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Construction design drawings done by a foreign company: will the new WHT on services apply?

30 June 2015   (0 Comments)
Posted by: Author: SAIT Technical
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Author: SAIT Technical

Q: We shall be grateful for your assistance with a query concerning the new withholding tax on service fees which comes into effect in January 2016. It is in connection with the definition of "service fees” and exemptions thereof, which are a bit vague.

Our client is a company based in South Africa (a South African resident taxpayer) and:

a)       It is to construct certain plant in South Africa for one of its South African customers.

b)      It has constructed this plant many times before, but the customer requires it to be modified to suit its needs.

c)       The re-designed plans for constructing the plant will be drawn up and provided by a fellow subsidiary of our client based in Australia.

d)      This Australian company will also provide technical/engineering knowledge and support for the construction of the plant.

e)      Our South African client will pay the Australian company for the services described in (c) and (d) above.

f)        The plant will be constructed in South Africa and then delivered to the customer.

 Do the above "services” represent "service fees” as defined?

 

A: From the facts it is not clear if the services are to be rendered in the RSA.  It is commonly accepted that the source of services income is the place where the services are rendered.  If that is not in the RSA we don’t have a right to tax.  The payments to the fellow subsidiary of the client based in Australia will not be subject to the withholding tax if the source is not within the RSA.  Section 31 will apply if this is not at a market related value.  We accept that the Australian company doesn’t have a permanent establishment or fixed base in the RSA. 

The withholding tax on service fees is levied (calculated at the rate of 15%) on the amount of any service fee that is paid (on or after 1 January 2016) by any person to or for the benefit of any foreign person to the extent that the amount is regarded as having been received by or accrued to that foreign person from a source within the RSA. 

In terms of section 51A of the Income Tax Act ‘service fees’ means any amount that is received or accrues in respect of technical services, managerial services and consultancy services but does not include services incidental to the imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information, or the rendering of or the undertaking to render any assistance or service in connection with the application or utilisation of such knowledge or information. 

The Explanatory Memorandum states "… that … withholding taxes be extended to cross-border consultancy, management and technical fees. This new withholding tax will be a final withholding tax that will be used to identify and collect revenue from non-resident taxpayers who provide certain services within a South African source that fall outside the normal tax. More specifically, all payments for services to a foreign resident from a South African source will be subject to withholding tax if those services are of a technical, managerial or consultative nature. These services should be understood as being comparable to technical fees covered in the context of certain tax treaties. Less technical services (such as hair stylists, real estate commissions and the like) should not be viewed as falling within the withholding paradigm.”

"…the liability is limited solely to South African sourced amounts.” 

"…the permanent establishment exemption will be adjusted in the case of all three withholding taxes. The exemption will apply only if the payment is "effectively connected with” the permanent establishment (because only this income is subject to the normal tax). The mere existence of a permanent establishment will not generate an exemption for wholly unrelated income. An explanation of the term ‘effectively connected’ is provided in the OECD Commentary on paragraphs 4 of Article 10 on dividends, 4 of Article 11 on Interest and 3 of Article 12 on Royalties. The "effectively connected” concept should be understood in the same context.”

"In addition, for the permanent establishment exemption to apply, the foreign payee must provide proof of SARS registration as a taxpayer. Without this proof, the payor must still withhold and no refund of withholding tax is possible.”

The treaty (protocol) states the following with regard to royalties:

"The term "royalties” in this Article means payments or credits, whether periodical or not, and however described or computed, to the extent to which they are made as consideration for:

(a) the use of, or the right to use, any copyright, patent, design or model, plan, secret formula or process, trademark or other like property or right;

(b) the supply of scientific, technical, industrial or commercial knowledge or information;

(c) the supply of any assistance that is ancillary and subsidiary to, and is furnished as a means of enabling the application or enjoyment of, any such property or right as is mentioned in subparagraph (a) or any such knowledge or information as is mentioned in subparagraph (b);

(d) the use of, or the right to use:

(i) motion picture films;

(ii) films or audio or video tapes or disks, or any other means of image or sound reproduction or transmission for use in connection with television, radio or other broadcasting;

(e) the use of, or the right to use, some or all of the part of the radiofrequency spectrum as specified in a spectrum licence of a Contracting State, where the payment or credit arises in that State; or

(f) total or partial forbearance in respect of the use or supply of any property or right referred to in this paragraph.

4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated in the other State, or performs in that other State independent personal services from a fixed base situated in that other State, and the right or property in respect of which the royalties are paid or credited is effectively connected with that permanent establishment or fixed base. In such case the provisions of Article 7 or Article 14, as the case may be, shall apply.

5. Royalties shall be deemed to arise in a Contracting State when the payer is a resident of that State for the purposes of its tax. Where, however, the person paying the royalties, whether the person is a resident of a Contracting State or not, has in a Contracting State or outside both Contracting States a permanent establishment or fixed base in connection with which the liability to pay the royalties was incurred, and the royalties are borne by the permanent establishment or fixed base, then the royalties shall be deemed to arise in the State in which the permanent establishment or fixed base is situated.”

And the treaty (in Article 14)

"Independent Personal Services

1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that State unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities. If he has such a fixed base, the income may be taxed in the other State but only so much of it as is attributable to that fixed base.

2. The term "professional services" includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.”

Disclaimer: Nothing in this query and answer should be construed as constituting tax advice or a tax opinion. An expert should be consulted for advice based on the facts and circumstances of each transaction/case. Even though great care has been taken to ensure the accuracy of the answer, SAIT do not accept any responsibility for consequences of decisions taken based on this query and answer. It remains your own responsibility to consult the relevant primary resources when taking a decision.


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