withholding tax on interest and royalties david warneke november 2012

WITHHOLDING TAX ON INTEREST AND ROYALTIES

DAVID WARNEKENovember 2012

WTI: Where we are…section 10(1)(h)

In an attempt to attract and retain foreign investment South Africa has historically not levied tax on interest paid to non residents.

Section 10(1)(h) currently provides an exemption from income tax for interest earned by non-residents unless:

• the non-resident is a natural person physically present in South Africa for 183 days or more in a year of assessment; or

• The non-resident carries on business in SA at any time during the year of assessment through a permanent establishment.

Where we are going… section 37I – 37N• A withholding tax on interest paid to non-

residents will become effective from 1 July 2013 (revised date per the 2012 TLAA).

• The interest must be paid to or for the benefit of any foreign person.

• Examples: 1. Interest is paid to a SA resident as collection agent for the creditor, who is a non-resident. WTI applies.

• 2. Interest is paid to a non-resident but the beneficial owner of the interest is a SA resident. WTI applies.

• The tax applies to the extent that the amount is received or accrued from a SA source in terms of S9(2)(b) (SA debtor unless interest attributable to a non-SA permanent establishment OR utilisation or application of funds in SA).

Where we are going… section 37I – 37N

• In order to bring all withholding taxes in line the withholding tax on interest will be introduced at a rate of 15%.

• The withholding tax will be a final tax.

It will apply in respect of:

(a) Interest that accrues OR

(b) Interest that is paid or becomes due and payable,

on or after 1 July 2013.

Therefore:

If interest is paid on or after 1 July 2013 WTI will apply (even in respect of interest that accrued prior to that date).

Whose responsibility is it?

The person making the interest payment for the

benefit of a foreign recipient is liable to

withhold this tax from the amount of interest

paid (s37L)

To the extent that amounts of withholding tax are owing to SARS

the ultimate liability for the tax rests with the person to whom the

interest is paid. (s37JA)

Note that as clarified in the Taxation Laws

Amendment Act of 2012, the withholding tax

liability is triggered on the earlier of interest

being paid or becoming due and payable(and not merely on the accrual) of

the interest (s37J).

Non residents who are exempt from the withholding tax on interest … 37K(3)

• Any non-resident natural person who is physically present in the Republic for a period exceeding 183 days in aggregate in the 12 months preceding the date on which the interest is ‘paid’;

• Any non-resident who at any time during the 12 month period preceding the date on which the interest was ‘paid’, carried on business through a permanent establishment in the Republic.

The WTI will not apply to the above non-residents as South African normal tax will, in these cases, be levied on their income in preference to the

WTI. If WTI applies, normal tax will not also apply and vice versa.

Per 2012 TLAA the payment of interest to CFC’s WILL trigger WHTI, however the interest will be

excluded from the CFC’s income calculation i.t.o 9D

Interest that is exempt from the withholding tax .. 37K(1)Interest received by or accrued to any non-resident in respect of:

• Any government debt instrument;

• Any listed debt instrument;

• Any debt owed by any bank (as defined) note: exclusion of back-to-back arrangements , the South African Reserve Bank , the DBSA or the IDC;

• The purchase price of goods imported into the Republic provided an authorised dealer (for exchange control purposes) has certified on the bill of exchange or letter of credit that a bill of lading or other document covering the importation of the goods has been exhibited to it;

• Interest payable in terms of section 27(6) of the Security Services Act to a foreign client;

• A collective investment scheme (other than in a collective investment scheme in property);

• Interest payable by a headquarter company (provided that the transfer pricing exclusions in s31(5) applies to the interest.

The exemption for interest paid by a bank to a non-resident will not apply where.. 37K(2)The exemption provided for interest paid or payable by a bank will not apply to ‘back-to-back’ arrangements.

For example, no exemption will apply to interest payments made by a domestic bank to a non-resident where a deposit at the bank made by that non-resident has been used as security for a loan to a resident.

Administrative issues.. 37L(2)

A person making an interest payment to a non-resident is obliged to withhold and pay to SARS 15% of the interest payment UNLESS:

- The interest IS exempt in terms of section 37K(1); OR

- The person making the interest payment is, by the date of payment, in possession of a declaration from the foreign person to or for whose benefit the payment is to be made stating that they are exempt from the tax in terms of section 37K(3).

Reduction of the withholdings tax rate where a double taxation agreement applies s37L(3)

The rate of withholding tax may be reduced if, by the date of the payment of the amount of interest, the person making the interest payment is in possession of a declaration submitted by the foreign person to or for whose benefit the payment is to be made, stating that a reduced rate of tax applies due to the application of a double tax agreement.

The trigger for withholding and the obligation to make payment to SARS s37MThe trigger date for the withholding of the tax is the date that the interest is paid or becomes due and payable.

Any person withholding any withholding tax on interest is obliged to pay the tax to the Commissioner by the last day of the month following the month during which the interest is paid.

The refund mechanism… 37NA non-resident who has not submitted one of the two relevant declaration forms to the payer of the interest on a timeous basis, has three years from the date of payment of the interest in which to submit the declaration form directly to SARS in order to claim the overpaid withholding tax from SARS.

Double Taxation AgreementsThe rate of withholding tax on interest may be reduced by the application of a DTA, depending on which state the ‘beneficial owner’ is resident in:

Country DTA Rate for Interest

United Kingdom 0%

USA 0%

Germany 10%

Mauritius 0%

Australia 10%

China 10%

Beneficial ownership

The term ‘beneficial owner’ is not defined for purposes of the WTI. For purposes of Dividends Tax it is defined as the person entitled to the benefit of the dividend.

• DTA’s rely on the concept of beneficial ownership to provide relief.• There is lack of consensus internationally regarding the meaning of

‘beneficial ownership’.• In the Canadian case of Prevost (The Queen v Prevost Car Inc 2009 FCA

57) it was held that the beneficial owner of a dividend is the person who receives dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. The person who is the beneficial owner of the dividend is the person who enjoys and assumes all the attributes of ownership.

• If interest is paid to a SA resident trust with a non-resident beneficiary, who is the beneficial owner of the interest?

Some issues1. The wording of s37JA vs DTA’s:

Say SA Co pays interest to Forco 1 but the beneficial owner of the interest is Forco 2. Forco 2 is liable to income tax on the interest in its country of residence. S37JA states that ‘a foreign person to which an amount of interest is paid is liable for the WTI’. However DTA’s rely on the concept of beneficial ownership. Forco 2 can’t claim DTA relief as in terms of S37JA the WTI was imposed on Forco 1. Forco 1 can’t claim DTA relief as it is not the beneficial owner of the interest.

2. How much of what is paid consists of interest?Assume:

• A loan of R100 m• Annual repayments of R25m• S24J interest to date of first repayment R20 m.

How much of the repayment of R25 m is interest?3. When is interest ‘due and payable’? Consider interest received by

discretionary and vesting trusts and crediting of interest to loan accounts.

Sections 8E – Hybrid Equity Instrumentss8E is an anti-avoidance section aimed at combatting schemes in which what are in substance loans are labeled as shares.EXAMPLE: If instead of granting a loan the lender is issued preference shares by the borrower then (in the absence of s8E) the lender receives exempt dividends instead of taxable interest.The effect of s8E is to reclassify these dividends to interest income / income (in the hands of the recipient only). The dividends will not be subject to DWT or WTI under these circumstances.

Sections 8E – Hybrid Equity InstrumentsIn order for s8E to apply there must be a ‘hybrid equity instrument’ which is

Any share other than an equity share where:

The 3 year Rule applies:- The issuer of the share is obliged to redeem the share within 3

year of issue; or- The share may, at the option of the holder, be redeemed in

whole or part within 3 years of issue; or


Any equity share where:

The 3 year Rule applies:- The issuer of the share is obliged to redeem the share within 3

year of issue; or- The share may, at the option of the holder, be redeemed in

whole or part within 3 years of issue; OR- At the time of issue it is likely that the issuer will terminate

within 3 years ANDThe share does not rank pari passu iro participation in dividends with the other ordinary shares (or with at least one other class where more than one class); orwhere the dividend payable on a share is calculated with respect to:- a specified rate of interest or the time value of money


Any preference share where:

The share is secured by a ‘financial instrument’ (as defined: the arrangement must be interest-bearing or determined wrt a rate of interest); orIs subject to an arrangement in terms of which a ‘financial instrument’ may not be disposed of

UNLESS THAT SHARE WAS ISSUED FOR A ‘QUALIFYING PURPOSE’

A ‘qualifying purpose’ is in essence the acquisition of an equity share in an ‘operating company’.Note that the reclassification from dividend to income occurs where any dividend or foreign dividend is received in respect of a share that was a hybrid equity instrument at any time during that year of assessment.

Sections 8EA – Dividends on 3rd party backed shares

s8EA is in essence an extension of S8E and applies where shares in respect of which the return (dividends or returns of capital) are guaranteed by a party other than the issuer. Such shares are more closely linked to debt than to equity as the shareholder does not expose itself to meaningful risk in the company (due to the third party guarantee).

Where section 8EA applies the dividends paid on such shares are reclassified to income in the hands of the recipient only. Dividends are not subject to DWT or WTI under these circumstances.

Section 8EA applies to any dividend received in a year of assessment in relation to a share which was at any time during that year a third party backed share.

Original provision effective from 1 October 2012


A 3rd Party Backed Share is defined as:- Any non-equity share or equity share if the dividend is based on a rate of

interest- in respect of which an enforcement right is exercisable by the holder or

an enforcement obligation is enforceable- As a result of any amount of any specified dividend, foreign dividend,

return of capital or foreign return of capital not being received by or accruing to the person entitled thereto.

Enforcement obligation

Means an obligation, whether fixed or contingent, of any person other

than the issuer of the share to:(a) Acquire the share from the

holder;(b)Make any payment in respect of

the share in terms of a guarantee, indemnity or similar

arrangement; or(c) Procure, facilitate or assist with

(a) or (b)

Enforcement right

Means any right, whether fixed or contingent, of the holder of the share (or connected person) to

require any person other than the issuer to:

(a) Acquire the share from the holder;

(b)Make any payment in respect of the share in terms of a

guarantee, indemnity or similar arrangement; or

(c) Procure, facilitate or assist with (a) or (b)


The Operating Company Exclusion

A dividend in respect of a 3rd Party Backed share can escape s8EA treatment (i.e. will not be reclassified to income) if it was issued for a ‘qualifying purpose’ i.e. the acquisition of an equity share in an operating company, in that in these circumstances one disregards enforcement rights or enforcement obligations exercisable / enforceable against certain persons e.g. companies that form part of the same group as the operating company or that are part of the same group of companies as the issuer.

WITHHOLDING TAX ON ROYALTIES

Where we are…section 35

Royalties paid to a person who is not a resident nor a CFC are currently subject to a withholdings tax levied at 12%.

There is an exclusion that applies if such amount is effectively connected with a SA permanent establishment

Section 35 provides that

• The person making payment of the royalty to the non-resident is liable to pay the withholding tax;

• Payment must be made to SARS within 14 days of the end of the month in which liability was incurred / payment received

Where we are going… section 49A – 49G• Section 35 of the Act will be repealed in

respect of amounts received or accrued on or after 1 July 2013 and will be replaced with sections 49A – 49G.

• The new provisions will apply in respect of:Royalties that are paid ORRoyalties that become due and payable,on or after 1 July 2013, but only to the extent that the

royalties were not subject to tax in terms of S35.

• Therefore, if a royalty accrues and is paid prior to 1 July 2013, s35 will apply.

• If a royalty accrues prior to 1 July 2013 but is paid thereafter, the new provisions will apply.

Where we are going… section 49A – 49G

• In order to bring all withholding taxes in line the withholding tax on royalties will be increased to a rate of 15%.

• As is currently the position, the withholding tax on royalties will be a final tax.

• The changes are intended to align the withholding tax on royalties with the withholding tax on interest and dividends in terms of the administration of these taxes.

What is a Royalty?‘Royalty’ means any amount that is received or accrues in respect of –

(a) The use or right of use of or permission to use any intellectual property as defined in section 23I (patents, trademarks, designs, copyrights or similar property or knowledge connected to use of above) or

(b) The imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information, or the rendering of or the undertaking to render any assistance or service in connection with the application or utilisation of such knowledge or information.

To whom the provisions apply

The withholding tax on royalties will apply to any royalty paid to or for the benefit of a non resident person to the extent that the amount is

regarded as having been received by or accrued to that foreign person from a source within South Africa.

Examples: 1. A royalty is paid to a SA resident as collection agent for the creditor, who is a non-resident. WTR applies.

2. A royalty is paid to a non-resident but the beneficial owner of the royalty is a SA resident. WTR applies.

When is a royalty from a SA source… section 9A royalty is from a SA source if:

- The royalty is incurred by a person that is a resident, including amounts incurred by a resident that relate to the imparting of scientific, technical, industrial or commercial knowledge (unless that royalty is attributable to a PE outside South Africa) or

- The royalty is received or accrued in respect of the use or right of use or permission to use IP in South Africa or in respect of the imparting of scientific, technical, industrial or commercial knowledge for use in South Africa.

Whose responsibility is it?

The person making the royalty payment for the

benefit of a foreign person is liable to

withhold this tax from the amount of the

royalty paid (s49E).

To the extent that amounts of withholding tax are owing to SARS

the ultimate liability for the tax rests with the person to whom the

royalty is paid (s49C).

The withholding tax liability is triggered on

the earlier of the royalty being paid or becoming

due and payable(and not merely on the accrual) of

the royalty (s49B).

Withholding tax exemption… 49DThe following persons are exempt from the WHT:

• Any non-resident natural person who is physically present in the Republic for a period exceeding 183 days in aggregate during the 12 months preceding the date on which the royalty is ‘paid’;

• Any non-resident who at any time during the 12 month period preceding the date on which the royalty was ‘paid’, carried on business through a permanent establishment in the Republic.

The WTR will not apply to the above non-residents as South African normal tax will be levied on the royalties in preference to the WTR. If WTR applies, normal tax will not also apply and vice versa.

• Royalties payable by a headquarter company (provided that the transfer pricing exclusions in s31(5) apply to the royalties).

Per 2012 TLAA the payment of royalties to CFC’s will trigger WTR, however the royalties will be excluded from the net income calculation of the CFC i.t.o 9D

Administrative issues.. 49E

A person making a royalty payment to a non-resident is obliged to withhold and pay to SARS 15% of the royalty payment UNLESS:

- The person making the royalty payment is, by the date of payment, in possession of a declaration from the person to or for whose benefit the royalty is paid stating that they are exempt from the tax in terms of section 49D.

The rate of withholding tax may be reduced where:

- the person making the royalty payment is, by the date of payment, in possession of a declaration submitted by the person to or for whose benefit the royalty is paid stating that a reduced rate of tax applies due to the application of a double tax agreement.

The payment and recovery of the tax.. 49F

The trigger date for the withholding of the tax is the date that the royalty is paid or becomes due and payable.

Any person withholding the withholding tax on royalties is obliged to pay the tax to the Commissioner by the last day of the month following the month during which the royalty is paid or when it became due and payable.

The refund mechanism… 49GA non-resident who has not submitted the one of the two relevant declaration forms to the payer of the royalty on a timeous basis, has three years from the date of payment of the royalty in which to submit the declaration form directly to SARS in order to claim the overpaid withholding tax from SARS.

Double Taxation AgreementsThe rate of the WTR may be reduced by the application of a DTA, depending on which state the ‘beneficial owner’ is resident in (see earlier slide on ‘beneficial ownership’)

Country DTA Rate for Royalties

United Kingdom 0%

USA 0%

Germany 0%

Mauritius 0%

Australia 5%

China 10%

Some issues

1. The wording of S49C vs wording of DTA’s:Say SA Co pays a royalty to Forco 1 but the beneficial owner of the royalty is Forco 2. S49C states that ‘a foreign person to which a royalty is paid is liable for the WTR’. However DTA’s rely on the concept of beneficial ownership. Forco 2 can’t claim DTA relief as in terms of S49C the WTR was imposed on Forco 1. Forco 1 can’t claim DTA relief as it is not the beneficial owner of the royalty.

2. Beneficial ownership: Say a royalty is paid to a SA resident trust with a non-resident beneficiary. Who is the beneficial owner of the royalty?

3. When is the royalty ‘due and payable’? Consider royalties received by discretionary and vesting trusts and crediting of royalties to loan accounts.

Questions??

Disclaimer

While BDO has taken reasonable steps to ensure that the information contained herein is reliable and of the highest quality and standard we cannot be held liable for any mistakes, representations or omissions, or any loss or damage due to the use of such information. We cannot provide any warranty or guarantee of any nature, express or implied in respect of the information contained herein, or the opinions of the presenter.

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withholding tax on interest and royalties david warneke november 2012

Documents

withholding tax liability

na withholding tax

income tax

levied tax

tax rests

final tax

withholding taxes

sa resident