In May 2010 draft legislation amending the general income tax exemption for interest earned by non- resident lenders from South African ("SA") resident borrowers was released by National Treasury for comment. As highlighted in a previous article, a number of issues were not adequately dealt with in the initial draft legislation.
It seems that the latest version of the proposed legislation contained in the Taxation Laws Amendment Bill, No. 28 of 2010 (the "TLAB") addresses some of these issues, for example collection of the tax and the unfair treatment for branches of foreign companies. It is expected that the TLAB will be promulgated in its current format shortly.
Once the proposed legislation becomes effective in January 2013, interest earned by a non-resident lender from a SA-resident borrower will continue to be deemed to be derived from a source in SA in terms of section 9(6) of the Income Tax Act, No. 58 of 1962 (the "ITA"). However, such interest may be subject to a withholding tax ("WHT").
The TLAB introduces a 10% WHT on interest which will apply to interest accruing to a non-resident (excluding controlled foreign companies ("CFC")) on or after 1 January 2013.
In terms of the proposed legislation, any person who makes payment of any amount of interest for the benefit of a non-resident (other than a CFC) must withhold an amount equal to 10% of that amount of interest from that payment. Such amount withheld must then be paid to the Commissioner for the South African Revenue Service (the "Commissioner") within 14 days after the end of the month during which the amount is withheld.
The 10% WHT will not apply to interest accruing to a non-resident lender in respect of, inter alia;
- any Government debt instrument held by the non-resident;
- any listed instrument held by the non-resident (the instrument can be listed in SA or outside of SA for the exemption to apply);
- any debt owed by any bank as defined in the Banks Act;
- any debt owed by the SA Reserve Bank;
- any debt owed by any other non-resident, unless that non-resident borrower is a natural person that is physically present in SA for more than 183 days in the relevant year of assessment or any person that during the relevant year of assessment carried on business in SA through a permanent establishment ("PE") in SA. This amendment deals with the previous preferential treatment for interest paid by a SA branch of a foreign company to a non-resident. ;
- certain interest payable by a headquarter company;
- interest earned on SA dealer and brokerage accounts;
- interest payable by SA collective investment schemes; and
- interest payable in respect of the purchase price of any goods imported or exported from SA and trade finance.
As is the case under current law, the above exemptions will not apply if the non-resident lender is a natural person that is physically present in SA for more than 183 days in the relevant year of assessment or any person that during the relevant year of assessment carried on business in SA through a PE.
The 10% WHT may be reduced in terms of an applicable double tax agreement ("DTA") concluded by the SA government. However, before the borrower is entitled to withhold the reduced amount in terms of an applicable DTA, the lender must submit a declaration to the borrower in the form prescribed by the Commissioner.
In terms of the interest articles of a number of DTAs concluded by SA, the interest WHT on interest paid by a SA resident borrower to a non-resident lender would be reduced to 0% provided, inter alia, that the non-resident recipient is tax resident in the relevant jurisdiction and the beneficial owner of the interest. This includes the DTAs with the Netherlands, Nigeria, Mauritius, Sweden, the United States of America (the "US") and the United Kingdom (the "UK"). The DTAs with the US and the UK contain limitation of benefits provisions which will make treaty shopping through these jurisdictions difficult. However, treaty shopping may be possible by interposing an intermediate lending company in a tax friendly jurisdiction which has negotiated a favourable DTA with SA.
National Treasury has therefore indicated that the SA government will again embark on a process of renegotiating DTAs with ‘so-called' low tax jurisdictions to limit the relief for interest WHT. It seems that these jurisdictions include Mauritius, Luxembourg, Cyprus, Hungary, the Netherlands, the Seychelles and Singapore. It is not clear whether the interest article of these DTAs will be amended so that some relief is available for the interest WHT or if the interest articles of the relevant DTAs will be amended in line with the Organisation for Economic Cooperation and Development's Model Tax Convention (the "OECD's MTC"). The majority of SA's DTAs are based on the OECD's MTC which limits the source state's right to tax interest income arising in the source state but paid to a resident of the other state to 10%, provided of course that the recipient is the beneficial owner of the interest. If the DTAs renegotiated follow the OECD's MTC, SA will effectively retain the right to impose the 10% WHT on interest paid and beneficially owned by residents in the so-called low tax jurisdictions.
As with the dividend WHT regime which was announced some five years ago, it is likely that the proposed legislation will be repeatedly amended before it becomes effective.