SARS) deal­ing with the tax de­ductibil­ity of var­i­ous types of debt.

The first cat­e­gory re­lates to “hy­brid debt”. In terms of the pro­posed rules if, for ex­am­ple, a debt in­stru­ment has cer­tain de­fined eq­uity-type fea­tures then the in­ter­est paid thereon will be re-char­ac­terised as div­i­dends both for the bor­rower and lender.

The bor­rower will there­fore not ob­tain a tax de­duc­tion in re­spect of the in­ter­est paid by it and the lender will be ex­empt from tax in re­spect of the in­ter­est re­ceipt.

The sec­ond cat­e­gory re­lates to “debt owed to un­taxed en­ti­ties within the same eco­nomic unit”. Th­ese rules es­sen­tially fo­cus on debt be­tween com­pa­nies in the same In­ter­na­tional Fi­nan­cial Re­port­ing Stan­dards (IFRS) group where the re­cip­i­ent is taxed at a low rate or is un­taxed on the in­ter­est re­ceived. In th­ese cir­cum­stances a lim­i­ta­tion for­mula will be ap­plied to the bor­rower in or­der to de­ter­mine the per­mis­si­ble quan­tum of in­ter­est which it may deduct for tax pur­poses. This for­mula es­sen­tially states that the de­duc­tion of in­ter­est will be limited to 40% of the debtor’s “tax­able in­come” plus in­ter­est re­ceived by the debtor, less in­ter­est paid by the debtor on third­party debt.

The third cat­e­gory re­lates to the im­pact of the trans­fer pric­ing rules on cross-bor­der debt. In this re­gard there are cur­rently no statu­tory thin cap­i­tal­i­sa­tion rules in re­spect of cross-bor­der debt be­tween re­lated par­ties. The pre­vi­ous thin cap­i­tal­i­sa­tion rules were re­cently re­moved from the In­come Tax Act and in­stead the arm’s length test ap­plies. Sim­ply put, when a com­pany bor­rows money from an off­shore re­lated party the quan­tum of fund­ing, as well as the in­ter­est-rate charged on such fund­ing, must be arm’s length in na­ture.

The me­dia state­ment pro­poses in­tro­duc­ing a safe har­bour for such ar­range­ments. In par­tic­u­lar, it is pro­posed that if in­ter­est paid on cross-bor­der con­nected party debt does not ex­ceed 30% of the bor­rower’s tax­able in­come, and the in­ter­est rate does not ex­ceed the prime or equiv­a­lent for­eign rate, then the in­ter­est paid will fall into the safe har­bour and will not be at­tacked by SARS as con­tra­ven­ing the trans­fer pric­ing pro­vi­sions.

Lastly, the me­dia state­ment deals with ac­qui­si­tion debt. Cur­rently, if a com­pany debt funds it­self in or­der to ac­quire as­sets from a group com­pany in terms of sec­tion 45 of the In­come Tax Act, the bor­rower must ob­tain a rul­ing from SARS as to the de­ductibil­ity of the in­ter­est on its ac­qui­si­tion fund­ing. It is now pro­posed in terms of the me­dia state­ment that this rul­ing process be re­placed by a statu­tory lim­i­ta­tion for­mula. In terms of this for­mula the de­duc­tion by the bor­rower of in­ter­est in­curred on debt used to ac­quire as­sets from a group com­pany in terms of sec­tion 45 of the In­come Tax Act is limited to 40% of the debtor’s tax­able in­come plus in­ter­est re­ceived by the debtor, less in­ter­est paid by the debtor on non-ac­qui­si­tion debt.

The same lim­i­ta­tion for­mula is pro­posed to ap­ply in cir­cum­stances where a com­pany is debt-funded in or­der to ac­quire or­di­nary shares in a group com­pany in terms of sec­tion 24O of the In­come Tax Act.

Th­ese debt pro­vi­sions will no doubt un­dergo fairly sig­nif­i­cant amend­ments be­fore their pro­mul­ga­tion into law to­wards the end of 2013. It is pro­posed that th­ese rules will ap­ply from 2014. Tax­pay­ers should there­fore fol­low th­ese de­vel­op­ments since they will af­fect a large num­ber of trans­ac­tions.

Peter Dachs and Bernard du Plessis are di­rec­tors and joint heads of ENS’s tax depart­ment.

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