The first draft of the Taxation Laws Amendment Bill, 2013 (the “Bill”) was published by National Treasury on 4 July 2013. Although the Bill proposes a number of interesting and complex issues, of particular interest is the amendment to the exit charge on interests in immovable property, especially in light of the recent amendments to the double tax treaty between South Africa and Mauritius, concluded on 17 May 2013.
South Africa taxes persons that are resident in South Africa on their worldwide income. This includes capital gains tax on the disposal of certain assets. Non-residents are subject to tax in South Africa on income from a source within South Africa.
Where a person ceases to be a resident, such event is a deemed disposal event in terms of which the person is deemed to have disposed of all its assets for market value on the day before ceasing to be a resident, and immediately reacquired the same assets at the same market value. The difference between the original cost of the assets (the base cost) and the market value of the assets on disposal is generally subject to capital gains tax (commonly referred to as the exit charge).
The exit charge, however, does not apply amongst others, to immovable property situated in South Africa or an ‘interest in immovable property’ as these assets will remain taxable under the source rules when the person becomes a non-resident. An ‘interest in immovable property’ refers to a direct or indirect shareholding of a minimum of 20% in a company or ownership or right of ownership in any other entity if more than 80% of the market value of that entity is attributable to South African immovable property held otherwise than as trading stock. These entities are commonly referred to as ‘immovable property rich entities’.
The interest in immovable property should be subject to capital gains tax in South Africa in future when disposed of by the now non-resident person, subject to double tax treaty relief. Depending on the relief provided in and the wording of the double tax treaty concluded between South Africa and the new residence jurisdiction of the non-resident, the disposal may ultimately not be subject to South Africa tax.
Generally, double tax treaties give the taxing rights on the disposal of immovable property to the jurisdiction where the immovable property is situated and the taxing rights on capital gains on movable property are given to the jurisdiction of where the owner of the movable property resides. Under the older tax treaties concluded with South Africa, an interest in immovable property is treated as a movable asset for South African purposes. This is because the term ‘immovable property’ is defined in the double tax treaty with reference to the law of the country in which the property is situated. No definition is currently provided for the term under the Income Tax Act 58 of 1962 (ITA) and South Africa’s common law definition of immovable property does not include an interest in immovable property. For this reason, certain treaties allow for the non-taxation of capital gains arising from the disposal of an interest in immovable property situated in South Africa. The result is that firstly, South Africa does not levy the exit tax upon cessation of a person’s residency and secondly, South Africa does not tax the person when they dispose of their interest in an immovable property rich entity. South Africa loses financially under both circumstances. It is this loophole which National Treasury proposes to close down.
The amendment proposed to section 9H of the ITA deletes the exclusion from the exit charge of an interest in an immovable property rich entity. With effect from 1 July 2013, a person ceasing to be a resident will therefore be deemed to have disposed of its assets, including an interest in an immovable property rich company at market value and re-acquired the assets at the same market value on the day before ceasing to be a resident.
The above proposed amendment aligns with SARS and National Treasury’s agenda to tax gains on the disposal of certain shares held in South African companies as seen in the newly amended double tax treaty between South Africa and Mauritius. The amended treaty now provides that the taxing rights on shares held by a Mauritian company in a South African company is conferred on South Africa, if the South African company derives more than 50% of its value from immovable property located in South Africa.
The proposed amendment and re-negotiation of the treaty with Mauritius indicates strongly that South Africa is serious about securing its taxing rights to gains derived from a South African source.