6 August 2010 by

Closure of sophisticated tax loopholes

During his budget speech Mr Pravin Gordhan amongst others announced that the Government will take further steps to reduce tax avoidance and specifically sophisticated tax avoidance arrangements such as the use of transfer pricing and cross-border mismatches. A number of schemes that have been identified for closure, amongst others the use of foreign tax credits or the conversion of interest into dividends. 

One of the examples that have been mentioned, is if South African taxpayers borrow funds to acquire foreign financial instruments that generate income, but are subject to a zero rate of tax by virtue of the existence of tax treaties that have been concluded by South Africa. In other words, even though the interest would generally have been subject to tax, the relevant treaty exempts these amounts such as in the case of the Brazilian treaty concluded by South Africa. In other instances, it appears that double tax credits have been claimed in the sense of the foreign income ostensibly being subject to the foreign tax system in circumstances where actual taxes are paid, but where the relevant credits can be claimed by a holding company or in a group context.

Another example that is mentioned, is if a taxpayer takes funds offshore to deductible payments (for example interest) in circumstances where those funds are remitted back to South Africa through foreign dividends that are exempt from tax. Currently foreign dividends are exempt to the extent that one holds a 20% equity interest in a foreign company. In circumstances where a South African resident holds both preference shares and equity shares, the effect would have been that dividends in respect of both the ordinary shares as well as the preference shares were exempt. It has now been indicated that the exemption for preference share dividends, guaranteed dividends and/or dividends derived directly or indirectly from South Africa will no longer be exempt.

Other measures that have been announced, deal with the use of so-called protected cell companies. A protected cell company is a company which is legally divided into separate cells on the basis that the liability of each cell is ring-fenced. Each cell effectively operates independently, even though one is dealing with one overall company. In these circumstances the cell would not constitute a so-called controlled foreign company as the cell would ultimately not comprise a substantial element of the overall interests in the company. It has now been announced that the legislature will focus on a specific cell irrespective of whether or not it may form part of a bigger company that has created a number of cells.

Emil Brincker, Director, Tax

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