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South African Budget Ushers In Dividends Tax Reform

By Editorial
March 6, 2012

Some important pre-announced changes, as well as some other proposals that have come as something of a surprise to taxpayers and tax experts alike, were announced by South African Finance Minister Pravin Gordhan in his 2012 Budget speech last month.

One of the most significant changes is the replacement of the Secondary Tax on Companies (STC) with a dividend tax. While the legislative framework for the dividend tax has been in place since 2009, the government has caused much uncertainty in the business community by subsequently refusing to pin down a date for the completion of the transition. Gordhan confirmed in the 2012 Budget however that the 10% STC will be replaced by the dividends tax on April 1, 2012, although at a rate of 15%, not the 10% rate that had been anticipated.

Something unique to South Africa, the STC, which was reduced from 12.5% to 10% in October 2007, is levied on the excess of dividends declared over dividends received and paid by companies resident in South Africa. Unusually, STC is imposed on companies or close corporations but not on shareholders. Branches of foreign companies are exempt from STC, but pay a higher ordinary corporate income tax rate. Foreign branches will, however, see a reduction in the branch tax rate as a result of these reforms, because they will be required to pay the new dividend tax instead of the existing branch remittance tax.

The new dividend tax brings South Africa more into line with international norms as, under the new system, the recipient of the dividend, not the company paying it, is liable for the tax relating to the dividend. The tax itself will be withheld at source by the company paying the dividend, or by a regulated intermediary, and then passed on to the South African Revenue Service.

The reasoning behind the conversion to a dividend tax is that it should make South Africa a more attractive international investment destination by eliminating the perception of a higher corporate tax rate, although it remains to be seen how the new system is received by investors in practice.

Other major changes, as detailed below, include the surprise announcement of an increase in the effective capital gains tax, moderate tax relief for small business corporations, the firming up of plans to introduce a carbon tax, modest personal income tax cuts, and a complete rethink on proposals to introduce a national tax on gambling operations. The government has also foreshadowed possible tax reforms to pay for the introduction of a publicly-funded health care system.

According to the National Treasury:

"The 2012 tax proposals support a sustainable fiscal framework over the medium term, while facilitating economic growth and a more competitive economy. Reforms will improve the fairness of the tax system, ensuring that income from capital is taxed more appropriately."

"Meeting South Africa's development challenges requires sufficient revenue to fund key expenditure priorities, while ensuring that public debt and debt-service costs are contained, and avoiding overburdening taxpayers. Government is taking steps to improve the efficiency of public expenditure and to root out corruption."

According to Gordhan, tax revenue recovered during 2010/11 and 2011/12, following the decline seen in 2009/10 during the global recession. It was, in fact, revised upwards for the 2011/12 year by ZAR2.9bn (USD375m) - to ZAR738.7bn - largely due to higher corporate income tax collections, and is expected to reach ZAR828.7bn in the next financial year. On that basis, revenue from tax would stabilize at about 25% of gross domestic product (GDP).

Total government revenue for 2012/13 is forecast at ZAR904.8bn, with expenditure at ZAR1.058 trillion, resulting in a budget deficit of 4.6% of GDP for the 2012/13 fiscal year (compared to 4.8% in 2011/12). However, Gordhan said the country's finances remain in good health, and pointed out that the deficit should be brought down to 4% and 3% of GDP in 2013/14 and 2014/15, respectively.

Annual public sector borrowing is therefore also expected to decline from 7.1% of GDP in 2011/12 to 5% in 2014/15; with total debt peaking at a total of 38.5% of GDP in 2014/15 - up from 36% in 2012/13.

The following is an outline of the major tax proposals affecting corporate and individual taxpayers:

Business Tax Measures

Turnover tax

Several reforms of the turnover tax for micro businesses (with annual turnover below ZAR1 million) were announced in 2011. Building on these reforms, micro businesses will be given the option of making payments for turnover tax, VAT and employees' tax at twice-yearly intervals from March 1, 2012. It is further envisaged that a single combined return will be filed on a twice-yearly basis from March 1, 2013. The number of returns required for these taxes will fall from about 18 per year to only two a year in 2013. The build-up of tax liability will require such taxpayers to ensure that funds are available when payment is due.

Introduced in 2009 to simplify tax for South Africa's smallest businesses, and thereby, it was hoped, increase rates of tax compliance among this group of taxpayers, the turnover tax is charged on a firm's revenue at the following scale (from March 1, 2011): 0% on the first ZAR150,000 of income; income between ZAR100,001 - ZAR300,000 is taxed at 1% of each ZAR1 above ZAR150,000; ZAR300,001 - ZAR500,000 at ZAR1,500 2% of the amount above ZAR300,000; ZAR500,001 - ZAR750,000 at ZAR5,00 4% of the amount above ZAR500,000; ZAR750,001 and above at ZAR15,500 6% of the amount above ZAR750,000.

Small Business Corporations

To encourage the growth of small incorporated businesses, the government proposes to increase the tax-free threshold for such firms from ZAR59,750 to ZAR63,556. Taxable income up to ZAR300,000 is taxed at 10%; this threshold is now increased to ZAR350,000 and the applicable rate reduced to 7%. For taxable income above R350,000, the normal corporate tax rate of 28% applies. These amendments will come into effect for years of assessment ending on or after April 1, 2012.

Limiting Excessive Debt

In the 2011 Budget, the government announced plans to restrict interest deductions associated with debt-funded intra-company transactions not conducted wholly for legitimate business purposes under section 45 of the Income Tax Act, with changes becoming effective from June 2011 in the case of intra-company transfers and August 2011 in the case of amalgamations and liquidations. The government intends to build on these changes by tackling the erroneous classification of certain instruments as "debt" to generate interest deductions for the debtor, when such instruments more accurately represent equity financing. To address these concerns, the government will enact a revised set of reclassification rules deeming certain debt to be equivalent to shares. In 2013 the government will also consider an "across-the-board" percentage ceiling on interest deductions, relative to earnings before interest and depreciation, to limit excessive debt financing.

The government is, however, proposing that the use of debt to directly acquire controlling share interests of at least 70% be allowed under Section 45, although the interest associated with this form of debt acquisition will be subject to the same controls as are applied to section 45 acquisitions.

Tax Incentives

New Legislation will introduce special economic zones, which will build on South Africa's current industrial development zone policy. The main aim is to improve governance, streamline procedures and provide more focused support to businesses operating within these zones. In support of this initiative, the following tax interventions will be explored:

  • A possible reduction in the headline corporate income tax rate for businesses within selected zones (as determined by the Minister of Finance after consultation with the Minister of Trade and Industry);
  • An income tax exemption for the operators of special economic zones; and
  • An additional deduction from taxable income for the employment of workers earning below a predetermined threshold.

In addition, to address a gap in the market for affordable housing for middle-income earners, a tax incentive for developers (and employers) to build new housing stock of at least five units for sale below ZAR300,000 per dwelling is under consideration. Options include either a tax credit or a deduction at either a fixed rand amount per unit or as a percentage of the value of the dwelling. This proposal will be refined after public consultation. Policy alignment with existing housing incentives and attempts to unblock regulatory bottlenecks will also be considered. The current tax hurdles associated with financial assistance given by employers to low-income workers to acquire a house will also be explored.

International Tax Proposals

Offshore reorganisations

In 2011, the government introduced rollover rules for some offshore reorganisations. The purpose was to give South African multinationals more flexibility when restructuring offshore subsidiaries, and to curtail the use of the offshore participation exemption to avoid tax. Now that steps have been taken to bring misuse of section 45 under control, government proposes to introduce an offshore section 45 provision. According to the government 'unbundlings' are being used to facilitate dual-linked structures that allow for foreign operations to be shifted outside South Africa's tax jurisdiction. Therefore, the participation exemption will be curtailed if the transaction indirectly strips value from a South African multinational.

Rationalisation of Withholding Taxes

International investors are subject to a final withholding tax when receiving royalties, at 12%, unless a tax treaty provides otherwise. They will also be subject to a final withholding tax on interest income as from 2013, subject to tax treaty exemptions. In the 2012 Budget, the government proposes to coordinate and streamline the procedures, rates and times for all of these withholding tax regimes, including the adoption of a uniform rate of 15%.

Environmental Measures

Carbon Tax

Following public consultation, government has revised the outline of its proposals for a carbon tax, and a draft policy paper will be published for comment in 2012. The proposed design features include:

  • Percentage-based rather than absolute emissions thresholds, below which the tax will not be payable;
  • A higher tax-free threshold for process emission, with consideration given to the limitations of the cement, iron and steel, aluminium and glass sectors to mitigate emissions over the near term;
  • Additional relief for trade-exposed sectors;
  • The use of offsets by companies to reduce their carbon tax liability; and
  • Phased implementation.

A carbon tax at ZAR120 per ton of CO2 equivalent above a basic tax-free threshold of 60% (with additional concession for process emissions and for trade-exposed sectors and a maximum offset of 5 to 10% until 2019/20) is proposed to take effect during 2013/14, with annual increases of 10% until 2019/20. Revenues from the tax will not be earmarked, but consideration will be given to spending to address environmental concerns. Incentives such as the proposed energy-efficiency tax incentive and measures to assist low-income households will be supported.

Electricity Levy

The electricity levy generated from non-renewable sources will be increased by 1c/kWh to 3.5c/kWh. The additional revenue will be used to fund energy-efficiency initiatives such as the solar water heater programme. This arrangement will replace the current funding mechanism that is incorporated into Eskom's (South Africa's electricity public utility) annual tariff application. According to the government, this will enhance transparency and enable government to use alternative agencies to deliver on energy efficiency initiatives. The government expects that the net impact on electricity tariffs should be neutral.

Gambling Tax Revision

The 2011 Budget proposed a withholding tax on gambling winnings above ZAR25,000. However, after broader consultation, a national gambling tax based on gross gambling revenue will be introduced. This tax, effective from April 1, 2013, will take the form of an additional 1% national levy on a uniform provincial gambling tax base. A similar tax base will be used to tax the national lottery.

Financial Transaction Tax Reform

South Africa has a financial transaction tax in place in the form of the securities transfer tax. This is a tax of 0.25% on purchases of shares, with an exemption for brokers who acquire shares for their own benefit. It is proposed that the current blanket exemption for brokers be abolished and broker transactions, where the beneficial ownership rests with the broker, be taxed at a lower rate. This reduced rate will also cover the purchase of shares utilised in support of derivative hedging. These amendments will come into effect on April 1, 2013. The government will also investigate the feasibility of including derivatives in the base of the securities transfer tax.

Taxation of Luxury Goods

From October 1, 2012, government proposes to subject the following items to ad valorem tax at the indicated rates:

  • Aeroplanes and helicopters with a mass exceeding 450kg but not 5,000kg at 7 %
  • Motorboats and sailboats longer than 10m at 10%.

Other Business Tax Measures

Removal of Foreign Branch Tax

Foreign companies with domestic income are subject to a 33% rate of tax, while domestic companies are subject to a 28% rate plus a 10% secondary tax. The additional 5% charge is seen as an additional charge because foreign companies do not pay STC. This charge will be dropped in light of the repeal of the secondary tax on domestic companies. It is presumed that the foreign company tax rate will be aligned with the domestic company rate at 28%.

Personal service providers are similarly subject to a 33% rate, which will also be reduced to 28%.

The government initially proposed a passive holding company regime to come into effect with the implementation of the dividend withholding tax to correct potential arbitrage between different tax rates. With the dividend withholding tax coming into effect at a 15% rate, these arbitration concerns are greatly reduced. Therefore, the passive holding company regime will be dropped.

Tax System Review for Insurers

The global insurance industry is undergoing reforms associated with solvency assessment and management projects. These rules will change the way insurers determine their reserves.

There are several related tax issues:

  • In the case of short-term insurers, certain reserves form the basis for tax deductions while providing a safety cushion for the insurers. To date, the regulatory and tax impact of these reserves has not been fully coordinated, leading to anomalies that have both positive and negative effects for short-term insurers. Captive insurers have also raised longstanding issues for the fiscus.
  • The principles of the four fund trustee system of taxation relating to long-term insurers has long been in need of review, Long-term insurers hold and administer assets on behalf of various categories of policyholders, in addition to managing assets for the benefit of shareholders. In recognition of these relationships, long-term insurance products are subject to the four funds system, with the insurer being taxed on return on assets as trustee for the policyholder. However, once the system moves beyond basic theory, it is often unclear whether issues should be determined from a policyholder perspective or a corporate shareholder perspective, and how the two perspectives can be combined. The system also lacks any correlation with the system of accounting, making factual verification and reconciliation difficult, if not impossible.

These concerns necessitate a comprehensive review of the tax system for insurers. To simplify the task, it is proposed that the tax system for calculating short-term insurance reserves be addressed in 2012, with long-term insurers being addressed in 2013. A short paper on long-term insurers will be circulated for comment by mid-2012.

Individual Tax Measures

Personal Income Tax Relief

Personal income tax brackets and rebates are adjusted to take account of inflation or "bracket creep", as well as provide limited real tax relief. The 2012 Budget proposes direct personal income tax relief to individuals amounting to ZAR9.5bn.

Implementation of Dividend Withholding Tax

As announced previously, the dividend withholding tax will come into effect on 1 April 2012, bringing an end to the secondary tax on companies. Pension funds that are exempt from income tax will receive their dividends tax free. For equity reasons it is proposed that the dividend withholding tax come into effect at 15% - five percentage points higher than the previous secondary tax on companies rate. However, there will be an estimated tax loss as a result of these changes of ZAR1.9bn.

Capital Gains Tax Increases

It is proposed in the 2012 Budget that the inclusion rate for individuals and special trusts for capital gains tax purposes (that is the amount of a capital gain that is included for tax purposes), will increase to 33.3%, meaning that the maximum effective capital gains tax rate increases from 10% to 13.3%. The inclusion rate for other entities (companies and other trusts) will increase to 66.6%, raising the effective rate for companies from 14.5% to 18.6% and for other trusts to 26.7%. These changes will come into effect for the disposal of assets from March 1, 2012.

To limit the impact of capital gains taxation on middle-income households, the exemption thresholds for individual capital gains and for primary residences will be adjusted significantly. The following exemptions for individual capital gains are increased from 1 March 2012:

  • The annual exclusion from ZAR20,000 to ZAR30,000
  • The exclusion amount on death from ZAR200,000 to ZAR300,000
  • The primary residence exclusion from ZAR1.5 million to ZAR2 million
  • The exclusion amount on the disposal of a small business when a person is over age 55 from ZAR900,000 to ZAR1.8 million
  • The maximum market value of assets allowed for a small business disposal for business owners over 55 years increases from ZAR5 million to ZAR10 million.

Medical Tax Credits

As announced in the 2011 Budget, income tax deductions for medical scheme contributions for taxpayers below 65 years will be converted into such credits. Monthly tax credits will be increased from ZAR216 to ZAR230 for the first two beneficiaries and from ZAR144 to ZAR154 for each additional beneficiary with effect from March 1, 2012. From that date onwards (apart from those with disabilities), where medical scheme contributions in excess of four times the total allowable tax credits plus out-of-pocket medical expenses combined exceed 7.5 % of taxable income, they can be claimed as a deduction against taxable income.

National health insurance is to be phased in over a 14-year period beginning in 2012/13. Over time, the new system will require funding over and above current budget allocations to public health. Funding options include an increase in the VAT rate, a payroll tax on employers, a surcharge on the taxable income of individuals, or some combination of the above. A discussion paper will be published by end-April 2012.

Savings Tax Breaks

To encourage greater savings among South Africans, tax-preferred savings and investment accounts are proposed as alternatives to the current tax-free interest-income caps. This will encourage a new generation of savings products. Returns generated within these savings and investment vehicles (including interest, capital gains and dividends) and withdrawals will be tax exempt. Aggregate annual contributions could be limited to ZAR30,000 per year per taxpayer, with a lifetime limit of ZAR500,000, to ensure that high net-worth individuals do not benefit disproportionately.

Retirement Reforms

To encourage South Africans to save for retirement, contributions by employees and employers to pension, provident and retirement funds will be tax deductible by individual employees. Individual taxpayer deductions will be set at 22.5 and 27.5%, for those below 45 years and 45 and above respectively, of the higher of employment or taxable income. Annual deductions will be limited to ZAR250,000 and ZAR300,000 for taxpayers below 45 years and 45 and above respectively. A minimum monetary threshold of ZAR20,000 will apply to allow low-income earners to contribute in excess of the prescribed percentages. Non-deductible contributions (in excess of the thresholds) will be exempt from income tax if, on retirement, they are taken as either part of the lump sum or as annuity income. Measures to address some of the complexities of defined benefit pension schemes will be considered. These amendments will come into effect on March 1, 2014.


Tags: tax breaks | individual income tax | capital gains tax (CGT) | corporation tax | gambling tax | carbon tax | offshore | withholding tax | tax incentives | budget | tax | dividends | South Africa



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