Removing barriers to entry for companies
SOUTH African taxresident companies or those with places of effective management in SA can qualify as headquarter (HQ) companies. A number of rules must be met, but once these hurdles are negotiated, the system makes SA an attractive destination for multinational companies wishing to invest in Africa. Each shareholder must hold 10% or more of the shares and voting rights in the company and where trade commences during an assessment year, the pre-trade period is ignored. Businesses can use dormant companies to qualify for the 10%.
Where the company’s gross income exceeds R5m, 50% or more of its gross income, for that assessment year, must comprise either: (i) rental, dividend, interest, royalty or service fee paid or payable by a foreign company in which the company holds 10%; or (ii) proceeds from the disposal in equity shares in a foreign company in which the company holds 10%, or IP licensed to a foreign company in which the HQ company holds 10%. The company’s gross income must take exchange differences into account. If the requirements are met, the HQ company regime can be elected. An annual report must be submitted to the minister.
For the end of an assessment year and previous assessment years, at least 80% of company’s total asset cost must be attributable to either (i) an interest in equity shares; or (ii) a debt owed to; or (iii) intellectual property (IP) licensed to a foreign company where the HQ company held 10%. Total assets include cash or bank deposits payable on demand. Where the asset market value was below R50k that assessment year is disregarded when determining the 80%.
An HQ company is subject to 28% income tax with certain tax exemptions — the balance is likely to qualify for foreign tax credits. Dividends declared are treated as foreign dividends for South African residents and non-residents and tax exempt. Dividends declared to shareholders are not subject to dividend withholding tax. Foreign dividends received by the company are tax exempt if it holds 10% in the foreign subsidiary paying the dividend. HQ companies are exempt from Controlled Foreign Company (CFC) rules and gains in the underlying companies are not attributable to them. Foreign investments constitute CFCs in relation to South African shareholders of the headquarter company, if South African shareholders hold more than 50% in the investees.
An HQ company is generally subject to South African transfer pricing rules except where it receives financial assistance from non-resident companies which is onlent to a foreign company and the headquarter company holds 10%. The transfer pricing rules do not apply where (i) an HQ company grants financial assistance to a foreign company in which it holds 10%; (ii) a foreign company grants the right of use of IP to the HQ company and (a) the HQ company grants it to a non-resident in which it holds 10%; and (b) the HQ company does not use the IP license, subject to exceptions, where the headquarter company holds 10%. The transfer pricing rules do not apply where an HQ company holds 10% in a foreign company and the HQ company grants an IP license to it.
Interest deductions on foreign loans and royalty payments on IP licenses are ring-fenced. Interest on foreign financial assistance is deductible against interest to the non-resident company in which the company holds 10%. Royalties paid are deductible against royalties earned from IP licenses granted to non-resident companies in which the company holds 10%. Excesses are carried forward and deemed to be incurred in the next year.
Interest received by nonresidents from a South African source is not subject to tax where the non-resident neither has a permanent establishment nor spend more than 183 days in-country in the tax year. SA imposes a 15% withholding tax on interest paid to non-residents. HQ companies are exempt from interest withholding tax on interest on foreign financial assistance granted to it by a nonresident company which holds 10% in the HQ company. Otherwise, the company is liable to a 15% interest withholding tax. HQ companies are exempt from royalty withholding tax on royalties incurred in granting of use, or right of use or permission to use IP to HQ companies by nonresident companies which hold 10% in it. In other cases they are liable to 15% royalty withholding tax.
HQ companies must disregard capital gains or losses triggered on the disposal of equity shares in a foreign company if they held 10% in the foreign company immediately before disposal.
Where an HQ company is created it is, subject to exceptions, deemed to dispose its assets at market value prior to converting and re-acquire the assets at market value on the day it became an HQ company which triggers notional income and capital gains tax. Where an HQ company is established: (i) its assessment year ends the day before it became one; (ii) the next assessment year starts when it becomes an HQ company; and (iii) it is, on the day before it became such a company deemed to declare and pay a dividend of an asset in specie. The asset in specie is, subject to exceptions, deemed to be the asset market value on that date less contributed tax capital of all classes of shares and is deemed to be paid to the person holding the shares in accordance with the effective interest of their shares. The deemed dividend is subject to a 15% dividend withholding tax payable by the HQ company.
Such a company may with the approval of the SA Reserve Bank invest outside SA without restriction, if: (i) its shares or debt are not JSE-listed, and its shares are not held by a shareholder with JSE shares or debt; (ii) each shareholder must hold 10%; (iii) South African residents’ equity may not exceed 20%; (iv) at the end of a financial year, 80% or more of the assets must be foreign (not cash and short term debt); (v) registration with the Bank remains valid; (vi) it is treated as a non-resident company for exchange control purposes. Transactions by South African entities with an HQ company are viewed as being with a non-resident.
SA is becoming more attractive for regional holding companies now, though the rules are quite complex. Let’s hope more make use of the new system.
HQ company regime can be elected if the requirements are met
Ferdie Schneider is head of tax at BDO South Africa.