South African Budget Cuts Corporate Tax, Phases Out STC

by Robert Lee, Tax-News.com, London

22 February 2008

A 1% cut in corporate tax, and confirmation that the Secondary Tax on Companies (STC) will be replaced with a withholding tax on dividends were the key features of the 2008 South African government budget, announced by Finance Minister Trevor Manuel on the 20th February.

Manuel unveiled an overall package of R10.5 billion (USD1.35 billion) in net tax relief, including a cut in the headline corporate tax to 28% from 29%, anticipated by tax experts prior to the budget speech, and in line with general international trends.

However, perhaps the most significant measure announced by Manuel impacting on business was the second phase of reforms to STC, which has often been cited by observers as a major hurdle to foreign investment. This will culminate in the introduction of a final withholding dividend tax at shareholder level in 2009.

In the first phase of the reform process, the rate of STC was reduced from 12.5% to 10% with effect from 1 October 2007. This reduction was coupled with a broadening of the tax base through the closing of commonly exploited loopholes. A further broadening of the base is planned for 2008.

The second phase of reform entails the actual conversion of the STC into a dividend tax on shareholders. As stated in the 2007 Budget Review, the implementation of this second phase is contingent on the revision of international tax treaties that limit withholding tax on dividends to zero per cent.

The tax treaties in question are Australia, Cyprus, Ireland, Kuwait, The Netherlands, Oman, Seychelles, Sweden and The United Kingdom. Most of these treaties have been renegotiated and are awaiting executive signatures and parliamentary ratification. It is anticipated that this phase will be completed by 2009.

According to Manuel, The new STC regime will follow the classical system of taxing distributed profits. As a general rule, shareholders will be subject to the new tax. The rate of the new tax will be 10%, as is currently the case for STC.

This dividend tax will be a separate final withholding tax, and dividends will not form part of shareholder income (the latter of which is taxable at marginal rates). As with the STC, the new tax will apply to distributions during the life of the company as well as in liquidation.

Non-corporate and non-resident shareholders will generally be subject to tax at a 10% rate on the full amount of dividends received. However, limited exemptions and deferrals from this withholding tax will be applied in the cases described below:

• Distributions to exempt entities – Company distributions to entities that are fully exempt from income tax will similarly be exempt from the new dividend tax. These entities notably include pension funds and Government. Entities that are partially subject to income tax will benefit from an exemption on dividends only if these entities are fully exempt in respect of investment (i.e. non-trading) income. Therefore, public benefit organisations will be exempt from dividend tax, but recreational clubs will be taxed on their dividends because clubs are only exempt from tax on investment income up to a monetary limit.
• Treaty relief – The dividend tax rate for non-resident shareholders may be limited if a tax treaty exists between South Africa and the shareholder’s country of residence. Depending on the proposed renegotiation of treaty rates, a 5% limit may apply.
• Intra-company dividends – As a general rule, underlying company profits should only be subject to one level of tax on distribution. This principle is critical when profits pass through two or more company levels. The STC system achieves this result in two ways. The first is by taxing the first company that declares the underlying profits as dividends while exempting subsequent dividends associated with these profits via the STC credit system. The second is by permitting an election that STC will not apply in the case of certain intra-group distributions. In a classical system, tax applies only on the last company level. The classical system achieves this result by exempting all inter-company dividends between resident companies (regardless of percentage shareholding) with the tax applying only at the level where dividends are declared to persons other than companies or to non-residents.

The net effect of these exemptions and deferrals will amount to an estimated loss to the fiscus of R6 billion in the first year.

To the extent that the new dividend tax applies, the company declaring the dividend will be required to withhold the tax upon declaration. This tax will be payable by the company to the South African Revenue Service (SARS).

Under transitional arrangements, it has been decided that STC credits accumulated prior to the implementation of the new system will be forfeited. However, given the delayed timing of the change, Manuel stated that taxpayers can still utilise STC credits in the interim.

The 2008 budget also modifies the tax regime for gold mining companies. Under the previous regime, gold mining firms could elect to pay a higher rate of income tax at 43%, instead of income tax at 34% with the STC applying when dividends are declared.

Under the new regime, The 43% option for the mining companies will be discontinued and the STC switches to a shareholder level. STC credits will also expire for gold mining companies when the new system goes into place.

Other important measures announced by Manuel included:

• Personal income tax relief for individuals amounting to R7.7 billion as a result of tax band revisions
• A simplified tax package for very small businesses with an annual turnover up to R1 million
• An increase in the compulsory VAT registration threshold from an annual turnover of R300 000 to R1 million
• Incentives to encourage venture capital equity investments in small and medium-sized businesses
• R5 billion in tax subsidies over the next three years to support the emerging industrial policy
• A review of learnership allowances to encourage apprenticeships
• Measures to encourage private land owners to protect biodiversity
• The introduction of an electricity levy of 2 cents per kilowatt hour.

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