Transition from secondary tax on companies (STC) to the dividend withholding tax (DWT) regime
The transition from STC to DWT will take place with effect from 1 April 2012. With the move to the new regime, it has been proposed to increase the DWT tax rate from 10% to 15%. Pension funds and PBO’s currently exempt from income tax will continue to be exempt from DWT.
The increase in the DWT appears to be aimed at more wealthy individuals and trusts who receive income in the form of dividends and capital gains which are effectively taxed at lower rates than ordinary income.
Double tax treaty relief will still apply for non-resident shareholders where the DWT may be reduced in terms of a treaty.
Other proposed amendments relating to the transition from STC to DWT include the following:
- Reduction of the tax rate applicable to non-resident companies (who are not currently subject to STC) from 33% to 28%;
- Reduction in the period available for the utilisation of STC credits brought across to the DWT regime from five years to three years;
- Removal of the higher income tax rate formula for gold mining companies;
- Removal of the proposed passive holding company regime, originally designed as an anti-avoidance mechanism, and which is no longer considered necessary with the increase in DWT rate.
The increase in DWT, together with the proposed increase in capital gains tax inclusion rates for individuals, effectively increases the tax burden of individuals who invest in equity shares in order to save for retirement. It seems that this approach has been adopted instead of a wealth tax which is applicable in some jurisdictions.
The reduction in the non-resident company tax rate places non-resident companies at a comparative tax advantage to resident companies whose dividends to non-residents are subject to DWT. This could have the unintended consequence of multi-national groups inevitably seeking to operate in South Africa by way of a branch instead of a subsidiary to take advantage of the lower effective tax rate for shareholders.
Increase in capital gains tax (CGT) inclusion rates
It is proposed to increase the CGT inclusion rates for companies from 50% to 66.6%.
The effective tax rate consequently increases from 14% to 18.66% for companies.
The increase in CGT inclusion rates appears to be aimed at achieving closer parity between the income tax and CGT consequences for transactions.
The increase in CGT inclusion rates may have the adverse effect of discouraging large investment by South African resident individuals and companies. From comments made by the Minister in his budget speech, it appears that, over the longer term, the intention would be to treat revenue and capital gains on the same basis.
Relief for small businesses
Reforms to the turnover tax regime for micro businesses and income tax applicable to small business corporations are proposed. The reforms are aimed at easing the compliance burden for companies qualifying for turnover tax, and providing tax relief for companies qualifying as small business corporations in the form of an increased tax threshold and reduced tax rate for taxable income less than R350 000.
Although the proposed changes are to be welcomed, one questions the limited application of these regimes. It is hoped that the provisions will be expanded in the future to include more taxpayers within these beneficial regimes, thereby encouraging the growth of small to medium enterprises.
The use of excessive debt in business
Proposed changes to the corporate rules, and in particular section 45 of the Income Tax Act, caused much public debate in 2011 and continues to be a focus area of National Treasury which is particularly concerned about a reduction of the tax base as a result of excessive debt in merger and acquisition-type transactions.
It is proposed that a revised set of rules be enacted concerning the reclassification of debt to equity to limit interest deductions in respect of instruments which are closer in substance to equity than debt.
It was announced that, going forward, National Treasury will consider an “across the board” percentage ceiling for interest deductions so as to limit excessive debt financing.
The use of debt financing and similar debt instruments is particularly relevant for companies which are looking to grow their businesses but do not have the internal funds to do so. It is hoped that the new set of rules are not overly complex and detract from the commercial attractiveness of debt financing necessary to finance business growth, and that the rules are sufficiently flexible so as not to stifle new businesses and expansions.
Debt used to fund share acquisitions
Interest on debt used to fund share acquisitions is currently disallowed as a deduction, whereas many countries allow the deduction. As a result, intra-company transactions in terms of section 45 of the Income Tax Act are used as an indirect acquisition technique to do a debt push down and facilitate an interest deduction through allowing debt to be matched to the underlying assets acquired.
It is proposed that interest associated with the use of debt to acquire a controlling interest of at least 70% in a company be allowed as a deduction, subject to the same limitations applicable to a section 45 transaction.
The proposed change is welcomed and will help to reduce the complexity and transaction costs incurred by companies when acquiring other business or doing group re-organisations.
Debt cancellations and restructurings
There are currently complex, punitive rules that apply from an income tax and CGT perspective where taxpayers are released, either in full or in part, from their debt obligations. National Treasury has announced that it intends to simplify these rules and eliminate adverse tax consequences when debt relief merely restores the taxpayer to solvency. Specific rules will apply to address situations where creditors agree to convert their debt interests into an equity stake as partial compensation for the debt.
The proposed changes are welcomed. It is hoped that the new set of rules will clearly set out the income tax and capital gains tax consequences applicable to debt cancellations and debt restructures, and will provide much needed relief to taxpayers in struggling economic circumstances.
Other proposed changes
The following is a list of other proposed changes / items under consideration as announced in the 2012 Budget Review:
- Property loan stock companies will be placed on an even footing with property unit trusts, with rental income from underlying entities being taxed on a flow-through basis similar to that applicable to property unit trusts.
- Special economic zones will be introduced to build on the industrial development zone policy and various tax incentives will be explored relating to the conduct of business in these zones, including a reduction in the corporate tax rate for companies in these zones.
- Consideration is being given to lifting the current prohibition of learnership allowances in the instance where a learner did not complete a prior registered learnership or when registration of the learnership is delayed owing to reasons outside of the control of the employer.
- A new tax incentive is under consideration for developers (and employers) for the construction of new housing units (five or more) for sale below R300 000 per dwelling.
- Potential changes to rules for company mergers and acquisitions and other restructurings in light of the new Companies Act (2008) will be considered after a series of workshops to be held by Government on the topic.
- The taxation of financial instruments on a mark-to-market basis to align the tax treatment with the accounting treatment will be considered over the next few years.
- A review of the system for taxation of short-term and long-term insurers and the tax treatment of captive insurers will take place.
- A comprehensive review of government grants qualifying for exemption will be performed.
- The connected person rule deeming assets to be acquired at the lower of a purchaser’s or connected person’s tax cost as they relate to the sales of trading stock will be removed.
- Interpretative guidance together with legislative refinements is expected later this year concerning the tax treatment of contingent liabilities disposed of as part of the sale of a business.
- It is proposed that shares issued in excess of their value as part of an arrangement to shift value between shareholders be subject to tax.
- It is proposed that conversions of share block companies to sectional title schemes be granted tax-free rollover treatment.
- Accelerated depreciation (50:30:20) applicable to energy projects such as wind, solar power and hydroelectric facilities will be extended to include the foundations and supporting structures associated with these arrangements.
- Consideration is being given to extending the incentive for newly developed and renovated buildings in urban development zones beyond the current expiry date of 2014.
- Captive finance schemes involving the use of artificial financing schemes to eliminate income will be reviewed for potential elimination.
- Proposed changes to the administration and compliance requirements for companies qualifying for section 12I industrial policy incentives will be made.