Tax (joint ventures) Q&A: South Africa
Authors: Riëtte Engels-van Zyl – Director & Marissa Wessels – Associate
Country Q&A | Law stated as at 31-Mar-2020 | South Africa
This Q&A provides country-specific commentary on Practice note, Tax (joint ventures): Cross-border, and forms part of Cross-border joint ventures.
1. Are partnerships tax transparent in your jurisdiction? What taxes might arise on the initial transfer of businesses from the joint venture partners to the joint venture entity, in case the latter is set up as a partnership? Are reliefs potentially available?
Yes, a partnership is not a separate legal person or taxpayer and each partner is taxed on the respective share of the partnership profits at their applicable tax rates.
For value-added tax purposes, an exception is made that allows a partnership to apply to be registered as a vendor despite the fact that a partnership is not a legal person.
When a partner introduces an asset to the partnership, this triggers a part-disposal of a portion of that partner's interest in the asset, while the other partners acquire a corresponding interest in the part disposed of. There are no reliefs available.
2. Can losses of a foreign partnership be offset against the profits of a corporate partner that is tax resident in your country?
Yes, subject to the relevant domestic tax legislation limitations that may be imposed on claiming any loss or deduction.
3. Do partnerships that are tax resident in your country generally receive similar benefits to companies under double tax treaties?
This depends on whether the specific double tax treaty recognises a partnership as a person for the purposes of that double tax treaty. In certain cases, partnerships are specifically excluded from the application of the double tax treaty and therefore, no benefits will be available.
4. Does your country have rules that restrict the proportion of a company's capital that is comprised of loans by affiliates (thin capitalisation rules)? If so, please explain in what circumstances these rules apply and whether they can be circumvented.
Yes, under South Africa's thin capitalisation rules contained in the Income Tax Act 58 of 1962 (Income Tax Act), financial assistance transactions are subject to the arm's length principle. To the extent that the financial assistance (in terms of the amount of the debt and/or the interest rate) is not arm's length, a primary transfer pricing adjustment, in the form of treating the transaction as if concluded between parties dealing at arm's length, and secondary adjustment, in the form of a deemed dividend, applies.
The South African Revenue Service requires taxpayers to consider the transaction from the perspective of the lender and the borrower:
From the lender, whether the amount could have been borrowed at arm's length.
From the borrower, whether the amount would have been borrowed at arm's length.
The international arm's length principle of the Organisation for Economic Co-operation and Development (OECD) also applies to all cross-border transactions between connected persons or, with effect from 1 January 2021, associated enterprises. Under this principle, the conditions made or imposed between connected persons and (with effect from 1 January 2020) associated enterprises in their commercial or financial relations must not differ from those that would be made between independent persons engaging in similar transactions under similar circumstances.
Under the current transfer pricing legislation, there must be a relationship between the parties and this arises where the parties fall within the ambit of the definition of “connected person” as defined in section 31 of the Income Tax Act. It has long being recognised in South Africa that the definition of “connected person”, mainly in respect of
companies, is much more restrictive when compared to the OECD definition of "associated enterprises" under Article 9 of the OECD Model Tax Convention (MTC) and referenced in the OECD Guidelines.
Concerns relating to the “connected person” definition primarily include its over-reliance on shareholding (which is akin to “participation in the capital” under the OECD’s definition of associated enterprises), whereas the OECD’s definition of “associated enterprises” comprises, in addition to the foregoing, participation in the control and management of an enterprise.
The extended scope of South African transfer pricing legislation that will also include “associated enterprises”, will necessitate a test in each instance on whether there is an “affiliation”. In particular, it must be determined whether one legal party that is connected to another is exercising control over the other party, which is the underlying concept of affiliation in terms of the definition of an “associated enterprise” which, from a transfer pricing perspective, is an important determination in considering whether prices between parties are being or could be influenced.
Certain penalties and interest could also be levied by the South African Revenue Service should the South African Revenue Service be of the view, in a notification to a taxpayer that, there is a contravention of the provisions of transfer pricing legislation.
5. If a company that is tax resident in your country transfers assets (including shares) to a company that is tax resident in another country, what taxes might arise? Are reliefs potentially available? (Please distinguish, if relevant, between assets that are located in your country and assets located in a foreign country.)
South African residents are taxed on their worldwide income. Accordingly, for a tax resident company there is no distinction between transferring assets in South Africa or in a foreign country. That company must account for the relevant tax in South Africa, subject to any relief that may be available for any taxes paid in any foreign jurisdiction.
The taxes that may arise depend on whether the particular assets are held as either:
Trading stock (where the receipt is subject to corporate income tax).
Capital assets (where the receipt is subject to capital gains tax).
Relief can potentially be available where shares are held in non-resident companies and the percentage shareholding exceeds 10%.
6. Is any tax or duty payable on the issue of shares by a company that is incorporated in your jurisdiction?
No, there is a specific exemption from any capital gains tax or securities transfer tax on the part of the company issuing the shares.
7. What rate of tax do companies pay in your jurisdiction and how is it assessed?
The current applicable rate for income tax for domestic companies and branches is 28%. Capital gains are currently taxed at an effective rate of 22.4% (calculated by multiplying the corporate income tax rate of 28% by the capital gains tax inclusion rate for companies of 80%).
Tax is assessed on an annual basis against the submission of applicable completed returns to the South African Revenue Service.
8. Can losses of a company that is tax resident in your country be surrendered for tax purposes to another company? If so, what conditions apply? Can losses be carried forward for tax purposes?
No, losses of one company cannot be transferred to another company.
Assessed losses within a company can be carried forward for tax purposes subject to the relevant company continuing to conduct a trade.
Although not yet enacted, it has been proposed by the South African National Treasury that, commencing on or after 1 January 2021, the offset of assessed losses that have been carried forward be restricted to 80% of a company’s taxable income for a specific year of assessment.
9. Are interest payments tax deductible in your jurisdiction?
Yes, subject to the interest payments being made in the production of income in the course and furtherance of conducting a trade. In the case of any interest payments made to non-resident shareholders, the interest rate should be agreed at an arm's length rate in compliance with South Africa's transfer pricing and thin capitalisation rules contained in the Income Tax Act.
10. Are withholding taxes applied to dividends, interest and/or other payments made by a company that is tax resident in your country to a foreign company? If so, what rates apply? Can they be reduced or eliminated in any circumstances?
Yes, the following withholding taxes are applicable:
The withholding tax rates can be reduced or eliminated having regard to the provisions of any applicable double tax treaty and subject to completion and submission of the relevant documents to the South African Revenue Service.
11. What is the tax treatment of dividends paid by a company that is tax resident in your country to a corporate shareholder (domestic or foreign)?
In the case of dividends paid by a resident company to a corporate resident shareholder, there is an exemption from the payment of any dividends tax.
Where dividends are paid by a resident company to a non-resident shareholder, then dividends tax will be levied at a rate of 20%, subject to any reduction or elimination in terms of the applicable double tax treaty.
12. What is the tax treatment of dividends received by a company that is tax resident in your country from a foreign company?
The dividends may qualify for full exemption from tax, depending on, among other issues:
The percentage shareholding held in the foreign company.
Whether the share is a listed share.
The nature of the distribution.
If the qualifying criteria for full exemption are not satisfied, then a formula is applied to exempt a portion of the foreign dividend from tax. Under the formula, the exempt portion of the foreign dividend is calculated by multiplying the aggregate amount of the foreign dividends received by a prescribed ratio. The ratio differs depending on whether the taxpayer is, for example, an individual or a company.
13. Are there any circumstances in which (undistributed) profits of a company in a foreign country can be imputed to a corporate shareholder in your country by tax authorities (controlled foreign company rules)?
Yes, the net income of a controlled foreign company may be imputed to South African residents holding more than 50% of the total participation rights or more than 50% of the voting rights in that foreign company (subject to relevant domestic tax legislation limitations).
14. Does your country have transfer pricing rules? If so, please explain broadly how they apply?
Yes, see Question 4.
15. What is the taxation treatment of below market rate loans made to the joint venture by its shareholders? Is any of the foregone interest imputed as income to the lender(s)? Will a zero rate loan be treated as a gift?
Ordinarily, in the case of a South African incorporated joint venture, the shareholders can advance interest free loans without any imputation of income to the lender or it being treated as a gift.
Riëtte Engels-van Zyl
Director, Corporate Commercial & Tax Advisory
Reproduced from Practical Law with the permission of the publishers. For further information, visit www.practicallaw.com
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