South Africa’s rather controversial secondary tax on companies (STC) is in the process of being overhauled. Certain significant changes to STC were announced recently in the Revenue Laws Amendment Bill, 2007. These changes represent a preliminary step towards the ultimate abolition of STC and its replacement by a more conventional withholding tax on dividends.
The current proposed changes to STC bristle with technical complexity and it is difficult to assess how these will affect individual shareholders. Exactly what form the proposed replacement of STC – namely the withholding tax on dividends – is also not altogether clear at this point. However, it might be interesting to speculate as to how this further change will also affect individual shareholders.
At first glance it seems that the interim system – in other words, the amended version of STC currently proposed – will benefit shareholders. This is because the rate of STC is said to drop from 12,5 % to 10 %. Therefore it would seem that mean that shareholders should receive a slightly bigger dividend, since the rate of STC applied when distributing the dividend is slightly lower.
However, there are two stings in the tail. The first is one of which the shareholder may not be directly aware. I refer to the fact that the range of distributions to shareholders which are subject to STC is going to be widened. In other words, certain distributions, which would previously have been free of STC, will now be caught within its net. The most significant example is liquidation dividends consisting of certain historical or revenue profits.
Although taxpayers may be unaware of the composition of the dividends that they receive – and therefore unaware of any such inherent additional STC liability – the quantum of the dividends would be affected by the change in these rules.
The second sting in the tail arises from the inter-action between STC and Capital Gains Tax (CGT). These two taxes dovetail to a significant extent. The draft legislation includes certain consequential CGT changes which may act to the disadvantage of taxpayers. These include the fact that certain capital distributions – which were previously free both of STC and CGT – will now have a CGT effect in the hands of taxpayers.
Therefore the apparent benefits of the cut in the rate of STC are counteracted by certain other measures. The net effect may well not be to the benefit of taxpayers.
Casting one’s mind ahead to the next phase of the process – the introduction of a withholding tax on dividends – perhaps the most significant immediate tax consequence arises for foreign shareholders in South African companies. This is because such shareholders may be entitled to claim relief from the withholding tax – or a portion of it - by invoking the terms of a Double Tax Agreement (DTA) between South Africa and their own country. Many DTA’s limit the rate of withholding tax that may be imposed by the authorities in one country in respect of dividends declared to residents of the other country.
However, assuming that the withholding tax stays at 10 % (and this is by no means certain), this remedy is unlikely to be available to individual foreign shareholders in South African companies. This is because most DTA’s limit the rate of dividend withholding tax to 15 % for individuals. Corporate foreign shareholders are generally more generously treated since DTA’s often limit withholding taxes to something like 5 %. In practice it is therefore only likely to be corporate foreign shareholders who will be able to claim DTA relief from the new South African withholding tax on dividends.
How will South African shareholders in companies be affected by the fact that STC is replaced by a withholding tax on dividend? This change means that, although the tax continues to be withheld and paid over by the company declaring a dividend, it is formally imposed on the shareholder rather than the company. Does this mean that the shareholder might be entitled to claim deductions against this tax? In view of the fact that dividends will be taxed at a different rate to other income, it is hard to envisage how such a system would work in practice.
Therefore, at this stage we are really only able to speculate about the implications of the replacement of STC with a withholding tax on dividends. As regards the interim phase, it seems that taxpayers should not get too excited about the cut in the rate of STC from 12.5 % to 10%. This is because this benefit is counteracted by certain STC and CGT changes which do not act to the benefit of shareholders.
By Billy Joubert : Billy Joubert is a Tax Director at Deloitte
