The introduction of the new dividends tax has seen a number of consequential changes to various provisions of the Income Tax Act 58 of 1962 (“the Act”). The latest one, which doesn’t seem to have attracted much attention, is the introduction of the partial dividend exemption for foreign dividends.
Under the current provisions of the Act, dividends declared by a resident company are subject to secondary tax on companies (“STC”) at a rate of 10%, which is a tax borne by the company. The dividends tax regime, from 1 April 2012, will shift the tax liability for dividends paid to the beneficial owner of the dividend.
By contrast, foreign dividends are, as a general rule, included in a beneficial owner’s gross income and is concomitantly subject to tax at the marginal rate applicable (i.e. natural persons at 18% - 40%, companies at 28%, trusts at 40%) although, there are various exemptions to this general rule contained in section 10(1)(k)(ii) of the Act.
Therefore, on the introduction of the dividends tax, a taxpayer who receives both local and foreign dividends could be subject to two separate tax rates. In order to address this disparity between the tax rates applicable to local and foreign dividends, clause 32 of the 2011 Draft Taxation Laws Amendment Bill (“TLAB”) proposes the introduction of section 10B into the Act.
Under section 10B, the general rule that foreign dividends will be included in the gross income of the taxpayer remains intact. Furthermore, the previously taxed income exemption which is currently located in section 10(1)(k)(ii)(cc) and the participation exemption currently situated in section 10(1)(k)(ii)(dd) will also be available for qualifying dividends. However, the participation exemption under section 10B differs from the current provision in that a resident is only required to have a 10% holding in the foreign company declaring the dividend as opposed to the 20% threshold contained in section 10(1)(k)(ii)(dd).
The major change brought about by section 10B is the introduction of the partial exemption. The partial exemption is available for residual foreign dividends (i.e. those dividends that do not qualify for the exemptions listed above). Under the current regime these foreign dividends would be subject to tax at the marginal rate applicable to the taxpayer. However, under the proposed section 10B(3), the residual foreign dividend received will qualify for the partial exemption in the ratio 18:28 for companies and 30:40 for individuals and trusts, in other words the residual foreign dividends will only be subject to tax to a ratio of 10:28 and 10:40.
For example, if a taxpayer is liable for tax at a marginal rate of 40% and receives a dividend in the amount of R2 000 000 from a foreign company (which is not a controlled foreign company), the dividend will form part of the taxpayer’s gross income. However, as the dividend qualifies for the partial exemption to a ratio of 30:40, the taxpayer will only include an amount of R500 000 in his taxable income, which will be subject to a 40% marginal rate, thereby resulting in an effective tax on the foreign dividend of R200 000 or 10% of the total foreign dividend received.
However, it should be noted that like every good tax provision there are various exceptions to the relief outlined above, these will be contained in subsections 4 and 5 of section 10B.
Finally, a taxpayer will still qualify for the section 6quat rebate for direct foreign taxes paid in relation to the foreign dividend. However, the foreign dividend de minimis exemption of R3 700, available to natural persons, will no longer be applicable.