New dividends tax brings both simplicity and complexity

- Ernest Mazansky, Director - Werksmans Attorneys

South Africa has just fallen in line with international tax trends with the introduction of a dividends tax to replace the secondary tax on companies (STC), a move likely to make South Africa a more attractive foreign investment destination.

However, while this may simplify tax from the perspective of foreign investors, and go some way to attracting capital flows, for local companies it introduces a number of complexities, says Ernest Mazansky, head of Werksmans tax practice.

Speaking at a recent Werksmans-hosted tax seminar, he described the major difference as lying in who pays the tax. “Conceptually we have moved away from a company tax to an effective tax on shareholders payable on the distribution of dividends by a company,” he told seminar delegates.Dear Janine Connor,

Of interest to local companies is that the South African Revenue Service (SARS) acceded to pressure to give credit for the many millions in STC credits that are currently on the books of South African companies.

“This was a sensitive issue for companies that had already paid the 10% STC and now their shareholders will have to pay another 10% dividends tax. The tax amendment now allows companies in effect to off set the amount of STC paid, as a credit against dividends tax for a period of 5-years. But they have to notify shareholders of the deduction. Failure to do so effectively results in their having to pay double tax. If you don’t notify all shareholders, you cannot use the STC credit as far as those shareholders are concerned,” said Mazansky.

The new tax further extends the principle of directors’ liability. The new legislation has more teeth in that it deems certain executive directors and shareholders of an unlisted company that fails to withhold the tax, liable for the dividends tax. Directors of private companies need to take special care as they are personally liable where the dividends tax is not withheld and paid by that company.

“This is nothing new, but continues the disturbing trend of eroding the concept of limited liability for companies,” said Mazansky.

The dividends tax rate will remain at 10%, as is currently the case with STC, and not being company tax but a dividends tax payable by the shareholder, the effective South African company tax rate is now simplified and fixed at 28%.

Mazansky said this places our company tax rate on a par with international practice, is familiar to international investors and will assist in the creation of tax certainty for foreigners.

Under the previous STC regime, a company declaring dividends had an effective tax rate of around 35%, when one added the STC to the corporate tax rate.

Under the new system, South African shareholders will pay a slightly higher effective rate of tax than under STC because the dividend is now declared exclusive of any dividends tax. For example, if a dividend of R100,000 is declared, under STC, that R100,000 is deemed to include the STC. The calculation can simply be described as R100,000 x 10/110 which results in STC of R9,090, leaving a net dividend for distribution to the shareholder of R90,909. Under the new system, the R100,000 will attract a dividend tax of 10%, which is R10,000, and will result in a net dividend of R90,000. The shareholder receives R909 less as a dividend.

The treatment for foreign shareholders may be different: many countries have double taxation treaties with South Africa. In terms of about seven of them, their residents who are shareholders will not pay the dividends tax. Mazansky said these agreements were largely already re-negotiated, and only awaited signing and ratification, something that was expected to be completed between late-2009 and early-2010 – hence the delay in implementing the new tax. Government has indicated that it is quite happy with a reduction in the rate to 5% for certain foreign shareholders under South Africa’s treaties with other countries.

The areas of complexity introduced by the amendment include: the introduction of a class of exempt organisations; the simplified definition of ‘dividend’; and the introduction of a concept of ‘contributed tax capital’ (CTC) which now gets introduced into the legislation.

“The dividends tax will be payable on the payment of any dividend declared by a company, subject to certain exemptions. Most importantly, the exemption applies where the dividend is declared to another resident company, thereby eliminating the payment of dividends tax on inter-company dividend distributions. This will assist groups of companies tremendously and will avoid unnecessary administration,” said Mazansky.

Another exemption is made for dividend distributions to exempt entities, such as Public Benefit Organisations (PBOs) and by ‘very small businesses’, provided the dividend declared does not exceed R200,000 a year.

The concept of CTC means that companies will now effectively have to maintain a ‘tax balance sheet’ as well as the usual accounting balance sheet. Mazansky described this as one of the complexities of the amendment, with questions as to whether smaller companies could manage such dual accounting, and whether the SARS had the capacity to police it.

The effective date of the new dividends tax is yet to be determined by the Minister of Finance, Trevor Manuel.