Unpacking Proposed Tax Amendments in the Budget
South Africa is in lockdown in the face of the coronavirus (COVID-19) outbreak, and although we aren’t able to meet face-to-face over this period, we know how important it is to stay in touch, and we will continue to keep you up-to-date on recent tax developments.
In this regard, it feels like a lifetime ago that the South African Minister of Finance delivered his 2020 Budget Speech on 26 February 2020. Given the far reaching impact of the COVID-19 related measures on economic activity in South Africa, it goes without saying that the Budget has been dramatically overtaken by the extraordinary events that are unfolding in South Africa and across the globe.
The Budget included references to various tax amendments and announcements regarding an overhaul of exchange control rules. It remains to be seen when and how the tax-related amendments will be introduced, but given that National Treasury will be under even greater pressure to collect tax revenues once this traumatic period in the country passes, it seems likely that at least some of these proposals will be implemented.
Be that as it may, we highlight certain of the more important proposed corporate and international tax-related amendments. We will, of course, keep you informed of any developments such as the release of the draft tax legislation, which may very well be released later in the year than usual.
RELAXATION OF EXCHANGE CONTROLS
Treasury has proposed a complete overhaul and modernisation of the exchange control systems to reduce some of the burdensome and unnecessary administrative approval processes. This should be good news to local and foreign businesses alike (once economic activity resumes).
In terms of this framework, it is intended that all foreign currency transactions will be allowed, except for those that are subject to capital flow management measures and/or pose a high risk in respect of a legitimate cross-border financial flows.
The Reserve Bank has indicated that the new system will be implemented over the next 12 months and will require that new legislation, such as “new capital flow management regulations”, be drafted along with the implementation of relevant tax amendments. Given the current situation, it is possible that this timeline may be extended.
The concept of emigration will be phased out for individuals. However, individuals who transfer more than ZAR10-million offshore will be subject to a stringent verification process. Such transfers will also trigger a risk management test that will include certification of tax status and the source of funds and assurance that the relevant individual complies with anti-money laundering requirements prescribed in the Financial Intelligence Centre Act. This will be phased in by 1 March 2021.
CORPORATE INCOME TAX RELATED PROPOSALS
Restriction of assessed losses
The government proposes broadening the corporate income tax base by restricting the offset of assessed losses carried forward to 80% of taxable income for years of assessment commencing on or after 1 January 2021.
In terms of current law, a taxpayer may set off a balance of the assessed loss brought forward from the previous year of assessment against income derived by such person from carrying on a trade in the current year of assessment.
In terms of the proposed amendment it seems that if, for example, a company has an assessed loss in a previous year of ZAR1 000 and earns taxable income of ZAR100 in the current year of assessment, only ZAR80 of such taxable income may be set off against the assessed loss brought forward from the previous financial year. The remaining ZAR20 will be subject to income tax at the rate of 28%. This will have a significant impact on companies with large assessed losses since, despite these assessed losses, such companies will pay tax if they are profitable (have taxable income) in any particular year.
It will be interesting to see whether this proposal will be reconsidered in light of the adverse economic impact of COVID-19. In particular, according to the OECD, one of the most urgent measures that governments around the world have been considering to counter the current economic crisis is“increasing the generosity of loss carry-forward provisions”.
Limitation on interest deductions
Government also proposes to restrict net interest expense deductions to 30% of earnings for years of assessment commencing on or after 1 January 2021. This is in order to combat base erosion and profit shifting by multinational corporations in situations where company debt or interest rates are artificially inflated and an interest deduction is claimed in South Africa whilst the interest is paid to a related party in an offshore jurisdiction with a lower tax rate.
A discussion document in respect of this issue has been released by Treasury which contains more details on the proposal and invites comments by 17 April 2020. It states that the intention is to ensure that debt funding utilised by South African entities is appropriate for the level of economic activity that the multinational group is conducting in South Africa.
The discussion document proposes that the new interest limitations apply to all entities operating in South Africa that form part of a foreign or domestic multinational group and that the rules apply to total net interest expense. Of note is that it appears to be wide enough to include external and connected party debt.
As a final statement, the discussion document invites comments on a potential safe harbour approach to determine if a taxpayer needs to apply the arm’s length principle to the quantum of the financing provided. It noted that the interest incurred on such financing will still be subject to transfer pricing rules and the interest limitation rule. This seems to imply a similar approach to the previous safe harbour under the thin capitalisation provisions.
Refining the corporate reorganisation rules
This first proposal deals with refining the application of anti-avoidance provisions that apply to transactions carried out in terms of the corporate reorganisation rules. In 2019, the intra-group provisions were amended to clarify the interaction between rules for the de-grouping of a group of companies and the anti-avoidance rules for the early disinvestment in a transferred asset. However, according to the Budget, the interaction between the anti-avoidance rules for de-grouping and the rules for the transfer of assets and the assumption of related debt may result in double taxation. It is proposed that the relevant provisions be amended to address this anomaly.
The second proposal deals with clarifying the rollover relief for unbundling transactions provided for in section 46 of the Income Tax Act, 1962 (the “Act”). The current unbundling provisions are subject to an anti-avoidance rule that excludes the shareholders and the unbundling company from benefitting from the rollover relief if 20% or more of the shares in the unbundled company are held by non-residents (either alone or together with individuals connected to those non-residents) after the transaction. According to the Budget, the current provisions create a loophole and the proposal seeks to amend the provisions to make provision for the 20% rule to apply, irrespective of whether the non-resident shareholders are connected persons in relation to each other.
Refining the taxation of REITs
The definition of a real estate investment trust (“REIT”) contained in the Act will be updated such that it will be in line with the Financial Sector Regulation Act, 2017 and that the consultation requirements regarding the listing criteria in an approved exchange be reviewed.
Treasury also proposes to clarify that the meaning of a share in the definition of a REIT excludes preference shares and non-equity shares from shares that must be listed on an exchange in order to qualify as a REIT. It has been confirmed that preference shareholders were never intended to benefit from the REIT tax dispensation as preference shares do not provide investors with equity exposure to the REIT but rather constitute a mechanism which provides funding to a REIT.
A further proposal addresses the mismatch that arises in circumstances where a REIT holds shares in a non-resident company. The mismatch arises where the foreign dividend received by the REIT qualifies for the participation exemption in terms of the Act and the REIT qualifies for a full tax deduction when it distributes profits from those foreign dividends. It is proposed that the relevant provisions in the Act be amended so that the foreign dividend is subject to tax if the recipient company is a REIT.
Refining the tax treatment of transfer of collateral in securities lending arrangements
The current anti-tax avoidance rules contained in the Act address dividend tax avoidance transactions in terms of which listed shares are lent or transferred as collateral from a person that would be liable for the tax to a tax-exempt person. The proposal seeks to extend the anti-avoidance rules to address situations where additional exempt parties are involved to facilitate the avoidance transactions. The proposed amendment may be intended to target transactions where the recipient of borrowed shares or shares received as collateral, transfers the shares to an entity which is exempt from dividends tax.
CROSS-BORDER TAX RELATED PROPOSALS
Refinement of anti-avoidance provisions regarding change of residence
When a company ceases to be a South African tax resident, it is deemed to have disposed of all its assets at market value, thus potentially triggering capital gains tax upon exit. The Budget raised a concern that residents that hold shares in such a company could subsequently dispose of such shares to a third party and qualify for the participation exemption in respect of any capital gain so realised. It is proposed that changes be made to address this concern.
Tax amendments in the context of “loop structures”
The current exchange control provisions restrict, subject to certain exceptions, the use of loop structures, in part to protect the tax base. However, the prohibition against these structures have been gradually relaxed and this relaxation may be increased in the context of the abovementioned relaxation of exchange controls.
However, Treasury seeks to introduce measures to combat the reduction of dividends tax and capital gains tax in such structures.
If loop structures are no longer restricted, it would be possible to set up a structure where a controlled foreign company (“CFC”) owns the shares in a South African company and any dividends flowing from such company to a resident individual or trust through the CFC are exempt for the individual or trust, thereby reducing the dividends tax liability for such individual or trust in respect of those dividends from 20% to a reduced rate as per the applicable double tax agreement.
It is thus proposed that the CFC legislation be amended to limit the dividend exemption available to a resident individual or trust relating to the accrual or receipt of dividends from a resident company to a CFC. As a result, such dividends would be taxed at an effective rate of 20% to align the tax treatment with instances where resident individuals receive dividends from resident companies.
Furthermore, if a resident disposes of shares in a CFC that owns South African assets, the unrealised gains attributable to the South African assets may not be taxed in South Africa if the resident qualifies for the participation exemption for capital gains. It is proposed that the participation exemption for capital gains on the disposal of shares in CFCs by residents should not apply to the extent that the value of those shares is derived from South African assets.
In conclusion, we now live in a time of great uncertainty and only time will reveal the long term effects of Covid-19 on our society and our economy. How this will impact on,inter alia, the above proposals formulated by government at a time when the current state of affairs could not have been imagined, remains to be seen.
For more information, please contact ENSafrica’stax department