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South African Firms Face Potential Foreign Taxation Minefield

by Robert Lee,, London

29 June 2005

Despite the existence of a number of double taxation avoidance treaties, South African companies planning to invest in Africa may still face considerable costs in terms of tax which could seriously erode a firm's bottom line, warns accounting firm Ernst & Young.

Since 1994, South Africa remains the biggest contributor of foreign direct investment (FDI) in the sub-Saharan region. The easing of conflict and the liberalisation of economies has gone some way towards increasing investor appetite, with the retail, banking and energy sectors among the prominent players in the region.

Charles MacKenzie, international tax partner at Ernst & Young, notes that even though South Africa has entered into double taxation agreements and treaties with a number of countries, foreign income earned by a South African resident is often taxed in both South Africa and the foreign country concerned.

This stems largely from South Africa’s residence based system of taxation.

The tax treaties make provision for the allocation of the primary right to tax to the country where the income is sourced and grants relief in the resident country by either exempting the income or crediting the foreign tax paid against the South African tax charge.

“However, in a situation where a South African resident earns foreign income from a non-treaty country and the income has its source (true or deemed) in South Africa, the South African resident may well pay double tax on the foreign income since section 6quat will not provide relief for any tax paid,” says MacKenzie.

A common example of such income, MacKenzie explains, is management fees paid by a non-resident for services rendered in South Africa which are subject to withholding tax in the foreign country concerned.

“The question often asked is whether the South African resident has to accept that such double taxation is part of the cost of doing business in non-treaty countries? Depending on the circumstances, the foreign tax may be a cost incurred in the production of income and hence deductible in the determination of taxable income, thereby providing a certain level of relief from double taxation," he noted.

MacKenzie points out that South Africa also has a domestic relief provision, in section 6quat, which permits the deduction of foreign taxes against South African tax payable in specific circumstances.

“Relief in terms of section 6quat is however, limited to foreign income which does not have its source in South Africa,” observes MacKenzie.

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