Relief under a tax treaty in the form of a lower withholding rate generally applies to dividends paid to a non-resident company holding 10% to 25% of the shares (depending on the relevant tax treaty) in the company paying the dividend. Normally, a lower withholding rate will not be provided for under a tax treaty, if a foreign company holds less than 10% of the shares in the company paying the dividend. The reduced rate in respect of the so-called participation exemption varies between 5% and 10% depending on the particular treaty. However, even where the person owns less than 10% of the shares in the company declaring the dividend, the dividend tax rate is generally limited to 15%.
South Africa / Sweden Double Tax Agreement
Article 10(2) of the South Africa / Sweden Double Tax Agreement, read with the Protocol thereto (SA / Sweden DTA), is an example of the provision of such relief and provides as follows:
However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident [ie South Africa] and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State [ie Sweden], the tax so charged shall not exceed:
- 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds at least 10% of the capital of the company paying the dividends; or
- 15% of the gross amount of the dividends in all other cases. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. [Our insertion]
In essence, the effect of Article 10(2) is that where a Swedish tax resident owns 10% or more of the shares in a South African tax resident company, any dividends declared by that South African tax resident company will be subject to a reduced dividends tax rate of 5% to the extent that the relevant formalities in section 64G(3) of the Income Tax Act, No 58 of 1962 (Act) have been complied with. Furthermore, even where a Swedish company, individual or trust owns less than 10% of the shares in a South African tax resident company, the dividends tax on any dividends declared by that company could be reduced from 20% to 15%. Generally, this relief is prevalent in the majority of the double tax treaties entered into between South Africa and other countries.
Interestingly, however, the Protocol entered into between South Africa and Sweden introduced further potential relief in respect of dividends. Article 10(6) of the SA / Sweden DTA constitutes what is commonly referred to as a “most favoured nation” clause and states the following:
If any agreement or convention between South Africa and a third state provides that South Africa shall exempt from tax dividends (either generally or in respect of specific categories of dividends) arising in South Africa, or limit the tax charged in South Africa on such dividends (either generally or in respect of specific categories of dividends) to a rate lower than that provided for in subparagraph (a) of paragraph 2, such exemption or lower rate shall automatically apply to dividends (either generally or in respect of those specific categories of dividends) arising in South Africa and beneficially owned by a resident of Sweden and dividends (either generally or in respect of those specific categories of dividends) arising in Sweden and beneficially owned by a resident of South Africa, under the same conditions as if such exemption or lower rate had been specified in that subparagraph.
In simple terms, this further relief is applicable where South Africa has entered into any other Double Tax Agreement with a third country, which provides for either a complete exemption or reduced dividends tax rate (ie less than 5% in the SA / Sweden DTA). To the extent that this is the case, the outright exemption or further reduced rate will override Article 10(2) and automatically apply to any dividends declared by either a South African or Swedish company to a shareholder who is resident in the other country and who owns 10% of the shares of the declaring company.
South Africa / Kuwait Double Tax Agreement (SA / Kuwait DTA) and application of “most favoured nation” clause
Having regard to the other double tax agreements entered into between South Africa and other countries, it appears only one agreement currently provides for the complete exemption from tax under similar circumstances. Article 10(1) of the SA / Kuwait DTA provides as follows:
Dividends paid by a company which is a resident of a Contracting State [ie South Africa] to a resident of the other Contracting State [ie Kuwait] who is the beneficial owner of such dividends shall be taxable only in that other Contracting State [ie Kuwait]. [Our insertions]
Hence where a South African resident company declares dividends to a Kuwaiti tax resident company, then Kuwait has the sole taxing rights and South Africa cannot levy any tax on such dividends. The additional benefit of this outright exemption in the SA / Kuwait DTA, is that it triggers the “most favoured nation” clause contained in Article 10(6) of the SA / Sweden DTA, such that any dividend declared by a South African company to a Swedish shareholder who owns 10% or more of the shares in the South African company, will not be subject to any South African dividends tax to the extent that the relevant formalities are complied with.
Ruling issued by SARS confirming application of the “most favoured nation” clause
The application and interaction of the “most favoured nation” clause was the crux of the issue in a recent ruling issued by the South African Revenue Service (SARS). SARS confirmed the above principle and ruled in Binding Private Ruling 267 (Ruling) that any dividends declared by a South African tax resident subsidiary company to its Swedish tax resident holding company will not be subject to South African dividends tax to the extent that the documentary requirements in section 64G(3) of the Act are complied with.
While the benefit of the “most favoured nation” clause is clear to see, taxpayers wishing to set up structures in order to take advantage of its application should be aware that most tax treaties which have such provisions also contain an anti-avoidance provision, which states that the “most favoured nation” clause will not apply where the main purpose or one of the main purposes in setting up the structure was to take advantage of the benefits of this clause.
Interestingly, other double tax treaties which have similar “most favoured nation” clauses, inter alia, include the SA / Netherlands DTA as well as the SA / United Kingdom DTA. However, both clauses in those tax treaties have their limitations in comparison to the South Africa / Sweden equivalent provision. In respect of the SA / Netherlands DTA, there is a date limitation in that the “most favoured nation” clause only applies where a further tax treaty between South Africa and a third state was entered into after the date of conclusion of the SA / Netherlands DTA. There is an argument that the SA / Kuwait DTA came into force prior to the SA / Netherlands DTA and hence cannot apply, such that the application of the “most favoured nation” clause in the SA / Netherlands DTA is not triggered. Furthermore, the SA / United Kingdom DTA merely provides that the countries shall enter into negotiations with a view to providing comparable treatment as may be provided for in respect of a tax treaty with a third State.
While the application of the “most favoured nation” clause is certainly beneficial under the specific circumstances, it remains to be seen for how long this exemption will apply. It is interesting to note that while Kuwait remains the only country with an outright exemption in respect of dividends, previously the tax treaties between South Africa and Cyprus as well as Oman also provided for outright exemption under certain circumstances. Both the Cypriot and Omani tax treaties were, however, relatively recently amended by protocols giving the country of source partial taxing rights and removing the outright exemption. As it happens, the Status Overview of All DTAs and Protocols published on the SARS website (last updated on 27 January 2017) reflects that the South Africa / Kuwait Protocol is currently being negotiated and it will, therefore, be interesting to see whether the new Protocol will amend the article pertaining to dividends thereby doing away with the outright exemption of dividends as it currently stands.