TAX ALERT TAX AND EXCHANGE CONTROL CONSIDERATIONS ON THE TRANSFER OF SHARES IN SOUTH AFRICAN COMPANIES BETWEEN NON-RESIDENTS IN THIS ISSUE

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1 21 JANUARY 2011 TAX ALERT TAX AND EXCHANGE CONTROL CONSIDERATIONS ON THE TRANSFER OF SHARES IN SOUTH AFRICAN COMPANIES BETWEEN NON-RESIDENTS It is quite common for multinational organisations to embark on restructuring projects affecting subsidiaries situated across the globe, including South Africa. As part of a restructuring process, it may result in the control of a South African subsidiary being transferred to another offshore holding company. This article deals with selected tax and exchange control implications where shares in an unlisted South African subsidiary are transferred between offshore group companies. As a first step in considering the possible tax consequences, one would need to determine whether the offshore group companies forming part of the transaction could be regarded as residents under South African tax law. This is an important consideration as South African residents are taxed on worldwide income whereas non-residents are only taxed on South African sourced income, subject to the application of a relevant Double Tax Agreement (DTA). IN THIS ISSUE A review of recent tax developments Tax and exchange control considerations on the transfer of shares in South African companies between non-residents Dividends now taxable in certain share incentive schemes Tax litigation: puzzling questions? Residence A "resident", as defined in section 1 of the Income Tax Act No. 58 of 1962 (the Act), means any person (other than a natural person) that is incorporated, established or formed in South Africa or that has its place of effective management (POEM) in South Africa. Further, the definition of the "resident" in section 1 of the Act specifically excludes any person that is deemed to be exclusively a resident of another country by virtue of the application of a relevant DTA that South Africa has entered into. Continued over page EVERYTHING MATTERS Cliffe Dekker Hofmeyr is a member of DLA Piper Group, an alliance of legal practices

2 Essentially, the determination of residence in relation to a company incorporated offshore comes down to where its POEM is situated. This is obviously a question fact depending on particular facts and circumstances and no hard and fast rules apply. Guidance is provided by the South African Revenue Service under Interpretation Note 6, which may not necessarily be relevant in a treaty context where OECD guidance would be more relevant. companies) if 80% or more of the market value of the equity shares at the time of disposal is attributable, directly or indirectly, to immovable property situated in South Africa and the non-resident owns at least 20% of the share capital of that company. An important aspect to consider with regards to CGT, where a land rich company is concerned, is that certain DTA's limit South Africa's taxing rights in cases where shares are disposed of / transferred by non-residents. Source On the assumption that the offshore holding company transferring the shares does not have its POEM in South Africa, and is therefore not regarded as a "resident", one must consider whether the source rules come into play. This is because non-residents are only subject to tax in South Africa on income from, or deemed to be from a South African source. Where amounts are from, or deemed to be from a South African source, a further enquiry is necessary to establish whether South Africa's taxing rights have been limited under a relevant DTA. The source of income from the sale of shares was considered in Overseas Trust Corporation Ltd v CIR, dealing with an investment company which carried on business in South Africa by buying and selling shares and securities, with a view to profit. During the course of the year of assessment in dispute the company had sold, amongst other assets, certain shares through brokers in Germany. The court held that the profits were derived from a source within South Africa due to the fact that the taxpayer carried on its share dealing activities in South Africa. It follows then that provided the factual circumstances support the view that the transfer of shares from one offshore group company to another occurred outside South Africa, it is unlikely that the source will be regarded as being from a source within or deemed to be within South Africa. Capital Gains Tax Notwithstanding the source rules discussed above, a non-resident will be subject to capital gains tax (CGT) on the disposal of shares in a South African company (commonly referred to as 'land rich' Securities Transfer tax The transfer of a security (including a share) of a company incorporated, established or formed inside South Africa will attract Securities Transfer Tax (STT) at the rate of 0,25% of the taxable amount (generally market value) of that security and is payable by the person acquiring the security, unless a specific exemption applies. In the current circumstance, STT would be payable by the South African subsidiary, however it has the right of recovery from offshore company acquiring the shares. Exchange Control Exchange Control is an often overlooked area in transactions of this nature. Dealings in securities in which non-residents have an interest are controlled in terms of Exchange Control Regulations which include the acquisition or disposal of any controlled security by a non-resident. The control is exercised by placing the endorsement "non-resident" on all securities owned, or in which non-residents have an interest. Without the required endorsement the offshore holding company would not be allowed to sell or transfer the affected securities to another offshore holding company. The endorsement of the securities will further facilitate the smooth repatriation of dividends in future. Ruaan van Eeden 2 l Tax Alert 21 January 2011

3 DIVIDENDS NOW TAXABLE IN CERTAIN SHARE INCENTIVE SCHEMES Companies must ensure that dividends declared to their employees after 1 January 2011 as part of their employee share incentive schemes are still exempt from income tax otherwise companies and their employees may be in for a surprise. In the Taxation Laws Amendment Act, No 7 of 2010 (the Amendment Act) amendments were made to the Income Tax Act No. 58 of 1962 (the Act) to the effect that dividends declared in respect of employee share incentive schemes shares will no longer be exempt unless: the restricted equity instrument constitutes an equity share; or the dividend constitutes an equity instrument as defined in section 8C of the Act. The critical issue to appreciate is the new definition of an "equity share" (which differs from the definition of an "equity instrument" in section 8C). An "equity share" is defined (with effect from 1 January 2011) in relation to a company as any share or similar interest in that company, excluding any share or similar interest that does not carry any right to participate beyond a specified amount in a distribution. Importantly, if any share in an employ share scheme does not carry the right to participate beyond a specified amount in a distribution, it will not be regarded as an "equity share". In addition, the new definition of an "equity share" requires the holder thereof to participate both in profits as well as a distribution of capital to be treated as an "equity share". It is therefore no longer an argument (as was the case with the old definition of an "equity share") that one would be dealing with an "equity share" if only one of the requirements is met (ie. entitled to participate in a distribution of either the profits or capital). For instance, an ordinary share in a company should not be affected by these amendments. However, share incentive schemes have been implemented using preference shares which may limit the employee's right to participate in the distributions of the company. Such shares held by an employee will not be regarded as an "equity share". Any dividends declared in respect of these shares (ie. shares that do not qualify as an "equity share") on or after 1 January 2011 will not be exempt from income tax. The employee will be liable to pay income tax on these dividends and the employer will have a responsibility to withhold pay-as-you-earn (PAYE) on behalf of the employee. Accordingly, these amendments will have implications for both the employee who will no longer enjoy the benefit of an exempt dividend and the employer who has an obligation to withhold PAYE. According to the SARS Explanatory Memorandum, the intention of the amendment is to align the treatment of capital distributions and dividends in respect of certain restricted equity instruments. Since 2008, capital distributions have been subject to income tax to prevent the partial cash-out by the holder of the restricted equity instrument, which reduces the value of the share. Similarly, in the case of a preference share, it was possible for a determined amount of dividends to be declared to the holder thereof before the shares vest in the employee. The employee therefore effectively "cashedout" in the form of exempt dividends before the vesting date and thereby reducing the value of the shares and ultimately the income tax liability falling within section 8C of the Act. If companies have not done so already, they should revisit their employee share schemes to ensure continued compliance with the Act and to ensure that the scheme still incentivises their employees. Companies should also be mindful that other minor amendments have been made to the Act which may have an effect on the tax treatment of their employee share schemes. Andrew Lewis 3 l Tax Alert 21 January 2011

4 TAX LITIGATION: PUZZLING QUESTIONS? There have been two cases recently which raise interesting conundrums when a taxpayer is engaged in litigating with the South African Revenue Service (SARS). In case number VAT 399 heard before the Tax Court sitting at Megawatt Park, SARS had issued an assessment relating to a VAT input credit (reported on SARS' website). The taxpayer was a Property Fund listed on the JSE. It had raised capital on the Exchange, and had initially claimed an input credit on the promoter's fee it had been charged for creating and issuing the linked units and buying the rental producing properties. Some six months later, the taxpayer reversed the input credit claim, and apportioned that input credit, treating some of the expenditure as pertaining to the creating and issuing of the linked units and the balance to the purchase of the properties (and therefore pertaining to the furtherance of making taxable supplies). The assessment was issued on the basis of the original input credit claim; there was confusion about the taxpayer's reversing that position and only subsequently claiming an input credit of R1,3 million. The court found that there was actually no dispute between SARS and the taxpayer: that the taxpayer had fully repaid the original input credit claim, and the subsequent R1,3 million was not in dispute based on the Rule 10 and 11 pleadings. The court arrived at an interesting conclusion as to how one claims an input credit. Relying on section 16(3) of the VAT Act, one must deduct the input tax from the sum of the output tax for that period. You cannot note on the side of the return that you are claiming such. If you did not claim it on the return, then it cannot be said that such amount was properly claimed. The correspondence did not serve to put the issue in dispute. So the matter was removed from the roll. It appears that you must claim the input credit on the return, and leave it for SARS to ascertain whether it wants to disallow the input. In the Supreme Court of Appeal, the case of Sprigg Investments 117 cc was delivered on 1 December 2010 ([2010] ZASCA 172). This was a matter appealed by SARS from the Tax Court sitting in Cape Town. The Tax Court had ordered SARS to furnish the taxpayer with adequate reasons for assessments for PAYE, VAT and income tax. When one gets into the body of Maya JA's judgment, the core problem in the matter was that the Tax Court had not been properly constituted. Thus the judgment being appealed to Bloemfontein was not a valid decision. Moreover, the highest court felt the judgment in the Tax Court had been poorly reasoned. Yet a decision of an improperly constituted court gets appealed directly to the highest court in terms of section 86A? Legally this is competent, but is it an appropriate use of SARS resources? But here was a real sting in the tail - the Supreme Court of Appeal held that the original matter should be struck from the roll. Because the taxpayer's original application for adequate reasons was held to be "mischievous" and costs were awarded against the taxpayer. The taxpayer (or his advisers) had better be careful what you ask a Tax Court for. Alastair Morphet To unsubscribe from this mailing list, please send an to marketing@dlacdh.com with Unsubscribe - Tax in the subject line. Or contact us if you wish to be added to our mailing list. This information is published for general information purposes and is not intended to constitute legal advice. Specialist legal advice should always be sought in relation to any particular situation. Cliffe Dekker Hofmeyr will accept no responsibility for any actions taken or not taken on the basis of this publication. 4 l Tax Alert 21 January 2011

5 CONTACT US For advice, please contact any member of our Tax team listed below. Emil Brincker National Practice Head T +27 (0) E emil.brincker@dlacdh.com Natalie Napier T +27 (0) E natalie.napier@dlacdh.com Ruaan van Eeden Senior Associate T +27 (0) E ruaan.vaneeden@dlacdh.com Ben Strauss Regional Practice Head T +27 (0) E ben.strauss@dlacdh.com Freek van Rooyen T +27 (0) E freek.vanrooyen@dlacdh.com Andrew Lewis Associate T +27 (0) E andrew.lewis@dlacdh.com Alastair Morphet T +27 (0) E alastair.morphet@dlacdh.com BBBEE STATUS: LEVEL TWO CONTRIBUTOR JOHANNESBURG 1 Protea Place Sandton Johannesburg 2196, Private Bag X40 Benmore 2010 South Africa Dx 154 Randburg and Dx 42 Johannesburg T +27 (0) F +27 (0) E jhb@dlacdh.com CAPE TOWN 11 Buitengracht Street Cape Town 8001, PO Box 695 Cape Town 8000 South Africa Dx 5 Cape Town T +27 (0) F +27 (0) E ctn@dlacdh.com If you would prefer to receive our publications electronically, please inform us by sending an to marketing@dlacdh.com with your full contact details th floor Protea Place Protea Road Claremont 7708, PO Box Claremont 7735 South Africa Dx 5 Cape Town T +27 (0) F +27 (0) E ctn@dlacdh.com EVERYTHING MATTERS Cliffe Dekker Hofmeyr is a member of DLA Piper Group, an alliance of legal practices