South Africa issues Budget 2015

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1 27 February 2015 EY Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date South Africa issues Budget 2015 A review of international tax aspects we are also taking further steps to combat financial leakages which deprive our economy of billions of rands through erosion of the tax base, profit shifting and illicit money flows. Nhlanhla Nene, Minister of Finance On 25 February 2015, the South African Minister of Finance delivered the budget speech for the 2015/16 fiscal year in Parliament. This Alert summarizes the key international tax aspects of the Budget. Transfer pricing documentation In recent years, the South African Government has taken measures to limit artificial reductions of taxable income through cross-border interest payments. Building on these steps, the Budget proposes amendments to improve transfer pricing documentation and reporting, and to change the rules for controlled foreign companies and the digital economy. Currently, the law in South Africa does not require a taxpayer to have transfer pricing documentation in place (it is currently advisable but not compulsory), but this may change. This is in line with the latest Draft Davis Tax Committee report 1 on the same subject which highlighted that South Africa should adopt rules requiring large multinational enterprises (MNEs) to disclose their transfer pricing in a masterfile, local file and country-by-country report, as recommended by the Organisation for Economic Cooperation and Development (OECD), for businesses with more than R1bn of group turnover. Tightening of the CFC rules The current controlled foreign company (CFC) rules mainly target passive income and what is commonly referred to as diversionary income. Diversionary income includes income derived from transactions between a CFC and a resident. Currently, there

2 are two sets of diversionary rules, i.e., imported services (where a resident imports services from a CFC) and imported goods (where goods are imported by a resident from a connected party CFC). Subject to certain exceptions, amounts payable in respect of diversionary transactions are attributable and taxable in the hands of the resident. This serves as a backstop to the arms-length transfer pricing principles, which the authorities have had difficulty in applying. The budget speech proposes to reintroduce another set of diversionary rules on the sale of goods by a CFC where the goods or tangible intermediary input were previously sourced from a connected party resident. The proposed new rules will apply in addition to the existing transfer pricing rules. Another set of rules that was previously abandoned without even making it to the income tax legislation are the rules around the control element in determining CFC status. It is argued that certain parties seek to undermine the CFC regime by interposing discretionary foreign trusts with group companies as beneficiaries. The proposed changes will seek to close this loophole. Capital gains tax (CGT) implications on cross-issue of shares In 2013, an anti-corporate migration rule was introduced in terms of which the cross issue of shares between a South African entity and a foreign entity were taxable on the full market value of the shares issued by the South African entity. The amendment came into effect on 1 April 2014 and applies to shares issued on or after that date. This new rule curtailed legitimate transactions involving local equity raising for the purposes of making a foreign acquisition and discouraged the use of South Africa as a Gateway to Africa. The 2015 Budget proposes to reconsider this rule. Repeal of foreign tax credit on local sourced service income In 2012, a special foreign tax credit was introduced for foreign taxes paid on services rendered in South Africa. The credit mainly served as cash flow relief in that mostly it would apply where a foreign country incorrectly applied a tax treaty and pending the resolution of the issue by the relevant competent authorities of the two countries. The Budget proposes to withdraw this relief on the basis that it effectively erodes the South African tax base. Refinements to withholding tax on service fees On 1 January 2016, South Africa will introduce a withholding tax on service fees at a rate of 15%. The budget proposes to make amendments to the provisions of this tax in order to clarify the application of the services withholding tax. Although, the exact changes to be undertaken have not been set out in detail, it is anticipated that these will include clarification on the meaning of the covered service fees and circumstances in which such fees can be regarded as sourced in South Africa. Adjustment to the withholding tax on interest On 1 March 2015, South Africa will introduce a withholding tax on interest at a rate of 15%. However, there is no specific definition of interest; meaning that the common law meaning would apply. It is proposed that a tailored definition of interest be introduced. Potentially, this will be in line with the meaning of the term for purposes of Article 11 of the OECD Model Tax Convention. An additional proposed amendment is for the realignment of the income tax source rules and the withholding tax on interest exemption. As a general matter, interest paid to a nonresident is subject to income tax or withholding tax on interest, with the two taxes applicable in the alternative. The income tax trigger is source, i.e., where the credit facility is used or applied in South Africa or the interest is incurred by a resident. The withholding tax on interest also applies to interest sourced in South Africa, subject to exemption if a nonresident payee is present in South Africa for more than 183 days or has a permanent establishment in South Africa. The assumption in respect of these exemptions is that the nonresident payee in this context will be subject to income tax. The proposed adjustments seek to align the source rules and the exemption from withholding tax on interest in the context of interest paid by a nonresident to another nonresident with a connection to South Africa. 2

3 Withholding on disposal of immovable property by nonresidents A purchaser of immovable property located in South Africa from a nonresident seller is required to withhold an advance income tax from the purchase price and pay it over to the Revenue authority. In terms of the current provisions the purchaser does not need to withhold tax in respect of any deposit paid until the agreement for that disposal has been entered into. This has caused uncertainty as to when the withholding of the tax must take place. In order to eliminate this uncertainty it is suggested that the wording of the provision be amended to clearly define the time of withholding. Nonresident CGT on immovable property Nonresidents are subject to CGT in South Africa on the immovable property situated in the Republic or an interest in such immovable property. The term immovable property is not defined; thus one has to look to the general legal definition of the term. This seemingly created uncertainty in the context of transfer of ancillary aspects such as a right to work, mineral deposits, and natural resources. Therefore, the concept of immovable property will be refined to provide certainty. Potentially, the new definition will be based on Article 6 of the Model Tax Convention. Endnote 1. See EY, South Africa s Davis Tax Review Committee issues report on BEPS, dated 16 January

4 For additional information with respect to this Alert, please contact the following: Ernst & Young Advisory Services (Pty) Ltd., Johannesburg Justin Liebenberg Rendani Neluvhalani Ide Louw Michael Hewson Charles Makola Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London Leon Steenkamp Gonçalo Dorotea Cevada Ernst & Young LLP, Pan African Tax Desk, New York Dele A. Olaogun Mzukisi Ndzipo

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