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A NUMBER OF proposed changes to South Africa’s tax rules – first published in May this year – were greeted with considerable enthusiasm, because it was felt they’d reinforce this country’s credentials as a gateway for investment into Africa, especially when compared to Mauritius and Botswana (see table).
The changes contained in the Revenue Amendments Bill (intended to come into effect in January next year) would give investors access to a tax regime that would encourage them to establish their African headquarters (HQ) in SA. An HQ is specifically defined in the Bill: basically, any South African company where, from day one, 80% of its investment in terms of cost is outside SA and 80% or more of its income comes from those foreign investments (eg, dividends, interest, technical/management fees).
National Treasury stated at the release of the draft Bill that the focus would be on three particular aspects of the tax regime, namely: controlled foreign company (CFC) rules, secondary tax on companies (STC) and thin capitalisation rules.
“Those three small changes will have a significant impact on the way business will be done in Africa,” says David Lermer, global tax leader: Africa at PricewaterhouseCoopers (PwC). Bearing in mind SA’s other advantages as a springboard into Africa – including its location, best in class airports and logistics infrastructure, sophisticated banking, accounting and legal systems – the new tax regime should make it very attractive as a place for establishing regional headquarters.
“We already have a participation exemption within our tax laws that enables South African based companies to receive tax-free dividend income from companies overseas in which they hold more than 20% of the equity. Those companies can also sell those shares to non-resident companies without attracting capital gains tax.
“With no dividend tax, STC, CFC legislation and thin cap laws, we open up our borders to potential company income and attracting well sought-after skills and management to our shores. However, a key factor is the continued expansions of tax treaties in Africa (see table).”
First, the CFC rules and the administrative burden that accompanies them wouldn’t apply to HQ companies based in SA. “Currently, in terms of SA’s CFC rules, an SA parent company with a foreign subsidiary is taxed at 28% on the income of its foreign subsidiary, subject to some complex exemptions that may apply to, among others, active business income. The SA parent company must also comply with some equally complex tax filing requirements. Under the new regime, if someone invests through SA and its HQ is half or more foreign owned 50%, CFC rules don’t apply,” says Lermer.
Second, HQ companies would also not be subject to STC or the proposed dividend tax and thus profits could be expatriated free of SA tax leakage.
Says Lermer: “If South African based companies declare and pay dividends they’re subject to 10% STC. However, HQ companies will be exempt from that tax. In addition, we can also use our various tax treaties to limit the foreign tax on dividends from subsidiaries or foreign tax on capital gains from their disposal.”
Lastly, “thin cap” anti-avoidance provisions in place to prevent offshore groups eroding SA’s tax base through excessive interest charges. Says Lermer: “The safe harbour currently is a debt to equity ratio of 3:1, so that South African companies don’t take on excessive loans from foreign group parent or sister companies, subsequently deducting large interest payments from otherwise SA taxable income. From January next year an HQ can borrow as much as it likes from a foreign group and not be subject to those rules if it on-lends the funds to its qualifying foreign investments.
“In addition, where a company is thinly capitalised – for example, 4:1 – the interest on the excess is normally treated as a dividend, meaning that excess interest isn’t deductible and subject to STC at 10%. That won’t apply to an HQ.
“Overseas investors will now have the ability to finance their operations within Africa with as much debt arranged via its HQ as they want, subject to consideration of local African thin cap provisions, if relevant.
“However, that’s only the start of the journey,’’ Lermer says. “It’s very early days and there’s no question this bold initiative will evolve over time,” Lermer says.
Andrew Knight, partner at Maitland, agrees a more careful review of the proposed rules revealed a number of other issues that needed to be addressed before the rules would be effective in making SA sufficiently attractive as an HQ destination.
Many of those were raised in comments to the South African Revenue Service, whose response was published in early August and which was in turn followed by a revised set of rules that have now been presented to Parliament for approval.
In addition to the three points addressed above, the principal characteristics of an HQ company are now expected to be the following:
* An HQ company may use its operating currency (which will frequently not be the rand) for purposes of tax reporting, and thus avoid being exposed to tax on currency fluctuations.
* Indications are SA’s exchange control regulations will be amended so as to exclude HQs from its ambit.
* As and when the withholding tax on interest payments is introduced (currently expected to be in 2013) that tax won’t apply to interest paid by HQ companies. The proposed tax of 10% won’t apply and thus is part of the package of measures that enables debt funding to flow freely through the HQ company.
* Dispensation from the thin cap rules has been confirmed in return for the interest expense to be only used as a deduction against interest income derived from its subsidiaries.
* From a transfer pricing perspective, an HQ company won’t be required to retain an interest margin on any back-to-back loan arrangements with its subsidiaries. Usually, a South African resident company – where it’s an intermediary in a back-to-back loan situation – would generally be required to earn an arm’s length spread. That wouldn’t apply to an HQ company.
* To the extent intellectual property licensed to it isn’t used in SA, royalties paid out by an HQ company should be free of withholding tax.
It would appear Government is serious about making SA attractive to investors into Africa while being conscious of its position as a member of the G20 and of the views of the OECD. National Treasury has done well to devise an HQ company tax regime that reflects a careful balance between providing a facility for the free flow of capital to and from target investments and creating a tax regime that can’t be accused of being a harmful tax practice.
Criteria of an attractive location
Tax:
* Wide treaty network.
* No CFC legislation.
* No thin capitalisation rules.
* Participation exemptions.
* Potential group relief.
* Exit charges.
* Tax certainty.
No tax:
* No exchange control regulations.
* Stability.
* Access.
* Infrastructure.
* Set-up costs.
* Running costs.
* Flexible corporate law system.
The changes contained in the Revenue Amendments Bill (intended to come into effect in January next year) would give investors access to a tax regime that would encourage them to establish their African headquarters (HQ) in SA. An HQ is specifically defined in the Bill: basically, any South African company where, from day one, 80% of its investment in terms of cost is outside SA and 80% or more of its income comes from those foreign investments (eg, dividends, interest, technical/management fees).
National Treasury stated at the release of the draft Bill that the focus would be on three particular aspects of the tax regime, namely: controlled foreign company (CFC) rules, secondary tax on companies (STC) and thin capitalisation rules.
“Those three small changes will have a significant impact on the way business will be done in Africa,” says David Lermer, global tax leader: Africa at PricewaterhouseCoopers (PwC). Bearing in mind SA’s other advantages as a springboard into Africa – including its location, best in class airports and logistics infrastructure, sophisticated banking, accounting and legal systems – the new tax regime should make it very attractive as a place for establishing regional headquarters.
“We already have a participation exemption within our tax laws that enables South African based companies to receive tax-free dividend income from companies overseas in which they hold more than 20% of the equity. Those companies can also sell those shares to non-resident companies without attracting capital gains tax.
“With no dividend tax, STC, CFC legislation and thin cap laws, we open up our borders to potential company income and attracting well sought-after skills and management to our shores. However, a key factor is the continued expansions of tax treaties in Africa (see table).”
First, the CFC rules and the administrative burden that accompanies them wouldn’t apply to HQ companies based in SA. “Currently, in terms of SA’s CFC rules, an SA parent company with a foreign subsidiary is taxed at 28% on the income of its foreign subsidiary, subject to some complex exemptions that may apply to, among others, active business income. The SA parent company must also comply with some equally complex tax filing requirements. Under the new regime, if someone invests through SA and its HQ is half or more foreign owned 50%, CFC rules don’t apply,” says Lermer.
Second, HQ companies would also not be subject to STC or the proposed dividend tax and thus profits could be expatriated free of SA tax leakage.
Says Lermer: “If South African based companies declare and pay dividends they’re subject to 10% STC. However, HQ companies will be exempt from that tax. In addition, we can also use our various tax treaties to limit the foreign tax on dividends from subsidiaries or foreign tax on capital gains from their disposal.”
Lastly, “thin cap” anti-avoidance provisions in place to prevent offshore groups eroding SA’s tax base through excessive interest charges. Says Lermer: “The safe harbour currently is a debt to equity ratio of 3:1, so that South African companies don’t take on excessive loans from foreign group parent or sister companies, subsequently deducting large interest payments from otherwise SA taxable income. From January next year an HQ can borrow as much as it likes from a foreign group and not be subject to those rules if it on-lends the funds to its qualifying foreign investments.
“In addition, where a company is thinly capitalised – for example, 4:1 – the interest on the excess is normally treated as a dividend, meaning that excess interest isn’t deductible and subject to STC at 10%. That won’t apply to an HQ.
“Overseas investors will now have the ability to finance their operations within Africa with as much debt arranged via its HQ as they want, subject to consideration of local African thin cap provisions, if relevant.
“However, that’s only the start of the journey,’’ Lermer says. “It’s very early days and there’s no question this bold initiative will evolve over time,” Lermer says.
Andrew Knight, partner at Maitland, agrees a more careful review of the proposed rules revealed a number of other issues that needed to be addressed before the rules would be effective in making SA sufficiently attractive as an HQ destination.
Many of those were raised in comments to the South African Revenue Service, whose response was published in early August and which was in turn followed by a revised set of rules that have now been presented to Parliament for approval.
In addition to the three points addressed above, the principal characteristics of an HQ company are now expected to be the following:
* An HQ company may use its operating currency (which will frequently not be the rand) for purposes of tax reporting, and thus avoid being exposed to tax on currency fluctuations.
* Indications are SA’s exchange control regulations will be amended so as to exclude HQs from its ambit.
* As and when the withholding tax on interest payments is introduced (currently expected to be in 2013) that tax won’t apply to interest paid by HQ companies. The proposed tax of 10% won’t apply and thus is part of the package of measures that enables debt funding to flow freely through the HQ company.
* Dispensation from the thin cap rules has been confirmed in return for the interest expense to be only used as a deduction against interest income derived from its subsidiaries.
* From a transfer pricing perspective, an HQ company won’t be required to retain an interest margin on any back-to-back loan arrangements with its subsidiaries. Usually, a South African resident company – where it’s an intermediary in a back-to-back loan situation – would generally be required to earn an arm’s length spread. That wouldn’t apply to an HQ company.
* To the extent intellectual property licensed to it isn’t used in SA, royalties paid out by an HQ company should be free of withholding tax.
It would appear Government is serious about making SA attractive to investors into Africa while being conscious of its position as a member of the G20 and of the views of the OECD. National Treasury has done well to devise an HQ company tax regime that reflects a careful balance between providing a facility for the free flow of capital to and from target investments and creating a tax regime that can’t be accused of being a harmful tax practice.
Criteria of an attractive location
Tax:
* Wide treaty network.
* No CFC legislation.
* No thin capitalisation rules.
* Participation exemptions.
* Potential group relief.
* Exit charges.
* Tax certainty.
No tax:
* No exchange control regulations.
* Stability.
* Access.
* Infrastructure.
* Set-up costs.
* Running costs.
* Flexible corporate law system.
