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Non-Residents Should be Cautious When Funding Private Equity or M&A Transactions in South Africa
South Africa has delayed the proposed reinstatement of withholding tax on interest, which was last seen two decades ago. The draft Taxation Laws Amendment Bill 2012, (Draft Bill) which was released for comment on 5 July 2012, proposes to amend various provisions of the South African Income Tax Act No 58 of 1962 (Act) relating to the taxation of South African sourced interest income in the hands of non-residents. These changes take place in the context of a general overhaul of the treatment of cross-border interest, royalty and dividend payments.
Most of these changes were scheduled to become operative with effect from 1 January 2013 but it appears now that the effective date of the interest withholding tax may move to 1 July 2013. Taxand South Africa provides a brief overview of the proposed changes relating to South African sourced interest income and will consider the impact the amendments may have in the hands of a foreign recipient of such interest income.
Foreign persons are subject to tax in South Africa on income sourced or deemed to be sourced in South Africa. As from tax years commencing after 1 January 2012, there is a statutory definition of "source."
An amount of interest received or accrued by a foreigner will be deemed to be from a source within South Africa if:
- The interest is attributable to interest incurred/paid by a debtor which is a tax resident in South Africa
- The interest relates to loans which are used or applied in South Africa.
Income tax implications
Non-residents earning South African sourced interest income must register as South African income taxpayers and furnish South African income tax returns. Furthermore, the interest income will be subject to income tax in the hands of such person, unless an exemption applies.
Currently the Act exempts from income tax any South African-sourced interest received by, or accrued to, a non-resident, provided such non-resident neither spent more than 183 days in aggregate in South Africa (where the non-resident is a natural person) nor carried on business through a permanent establishment in South Africa at any time during the relevant tax year.
The Draft Bill proposed to amend this exemption, so that any South African sourced interest received or accrued to a non-resident will be subject to income tax, unless the interest income is subject to the new withholding tax on interest. In terms of the Draft Bill, the amendment will apply to interest which is paid or becomes payable on or after 1 January 2013, although one might assume that the effective date of this amendment will be postponed until 1 July 2013, when the interest withholding tax becomes operative.
The basic principle is that if interest is subject to the interest withholding tax, it will be exempt from income tax. Conversely, if the interest is exempt from the interest withholding tax, such interest income will not be exempt from South African income tax. It remains to be seen how the final form of the legislation will deal with this interaction.
Withholding tax on interest
The rate of withholding tax was initially enacted as 10% but it is proposed to increase it to 15%, in line with the withholding tax rates for royalties and dividends.
The withholding tax is not a mechanism for collecting any South African income tax which may be due by non-residents, but is a separate tax.
The person to whom the interest is paid will be liable for the tax but the person making such payments has a withholding obligation.
Certain categories of non-residents will be exempt from the tax, for example, a non-resident carrying on business through a permanent establishment in South Africa.
Generally, interest on widely held investments issued by, for example, collective investment schemes; publicly available investments (e.g. deposits in banks); Government, certain Government-owned entities; and listed debt instruments will also be exempt from the withholding tax, irrespective of the nature of the non resident recipient.
The rate of the interest withholding tax may be reduced in accordance with applicable double taxation agreements concluded by South Africa.
The Draft Bill proposed to introduce new rules in terms of which debt may be reclassified as equity in certain instances, with interest recharacterisation as a non-deductible dividend. These recharacterisation rules have also been postponed for further consideration.
Non-residents deriving interest income from a South African source should anticipate that such income will be subject to either income tax or the new withholding tax on interest in South Africa in 2013. Non-residents are cautioned to carefully consider the impact that the proposed amendments may have in relation to funding of private equity and M&A transactions in South Africa, or investment into certain categories of South African debt.