Ruling on withholding tax on interest and the application of a treaty

The South African Revenue Service (SARS) issued Binding Private Ruling No 181 (Ruling) on 4 November 2014, which deals with the application of a treaty for the avoidance of double taxation to withholding tax on interest.

The applicants were three companies incorporated and tax resident in South Africa, who intend to construct wind farms in South Africa. The Danish Government, through a funding scheme, intends to provide funding to the applicants for purposes of constructing the wind farms. Once the projects are complete, interest will become payable by the ato the Danish Government (via the funding scheme) in respect of the funding, the term being a period of 15 years.

The funding scheme will be the beneficial owner of the interest, and will not have a permanent establishment (PE) in South Africa.

Section 50B of the Income Tax Act, No 58 of 1962 (Act) will impose a withholding tax on interest payable to non-residents at the rate of 15% as of 1 January 2015.

The applicants were clearly concerned that they would have to withhold tax on the interest that will become payable to the Danish Government through the funding scheme (who are clearly non-resident).

However, s50E(3) of the Act provides that a person paying interest to a non-resident may withhold tax at a reduced rate as a result of the application of an agreement for the avoidance of double taxation, provided that the non-resident submits a relevant declaration and undertaking.

Article 11(1) of the international treaty between South Africa and Denmark in respect of the avoidance of double taxation (Treaty) provides that interest arising in South Africa, and paid to a resident of Denmark, may only be taxed in Denmark, where the resident of Denmark is the beneficial owner of the interest. Article 11(3) of the Treaty does however provide that Article 11(1) will not apply where the debt is connected to a PE of the Denmark resident in South Africa.

It should be noted that the Treaty does not as such provide for tax on interest to be levied at a reduced rate, but rather that South Africa may not tax interest payable to a resident of Denmark at all (where the Denmark resident is the beneficial owner of the interest and the debt is not connected to a PE of a Denmark resident in South Africa).

SARS ruled that section 50E(3) of the Act will apply in respect of the interest payable to the Danish Government (via the funding scheme) and that the interest will subject to tax in South Africa at the reduced rate of 0%, provided that the relevant declarations and undertakings are submitted by the funding scheme. The ruling will however only be valid for a period of 5 years from the estimated date of completion of the wind farms, and not the entire term of the funding.

The Ruling is interesting because:

• SARS has construed the forfeiture of taxing rights in terms of article 11(1) of the Treaty as tax at a reduced rate of 0% in the context of s50E(3) of the Act; and
• it concerns the application of legislation that has not yet come into operation – withholding tax on interest will only come into operation on 1 January 2015.