UNIFORM CROSS-BORDER WITHHOLDING REGIME TO PREVENT BASE

[Applicable provisions: Sections 37J through 37O and section 49A through 49G; new sections 49; 50 and 51]

I. Background

A. South African cross-border withholding taxes

South Africa has long history of imposing withholding tax in the case of cross-border royalties (at 12 per cent). From 1 April 2012, South Africa introduced a dividends tax on cross-border dividends (which replaced the Secondary Tax on Companies). From 2011, an announcement was made to enact a unified cross-border withholding regime for interest at 15 per cent (and in 2012, a 15 per cent royalty withholding regime was proposed to replace the pre-existing royalty regime). Both regimes have been enacted for future implementation as of 1 July 2013. All of the above cross-border withholding regimes can be reduced or eliminated by an applicable tax treaty.

B. Local permanent establishments

Withholding taxes are designed to tax passive income. Once a non-resident entity has a permanent establishment in South Africa, the permanent establishment will be taxed on a source basis at a rate of 28% (i.e. at ordinary rates under the normal tax). As a result, the pending withholding regime contains an exemption for South African sourced interest/royalties if a non-resident carries on business in South Africa through a permanent establishment at any time during the year of assessment. South African sourced interest/royalties earned by foreign entities outside of this permanent establishment rule will be subject to a 15 per cent withholding.

II. Reasons for change

A. Lack of cross-border withholding taxes on management/technical fees

Unlike most developing countries, South Africa does not have a withholding tax on management or technical fees. Like interest and royalties, these fees generate local deductions, thereby giving rise to potential base erosion. Internal data suggest that these fees amount to billions per annum, much of which is shifted to low-tax jurisdictions. Hence, some form of protection in the form of withholding is needed to protect the tax base as has already been enacted for cross-border interest and royalties.

B. Taxation of permanent establishments

The current nexus between taxation under normal tax versus 15 per cent withholding is partially inappropriate. While the permanent establishment test is an international standard, OECD principles suggest that normal taxation should be limited solely to amounts that are effectively connected to the permanent establishment. The mere existence of a permanent establishment should not push all locally sourced income away from withholding taxes.

In addition, concerns exist that many foreign entities with permanent establishments are not properly filing their tax returns while acting as the basis for exemption from withholding taxes.

Lack of proper registration means that certain foreign entities are improperly avoiding South African tax altogether.

III. Proposal

A. Proposed withholding taxes on cross-border fees

In view of the above, it is proposed that pending withholding taxes be extended to cross-border consultancy, management and technical fees. This new withholding tax will be a final withholding tax that will be used to identify and collect revenue from non-resident taxpayers who provide certain services within a South African source that fall outside the normal tax. More specifically, all payments for services to a foreign resident from a South African source will be subject to withholding tax if those services are of a technical, managerial or consultative nature.

These services should be understood as being comparable to technical fees covered in the context of certain tax treaties. Less technical services (such as hair stylists, real estate commissions and the like) should not be viewed as falling within the withholding paradigm.

In line with other cross-border withholding taxes, the withholding tax on technical, managerial or consultative service fees will be levied at the rate of 15 per cent of the gross amount of fees paid to a foreign-resident (subject to tax treaty relief). The structure of the regime will largely follow the structure for withholding taxes on royalties (more specifically as described below).

1. Liability for tax

As with other withholding taxes, the liability to withhold tax on technical, managerial or consultative service fees will remain with the person making payment (payor) of those service fees to or for the benefit of a foreign person. As stated above, the liability is limited solely to South African sourced amounts. Payment of this withholding charge satisfies any potential liability of the foreign payee.

2. Exemption from withholding tax on service fees

Like withholding taxes on interest and royalties, withholding tax on service fees will be subject to the following exemptions:

a. A foreign payee will be exempt from withholding tax if that foreign payee is a natural person who was physically present in South Africa for a period exceeding 183 days during the twelve month period preceding the date on which the fees are paid;

b. A foreign payee will also be exempt if the service fees are effectively connected to a South African permanent establishment (see the discussion of the permanent establishment exemption below).

In addition, service fees paid in respect of services rendered by any person in his or her capacity as an employee will be exempt (because these amounts fall within Fourth Schedule pay-as-you-earn withholding).

3. Obligation to withhold and declaration for exemption or reduction

Persons potentially subject to withholding can be relieved of their withholding liability only if these payors receive a declaration of exemption/treaty relief from the payee. This declaration must be submitted by the earlier of the date set by the payor or the date of payment.

4. Payment and recovery of tax

Payment to SARS of withholding tax on service fees must be made at the close of the month following the month in which service fees are paid.

5. Refund mechanism

The foreign payee may claim a refund from SARS if a withholding tax on fees is improperly withheld. The foreign payee may claim a refund if the refund claim is made to SARS within three years after payment of the applicable service fees.

6. Currency translation rules

If the payment of service fees is denominated in a foreign currency, the currency must be converted to the South African Rand at the spot rate on the date of withholding.

B. Permanent establishment exemption

Both the pending interest withholding regime and the pending royalty regime exempt payments to foreign persons from withholding tax if those foreign persons have a South African permanent establishment. This exemption will also apply in the case of the proposed withholding tax on cross-border services. This exemption exists because the South African permanent establishment is subject to normal tax (i.e. 28 per cent of taxable income).

However, the permanent establishment exemption will be adjusted in the case of all three withholding taxes. The exemption will apply only if the payment is “effectively connected with”

the permanent establishment (because only this income is subject to the normal tax). The mere existence of a permanent establishment will not generate an exemption for wholly unrelated income. An explanation of the term ‘effectively connected’ is provided in the OECD Commentary on paragraphs 4 of Article 10 on dividends, 4 of Article 11 on Interest and 3 of Article 12 on Royalties. The “effectively connected” concept should be understood in the same context.

In addition, for the permanent establishment exemption to apply, the foreign payee must provide proof of SARS registration as a taxpayer. Without this proof, the payor must still withhold and no refund of withholding tax is possible. This proof requirement ensures that foreign persons can no longer escape the ambit of legally required withholding taxes and the normal tax in the case of South African source interest, royalties or services fees.

C. Royalty withholding tax

The royalty withholding tax that is currently contained in the Income Tax Act will continue to apply, however at a reduced rate of 12%. The increased rate of 15% will come into effect with the introduction of the new withholding tax on royalties.

IV. Effective Date

The proposed amendment will be effective for interest that is paid or payable on or after 1 January 2015. The proposed amendment will be effective for service fees paid or payable on or after 1 January 2016. The proposed amendment will be effective for royalties that are paid or payable on or after 1 July 2013. The effective date rules also contain anti-avoidance mechanisms to prevent artificial accelerations of incurrals before the effective date so as to otherwise avoid the new withholding regimes.

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