By Noxolo Ntombela (ENS Tax Ensight)
Executive summary (SAIT Technical)
The Draft Taxation Laws Amendment Bill proposed a number of amendments to section 9I of the Income Tax Act that deal with international headquarters companies. The purpose of the HQ company tax regime is to promote SA as the regional financial hub for Africa and to thus ensure that the existing tax system does not hinder the use of SA by foreign multinationals as the regional economic hub for investments in the continent. Current exemptions include exemptions from dividends tax on outbound dividends, income tax on inbound dividends and from the CFC attribution rules. It is, inter alia, proposed that the current transfer pricing rules be relaxed in respect of back to back licensing of intellectual property through the use of a HQ company.
A number of amendments are proposed in the Draft Taxation Laws Amendment Bill, 2012 (the "Draft TLAB”) to section 9I of the Income Tax Act No. 58 of 1962 ("the Act”) that deal with international headquarter companies ("the HQ Company”). The HQ company regime is intended to provide tax rules that promote South Africa ("SA”) as the regional financial hub for Africa. Consequently, the purpose of HQ Company tax regime is to ensure that the existing tax system does not hinder the use of South Africa by foreign multinationals as the regional economic hub for investments into Africa.
The current tax benefits enjoyed by HQ Companies include exemptions from dividends tax on outbound dividends; from income tax on inbound dividends; and from attribution rules applying to ‘controlled foreign companies’ under the provisions of section 9D. In addition, South Africa’s transfer pricing and thin capitalisation rules are generally waived on financial assistance provided by and to the HQ Company.
In order to qualify as a HQ Company, a resident company must meet certain criteria as set out in Section 9I of the Act. The requirements for an HQ Company are mainly that:
- each shareholder of the HQ company must hold at least 10% of the HQ’s equity shares;
- the company’s asset base must comprise at least 80% participation interests in foreign subsidiaries (that is, equity, loans and intellectual property); and
- if the income of the HQ exceeds R5 million per annum, at least 50% of the HQ company’s gross income must be derived from the aforementioned asset base.
The 10% shareholder test and the 80% asset test must be satisfied for the relevant year of assessment, as well as all prior years of assessment in which that company existed, that is, "the always qualification rule”. In contrast, the 50% gross income test needs to be satisfied only in respect of the relevant year of assessment. In addition the HQ company must file an annual election to become (and remain) a HQ company.
The proposed changes to the Draft TLAB aim to relax "the always qualification rule” to the extent that the company at issue is effectively dormant. As stated above, the 10% shareholder test and the 80 asset test must be satisfied not only for the relevant year of assessment but also for all prior years of assessment in which that company exists. Thus "the always qualification rule” creates practical difficulties in the case of certain start up operations. It is often not only practical, but also convenient to use "shelf-companies” previously in existence to start up business in SA. The use of shelf-companies therefore creates an impediment to benefiting from the HQ Company regime.
It is proposed that a company will qualify for the HQ Company benefits provided that:
- the company was not engaged in trade during any year of assessment; and
- the company must not have held assets in excess of R50,000 during any year of assessment.
These provisions will effectively ensure that the dormancy period(s) of a company does not prevent application of the HQ Company relief mechanism. This will certainly be welcomed by potential inbound investors wishing to establish a HQ Company in South Africa through the use of a shelf company. This aspect was emphasised at the recent National Treasury workshop (on the Draft TLAB) where it was stated that "start up relief should apply to new entities that do not trade for part of a year, as often a shelf company is acquired mid-year”.
Moreover, and in line with the intended policy premise of the HQ Company regime, it is proposed that the current transfer pricing rules be relaxed in respect of back to back licensing of intellectual property through the use of a HQ Company. The proposed rules in this regard will mimic the existing rules in respect of back-to-back loan interest.
More specifically this will result in:
- net losses created being ring-fenced; and
- exemption of withholding tax in respect of back to back royalties if the royalties are paid to a 10% or greater shareholder (the current HQ Company regime allows for the tax free flow through of dividends and interest, but not royalties).
Sections 20C (ring-fencing of interest and royalties incurred by HQ Company) and 31 (Transfer pricing rules) of the Act have been amended to coincide with the above amendments proposed to the HQ Company regime.
These amendments which will assist in making South Africa more competitive are to be welcomed.
This amendment will come into effect on 1 January 2013 and will apply in respect of any year of assessment commencing on or after that date.