Deletion of the passive holding company regime
17 July 2012
Posted by: SAIT Technical
By Nicole Paulsen (DLA Cliffe Dekker Hofmeyr Tax Alert 13 July 2012)
With the abolition of secondary tax on companies, and the introduction of the new dividends tax regime, there existed an incentive for individual investors to hold dividend-producing shares (and other investments producing a 'passive income') in a company rather than in their personal capacities. The underlying rationale for shareholders to hold their dividend-producing shares in a company and not in their personal capacities was due to the fact that the new dividends tax regime created an arbitrage opportunity for the individual taxpayer. This is owing to the fact that dividends tax is (for the most part) not levied on the company but on the recipient shareholder. Resident companies receiving dividends are also exempt from dividends tax. Furthermore, the combined effective tax rates on corporate earnings were lower than the marginal rates applicable to the individual taxpayer.
This mechanism used by the individual taxpayer would eventually lead to the erosion of the tax base as the holding of dividend-producing shares in companies in essence constituted an avoidance of dividends tax to be levied on the individual. It is for this particular reason that the South African Revenue Service (SARS) proposed the passive holding company regime. The passive holding company regime was proposed as an anti-avoidance measure used to counter the arbitrage of income tax rates between individuals versus the combined effective tax rates on corporate earnings. In this regard, the combined effective tax rates on corporate earnings refer to the corporate income tax rate of 28% and the dividends tax.
However, at the time of proposing the passive holding company regime, it was anticipated that dividends withholding tax would be introduced at the rate of 10% and therefore the arbitrage opportunity for the individual taxpayer between the individual rates and the combined company rates appeared to be quite high. However, in terms of the 2012 budget, SARS increased the rate of tax under the dividends tax from 10% to 15%. This increase in the dividends tax rate substantially minimised the arbitrage opportunity between individual rates and combined company rates to the extent that the effective tax rates for company profits are now 38,8%, whereas the marginal rate of tax for the individual is 40%. What is important to note in this regard is that the combined company rates are very close to the individual tax rates and for this particular reason there is no longer an incentive for an individual to hold his dividend producing shares in a passive holding company. Therefore, with the introduction of dividends withholding tax at the rate of 15%, the necessity for the passive holding company regime has been nullified.
For the said reasons the proposed passive holding company regime is to be scrapped and will accordingly never come into effect.