Foreign tax credits: Sars's new rules
19 July 2011
Posted by: SAIT Technical
Johan van der Walt
Since the introduction of residence-based taxation, SA residents are taxed on their world-wide income. In respect of tax paid overseas (on income from abroad), SA residents are eligible for tax credits. Non-residents are only taxed on income derived from sources within SA, alternatively deemed to be within SA. There is no exhaustive definition in the Income Tax Act (the Act) of the concept "source within the Republic" - hence the source of income then has to be determined with reference to the common law (eg, see CIR v Lever Brothers & Unilever LTD (1946 AD).
The Act, however, does provide specifically that certain receipts or accruals will be deemed to be from a source within SA, irrespective of the actual source of such income.
Section 9 of the Act deals with the various items of income that are deemed to be from a source within the Republic. These deeming rules thus create deemed SA sourced income (in addition to SA source income under the common law) and cover e.g. interest, royalties, and capital gains (amongst others).
Under the draft Taxation Laws Amendment Bill, 2011, (the TLAB) out for comment at the moment, the current section 9 will be substituted in its entirety by a new section 9. According to the Explanatory Memorandum, the reason for this is that the current source rules give rise to uncertainty, thereby imposing additional costs in respect of cross-border activities with little or no benefit to the fiscus. The uncertainty apparently arises due to differing interpretations regarding the applicability of the common law.
Furthermore, the statutory regime relating to source is scattered throughout the Act. All of this ultimately makes SA a less attractive regional holding company destination from a tax perspective.
The TLAB therefore, in order to remedy the above-mentioned deficiencies, proposes a new uniform dispensation relating to "source". The new dispensation will be an amalgamation of the common law, pre-existing statutory law and tax treaty principles.
The uniform source rules will largely take as point of departure tax treaty principles so that the SA system is globally aligned. The common law remains as a residual method to determine source in respect of undefined categories of income. Hence the concept of deemed source will be eliminated going forward.
The source categories to be covered in the new proposed section 9 are as follows:
Dividends - The intention is that the source of dividends would be determined using OECD principles and dividends from domestic resident companies and will be viewed as SA sourced. "Foreign dividend" (as defined) will solely cover dividends from foreign resident companies and will be regarded as foreign sourced. The "share register" concept disappears completely.
Interest - The source of interest will require a two-part test, namely 1) the residence of the debtor paying interest, or 2) the place where the loan funds are utilised.
Royalties - Going forward, the source of royalties will, firstly, be based on the residence of the party making royalty payments, and, secondly, SA sourced royalties will exist if the royalties relate to the use, right of use or grant of permission to use intellectual property within SA.
There will no longer be any focus on the party creating, devising or developing intellectual property and that, according to the Explanatory Memorandum, should remove the current disincentive to generate intellectual property within SA.
Private sector services - The TLAB proposal is that the test for determining the source of service income should focus solely on where the services are rendered. In addition, there will be newly legislated source rules that will create statutory allocation rules. Where services are rendered partly inside, and partly outside SA, the source for such services would be apportioned based on the time spent inside and outside of SA
Related annuities and pensions - The principles applicable to the source determination for service income will be equally applicable. Thus, where the underlying services are rendered in SA, the source of the associated annuities and pensioned would likewise be viewed as SA sourced.
Government services and associated annuities / pensions -
The current law will largely be retained. The source for services rendered to the various tiers of government will be deemed to be in SA, without regard to the location where such services are actually rendered.
Capital gains - The current deeming provisions relating to capital gains in respect of immovable and movable property are already in line with the OECD model tax treaty principles. Therefore, the current statutory source rules in respect of same will essentially remain.
Residual - Here the concept of "originating cause" (refer CIR v Lever Brothers above) will be incorporated into legislation as a residual category. This doctrine will thus remain the basis for determining the source of any residual item of income not
covered under the categories dealt with above (e.g. rental income, insurance premium and trading stock profits.
Foreign - Items of income that fall outside the SA sourced categories listed above will be explicitly treated as foreign source income.
As is currently the case, foreigners will not be subject to SA tax in respect of foreign source income and SA residents will continue be subject to tax on a world-wide basis with only foreign sourced income generally eligible for foreign tax credits.
The proposed amendment in the TLAB will apply to receipts and accruals in respect of years of assessment commencing on or after 1 January 2012.
Johan van der Walt, is a director of tax at Cliffe Dekker Hofmeyr