The 2017 Draft Taxation Laws Amendment Bill (draft TLAB), issued on 19 July 2017, proposed some important legislative changes that are bound to have a significant impact once implemented. Following the receipt of comments from the public and other interested parties, National Treasury and SARS issued a draft response document on 14 September 2017 in which they outline their assessment of the comments and suggestions which have been made.
Although we will have to wait for the final Taxation Laws Amendment Bill, which is anticipated to be issued in October or November, to see what the revised legislative changes will entail, the preliminary responses provided by National Treasury and SARS gives a fair indication of what can be expected.
Foreign employment exemption
The draft TLAB proposed to repeal the current section 10(1)(o)(ii) employment income exemption in respect of South African residents working abroad.
Following concerns expressed about the negative impact this would have on the finances of affected individuals and remittances to South Africa, National Treasury has indicated that the proposed amendment will be changed to allow the first R1 million of foreign remuneration to be exempt from tax in South Africa, provided the individual is outside of South Africa for more than 183 days, as well as for a continuous period of longer than 60 days during a 12 month period.
This exemption threshold should reduce the impact of the amendment for lower- to middle-class South African tax residents who are earning remuneration abroad. It is anticipated that a further effect of the exemption threshold will also be that South African tax residents in high income tax countries are unlikely to be required to pay any additional top up payments to SARS.
Although the tax system does not usually cater for differences in the cost of living in different countries, National Treasury believes that the exemption threshold will mitigate these types of concerns and this threshold is a simpler and cleaner solution compared to a country-by-country cost of living adjustment.
A further concern expressed was that the proposed effective date of this amendment, being 1 March 2019, will have a significant and sudden impact, especially on taxpayers that arranged their affairs according to a multi-year employment contract. To allow greater time for individuals to adjust either their contracts or their circumstances and to finalise or formalise their tax status, it is proposed that the effective date for this amendment will be extended to 1 March 2020.
On the likely cashflow impact that the proposed amendment will have, where a taxpayer may be required to pay tax in both South Africa and in the foreign country of employment, National Treasury indicated that the South African employer is permitted to apply for a PAYE hardship directive to SARS that would take foreign employment taxes into account, thereby avoiding double taxation. In respect of provisional taxpayers, the current tax legislation already makes provision for such taxpayers to consider foreign taxes paid in their South African provisional tax calculations, which would also avoid the cashflow effect of double taxation.
National Treasury and SARS were not willing to accept proposals that the foreign tax rebate provisions of section 6quat be amended to take foreign social security and pension contributions into account. National Treasury’s view on this aspect is that social security contributions have a different nature compared to taxes on income as they imply a potential future benefit for those contributions (such as a state pension). Foreign state pensions paid to South African tax residents are exempt from tax in South Africa and allowing a credit for these contributions could be construed as Treasury allowing a tax deduction for both contributions and payments.
National Treasury noted various other concerns expressed, including that the amendment will lead to an accelerated breaking of South African tax residence by individuals in order for them not to be negatively impacted by the proposed amendment, but Treasury seemed largely “unperturbed” by this possibility including the likely impact this could have on South Africa’s skills base.
Share buy backs and dividend stripping
Although the Income Tax Act already contains anti-avoidance provisions aimed at countering so-called “dividend stripping” schemes, the ambit of the provisions is very narrow.
Dividend stripping occurs when a seller of shares in a company avoids paying income tax or capital gains tax arising on the sale of shares in that company by ensuring that the company in which the shares to be sold are held, declares an exempt dividend prior to the sale of shares in that company. The exempt dividend declared decreases the value of the shares in that company prior to the sale of shares in that company. As a result, the seller extracts value from the company selling the shares through tax exempt dividends. Thereafter, the seller can sell the shares at less value, thereby avoiding paying a normal tax. A share buy-back can achieve a similar outcome under the existing tax legislation.
Proposed amendments aimed at countering such schemes were included in the draft TLAB and it was proposed that such amendments would come into operation on the date of publication of the draft TLAB for public comment, being 19 July 2017, and these amendments would apply in respect of any disposal on or after that date.
In essence the proposed amendment would affect any disposal of shares held by a company where a shareholding of at least 50% was held (or at least 20% where no other shareholder holds the majority shares and voting rights), within a period of 18 months prior to such disposal. Any dividend that was received within 18 months prior to, or as a result of, or connected to the disposal would be re-classified as proceeds on disposal and will not be regarded as an exempt dividend.
These extended anti-avoidance measures would therefore also apply to share sale transactions where there is no avoidance taking place as the measures will taint all dividends received in the preceding 18 months irrespective of whether they are related to or linked to the share sale.
National Treasury has conceded that although the 18-month period will remain, the application of the revised rules will be limited to dividends that are considered excessive as compared to a normally acceptable dividend (known as extraordinary dividends) received by a company within 18 months preceding the disposal of a share in another company. In this regard, any dividends received within 18 months preceding a share disposal in respect of that share that exceed 15 per cent of the higher of the market value of the share disposed of (as determined at the beginning of the 18 month period and the market value of the shares on the date of disposal) will be treated as extraordinary dividends and will therefore be subject to the anti-avoidance measure.
Concerns were expressed that the proposed anti-avoidance measure is too wide and negatively affects vanilla preference shares typically used by companies to raise funding. Such shares typically carry a coupon linked directly to the prime interest rate and are redeemable at their original subscription price after as long as 10 years. In some instances, the preference dividends for the past years are all accumulated but not declared and are only declared upon redemption. This means that all such accumulated preference dividends would be tainted.
National Treasury conceded on this matter and the provisions will now exclude preference shares to the extent that the dividends on such shares are determined with reference to a specified rate of interest to the extent that the rate of interest does not exceed 15 per cent.
On the application of the proposed revised rules from 19 July 2017, concerns were raised that it would apply retrospectively to dividends received prior to 19 July 2017. In particular the changes will affect transactions that were already entered into before that date but that are subject to suspensive conditions.
National Treasury has indicated that the proposed effective date will be changed to ensure that arrangements whose terms were finally agreed to by the parties thereto on or before 19 July 2017 will not be subject to the new provisions.
The qualifying threshold percentages (i.e. 50% / 20%) contained the draft TLAB will be amended as it has been brought to National Treasury’s attention that it is unlikely to curb the abuse at which these amendments were specifically aimed. In a listed environment, there is unlikely to be a 20 per cent shareholder. National Treasury accepted this and indicated that in the case of a listed company a lower shareholding can confer a significant influence upon a shareholder. Therefore, a lower shareholding benchmark of 10 per cent will apply to listed companies.
With regard to non-listed companies, the proposed 50% and 20% interest thresholds will remain, with some refinements.
Although National Treasury noted concerns expressed about the potential effect these revised provisions could have on various Black Economic Empowerment (BEE) shareholding schemes, it expressed the view that as with all other share investors, the share disposal of BEE partners should be subject to these anti-avoidance measures in the instance that the value of their shares has been reduced by exempt dividends. Smaller BEE holdings or shares held by individuals would not be subject to these anti-avoidance measures.
On the interplay between the corporate roll-over provisions contained in section 41 to 47 of the Income Tax Act, National Treasury clarified that the proposed amended anti-avoidance measures will be modified to ensure that they are not avoided by taxpayers by taking advantage of the corporate roll-over provisions.
For further information and for assistance in understanding the matters pertaining to immovable property or any other tax enquiries, please contact our tax team.