PROPOSED CHANGES IN THE FOREIGN TAX POLICY ARENA

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PROPOSED CHANGES IN THE FOREIGN TAX POLICY ARENA

• National Treasury
• Tax Policy Chief Directorate

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Balancing of Interests (1)

• 1. Tax Policy should not accelerate the flow of
  capital offshore. Tax Policy should instead seek
  to retain capital wherever possible.
• 2. Capital outflows come in two forms
• a) South African business can shift various
  funds offshore.
• b) South African business can move their legal
  personality (i.e., their headquarters)
  offshore.

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Balancing of Interests (2)

• 3. Tax Policy must seek to prevent both the
  artificial outflow of funds and the artificial
  outflow of HQs.
• a) Total exemptions from tax in the foreign
  arena artificially encourage South African
  businesses to shift funds offshore.
• b) Uncompetitively high-tax measures in the
  foreign (and in the domestic) arena
  artificially encourage South African business
  to move their HQs offshore.
• 4. Tax measures must be balanced because both
  concerns are diametrically opposed to one another.

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The South African Context

• 1. The balance required in the South African
  context is particularly troublesome because
• a) South African taxpayers have
  disproportionately large amounts of liquid
  capital at their disposal. These liquid funds
  will be quick to capitalise on tax exemptions
  within the foreign arena.
• b) As an emerging market, South Africa must
  utilise a tax system that is more competitive
  than its industralised brethren or risk the
  flight of domestic HQs.

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Current Dividing Line

• 1. South African companies are not subject
  immediate tax on their active foreign operations
  held through foreign subsidiaries (technically
  referred to as Controlled Foreign Entities or
  CFEs). This lack of immediate taxation
  prevents the outflow of HQs.
• 2. However, the prevention of fund outflow
  requires, immediate tax for
• a) passive CFE portfolio income and
• b) CFE income from diversionary transactions.

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Pro-Competitive Amendments (1)

• 1. Enactment of a Participation Exemption
• a) Purpose To exempt dividends and sale
  proceeds for foreign shareholdings representing a
  meaningful participating stake in an active
  company.
• b) Requirements
• (i) The shares must be ordinary shares,
  or participating preference shares, in a
  company that does not consist mostly of passive
  financial instruments and
• (ii) The share interest before the transaction
  must amount to 25 percent of the total (and be
  held for 18 months for the gain sale exemption).

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Pro-Competitive Amendments (2)

• 2) Technical Changes
• a) The legislation ignores less than 5 per cent
  South African shareholders when determining the
  CFE status of listed foreign companies.
• b) The legislation reduces the capital gains tax
  to 10.5 per cent for individual ownership of
  tainted CFE income.
• c) The legislation reduces the statutory rate to
  13.5 percent for determining whether CFE
  capital gains are exempt under the designated
  country exemption.

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Pro-Competitive Amendments (3)

• d) The legislation expands the 5-per cent de
  minimis exception for passive capital gains
  (i.e., reducing the calculation from gross
  proceeds to net gain).
• e) The legislation extends the designated
  country exception to all dividends flowing
  through a designed country CFE even if the
  underlying profits were generated in a
  non-designated country CFE.
• f) The foreign dividend legislation eliminates
  deemed dividend treatment for the sale foreign
  shares. These sales now fall solely under the
  capital gains tax.

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Effective Dates

• The proposed amendments alter a variety of
  recently introduced items of legislation
  introduced over the course of the last 18 months
  (i.e., the capital gains tax, the residence-based
  tax, and the foreign dividend legislation).
  Taxpayer-favourable changes are being
  incorporated retroactively wherever possible.

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Liquid Portfolio Syphoning Amendments (1)

• 1. Currency changes
• a) Foreign Equity Instruments. Pursuant to the
  Capital Gains Tax introduced last April, most
  foreign non- currency asset sales will exclude
  currency gain/loss.
• (i) However, currency gain/loss will be
  included if that gain/loss arises from
  foreign equity instruments (e.g., listed
  foreign shares, listed unit portfolio
  interests, and commodities listed on an
  index).
• (ii) This tax applies equally to all taxpayers,
  including CFEs.

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Liquid Portfolio Syphoning Amendments (2)

• b) Distinguishing between 24I versus capital
  currency gains/losses. Section 24I versus the
  capital gains tax regime applies on an
  taxpayer-by-taxpayer basis.
• (i) All companies, any trust with a trade, and
  any individual who trades in currency items
  are subject to 24I with respect to all their
  foreign currency assets.
• (ii) All other taxpayers (e.g., individuals)
  are subject to the capital gains tax regime
  with respect to all their foreign currency
  assets.

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Liquid Portfolio Syphoning Amendments (3)

• (iii) Section 24I taxpayers are taxed on their
  foreign currency at ordinary rates at an
  annual mark-to- market basis, and all capital
  gains taxpayers are subject to tax only when
  converting into and out of a foreign currency.
• c) Anti-avoidance rules.
• (i) The list of foreign currency items will be
  expanded to include commodity forward
  contracts and commodity option contracts
  denominated in foreign currency forthcoming.

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Liquid Portfolio Syphoning Amendments (4)

• (ii) Currency losses on loans cannot be
  deducted if the loan proceeds are used to
  acquire foreign assets exempt from currency
  gain.
• (iii) Currency losses with connected CFEs
  cannot be deducted if no corresponding income
  is included.
• d) Foreign Currency Definition. The legislation
  refines the definition of foreign currency to
  provide priority for permanent establishments.
  Permanent establishments are exempt from
  currency taxation with respect to their local
  currency, and currency movements into and out
  of a permanent establishment trigger tax.

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Liquid Portfolio Syphoning Amendments (5)

• 2. CFE Passive income amendments
• a) Narrowing the financial institution
  exception. The legislation narrows the
  exemption for financial institutions to ensure
  that the exception does not cover treasury
  portfolio operations of intra-group finance
  CFEs.
• c) Anti-round tripping clause. The legislation
  narrows the exemption for financial
  institutions to prevent more subtle forms of
  round-tripping (shifts of interest offshore
  followed by the repatriation of dividends).