Double Taxation Agreement Between South Africa And Mauritius
10 October 2013
Posted by: Author: Norma Church
Author: Norma Church (Grant Thornton)
On 17 May 2013, the governments of South Africa (SA) and Mauritius signed a new double taxation agreement (new DTA) following indications from both SARS and National Treasury that the existing DTA is being abused, leading to the erosion of the tax base. If the agreement is ratified by both countries, the new DTA is anticipated to come into effect from 1 January 2015. Considering this motivation for introducing a new DTA, it comes as no surprise that the new DTA introduces many changes that will affect those using Mauritian companies for investment by non-residents into South Africa, or for foreign investment by South Africans.
One of the most notable changes in the new DTA is that it introduces a new tiebreaker test to determine a person’s (other than a natural person, for example a company or trust) tax residency. According to the existing DTA, where a person is regarded as resident of both SA and Mauritius, based on the application of these countries’ domestic laws, the ultimate residency of that person is determined by applying the "place of effective management” test.
This test will be replaced in the new DTA, with a discretionary regime, which requires SA and Mauritian tax authorities to agree, by means of bilateral negotiations, on the residence of the person. However, this process, referred to as the Competent Authority Procedure (CAP), has historically proven to be cumbersome and therefore not recommended by the Organisation for Economic Co-operation and Development (OECD).
Should SA and Mauritius fail to reach agreement on a person’s residency, the person will not be entitled to rely on the new DTA for double tax relief and will be subject to taxation in both countries, according to their respective domestic tax laws. Although at first glance this seems onerous, one should bear in mind that a taxpayer in SA will receive a foreign tax credit for any tax paid in Mauritius on the same profit and hence ‘double tax’ is unlikely to ever arise.
A company incorporated in Mauritius, and therefore resident in Mauritius under domestic law, will only be regarded as resident in SA if it were effectively managed in SA. In such cases, the CAP would apply in determining the company’s ultimate residency. However, if the company is not effectively managed in SA, SARS would have no grounds to regard the company as resident in SA and therefore the CAP would not apply.
Therefore, this new tiebreaker test highlights the importance for companies wishing to be treated as Mauritian residents, to ensure that they are not effectively managed in SA. This is not a new issue, as significant tax risk already exists, where a SA company resident in Mauritius is unable to prove that its top-level operational and strategic management occurs outside SA. Therefore, companies should review their existing international structures; and specifically those relying on Mauritian tax residency, to verify that the place of effective management is not SA. It is important to note that SA looks at day-to-day senior management, and not necessarily the location where board members make strategic decisions, when determining the location of effective management. This approach is contradictory to OECD principles and is currently being revisited by SA in a discussion paper on Interpretation Note 6: Place of Effective Management circulated by SARS.
Capital Gains Tax and Immovable Property
The new DTA introduces another significant change, whereby a contracting state may tax a capital gain arising from the disposal of shares, which derives more than 50% of their value directly or indirectly from immovable property situated within that contracting state.
As Mauritius doesn’t tax capital gains, this amendment is actually relevant to SA. In terms of the existing DTA, if a Mauritian resident disposed of shares in a property rich company, and this property is located in SA (SA property rich companies), the Mauritian resident will not be subject to capital gains tax (CGT). However, with the introduction of this amendment, non-residents investing in South African property via a Mauritian structure will in future be liable for CGT when they sell their shares in the SA property rich companies. This will affect foreign investment via Mauritius into SA’s mining and property sectors as it will no longer be tax efficient to use a Mauritian holding company to hold shares in SA mining or real estate companies, once the new DTA is in force.
Finally, despite the 50% asset test in the new DTA, it is important to note that in terms of SA domestic law, a non-resident, holding shares in a SA property rich company will only be subject to CGT if:
- 80% or more of the value of those shares is attributable to immovable property located within SA, and
- the non-resident holds at least 20% of the shares in that company.
Withholding Taxes Interest
in the recipient’s country of residence, if the recipient is the beneficial owner of that interest. i.e. a Mauritian lender, who is the beneficial owner of the interest, is not subject to SA withholding tax. When the new DTA is introduced, this exemption will no longer apply and instead SA may then impose a withholding tax on interest, limited to 10% of such interest. This is particularly relevant considering the pending introduction of a withholding tax on interest in SA from 1 January 2015. Mauritius does not currently impose a withholding tax on interest paid by Category 1 (GBL1) and Category 2 (GBL2) Global Business License companies.
While royalties are currently exempt from withholding tax on royalties, the new DTA will introduce a 5% withholding tax.
In terms of the existing DTA, the withholding tax on dividends (DWT) is reduced to 5%, if the beneficial owner is a company holding at least 10% of the dividend paying company’s capital. In all other instances, DWT may not exceed 15%. When the new DTA is adopted, the DWT rate of 5% will remain unchanged for companies holding 10% of the dividend paying company’s capital. However, the DWT on distributions to any beneficial owner, regardless of its legal structure, that holds less than 10% of the dividend paying company’s capital, will be decreased from 15% to 10%.
Two further inclusions in the definition of "permanent establishment” have widened the net for the taxation of sourced-based profits.
Briefly, these two inclusions are:
- the furnishing of services by an enterprise through employees or other personnel; and
- the performance of professional services or other activities of an independent character by an individual,
This applies where these services/ activities continue within a contracting state (i.e. either Mauritius or SA) for a period exceeding, in aggregate, 183 days in any 12-month period commencing or ending in the fiscal year concerned.
Conclusion: How does this affect Mauritian Structures?
The new DTA favours SA, but Mauritian companies will generally be disadvantaged compared to the existing DTA. In particular, dual resident Mauritian companies, Mauritian companies extending interest-bearing debt to SA persons and Mauritian companies that own shares in SA property rich companies, are affected.
However, while the new DTA has been signed, it has not been ratified and may still be subject to amendment. It is our understanding that the new DTA has caused concern amongst Mauritian institutions, investors and advisers, resulting in a delegation of senior industry figures meeting with the responsible Mauritian officials to propose the introduction of a protocol to achieve the following:
- Broaden the scope of the Most Favoured Nation clause (MFN), to include capital gains, interests and royalties. In effect, what needs to be ensured is that Mauritius, as a fellow SADC member, is not singled out for discriminatory treatment which will favour financial centres in other parts of the world;
- Include a grandfathering clause, to protect existing investments/ arrangements that were made in good faith under the 1996 treaty;
- Provide clarity regarding the exercise of the administrative discretion in the case of dual residents;
- Allow for a reasonable period of transition (e.g. five years), before new terms apply.
For now, there is uncertainty regarding the applicability and impact that the new DTA may have for Mauritian structures. However, the signing of this treaty should prompt business to proactively review their Mauritian structures and make changes where necessary, to prepare for and address the implications of the new DTA.
This article was first published in TaxTalk Magazine (September/October Edition 2013)