As exchange controls are relaxed, the tax net gets tighter

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As outlined in the Budget Review: “Government will be modernising the foreign exchange control system. As a result, a new capital flow management system will be put in place. This new system will move from a ‘negative list’ system to one where all foreign-currency transactions, other than those contained on the risk-based list of capital flow measures, being allowed.”

The phasing out of the current concept will have a direct impact on the application of the tax rules as the legislation makes provision for payment of lump-sum retirement benefits when a member emigrates from South Africa and such emigration is recognised by the SARB for exchange control purposes. 

The draft Taxation Laws Amendment Bill, which was published at the end of July 2020, comes with an overhaul of the regime for taking your pension benefits abroad. In terms of the proposed amendments, expatriation of these benefits will be subject to a much stricter process from 1 March 2021 onwards.

In respect of individuals, one of the changes to be implemented is the phasing out of the concept of “emigration” for exchange control. 

According to Jean du Toit, Head of Tax Technical at Tax Consulting SA, under the current dispensation, taxpayers may withdraw their retirement funds prior to their retirement date, upon emigration for exchange control purposes. 

The lump-sum payments are allowed when a member of pension preservation, provident preservation or retirement annuity fund withdraws from such structures due to emigration to another country. 

“This means that emigrating members can withdraw, with normal withdrawal taxes payable, without having to wait until the retirement age of 55 to do so,” says du Toit. “With the announcement to move away from SARB formal emigration, there is a need to change this provision.” 

How Are Currency Exchange Rates Determined? | Britannica

The new tax bill proposes an amendment, however, which still provides for a payment of a lump sum benefit when a member ceases to be an SA tax resident, but only if such member has remained a non-tax resident for at least three consecutive years or longer. 

It essentially means that the lump sum payments can only be made three years after ceasing to be an SA resident, and when the change comes into operation on 1 March 2021, people’s capital might be tied for longer than hoped.

That is according to Ruaan van Eeden, tax and exchange control specialist and RTX Advisory. “From 2021, if the bill is approved, a person can prove they have been non-resident for tax purposes for that unbroken period of time, which could prove controversial.”

He says the amendment itself does not come as a surprise, as the government made its intentions clear in the Budget Speech, but the specified time period might turn out to be controversial. “No reason has been given for the stipulation.” 

“The determination of a person’s tax residency is very much an exhaustive, fact-driven enquiry. It is inconceivable to see how SARS will accept an assertion of non-residency unless you have indicated a cessation of residency in your tax return at some point,” he adds. 

The other significant change proposed in the bill is the relaxation of exchange control rules in respect of “loop structures”.

According to the Explanatory Memorandum, “loop structures (where a SA resident owns in excess of a 40% shareholding of a foreign company that reinvests into the Common Monetary Area back home), are currently in contravention of the Exchange Control Regulations as they contravene the regulation that capital or any right to capital is directly or indirectly exported from SA”.

If the bill is enacted, a resident corporate shareholder will be taxed at 28%, which results in a 20% effective tax rate on South African dividends received by a foreign-held company. 

A loop structure arises where a South African exchange control resident (individual or company), has an interest in a foreign structure and that foreign structure directly or indirectly owns assets in the Common Monetary Area, consisting of South Africa, eSwatini, Lesotho and Namibia, says Robyn Berger, tax partner at Bowmans.

“The law currently prescribes that these structures are only permitted in very limited circumstances, typically where South Africans in aggregate do not own more than 40% of the shares in the foreign company, regardless of the extent of ownership held by the foreign company in the local assets.”

The intention now is to abolish the exchange control prohibition on loop structures, she adds. “It is very concerning that some of the proposed changes do not only address perceived tax leakage, but add a substantial additional tax burden, thus penalising certain loop structures.”

Accordingly, while loop structures will become permissible from an exchange control perspective, some of the tax proposals are so punitive that one can only speculate as to whether South Africans will, in fact, benefit from the proposed loop structure relaxation, Berger says.

If the bill is enacted, a resident corporate shareholder will be taxed at 28%, which results in a 20% effective tax rate on South African dividends received by a foreign-held company. 

In addition, the inclusion rate is not adjusted where the resident shareholder is an individual, which means that South African dividends could be taxed at a rate of up to 32.14% where the resident shareholder of the offshore operation is an individual.

Capital gains tax also applies and the tax cost will also not be reduced under any applicable Double Taxation Agreement. 

Bernie Herberg, Director in the Relationship Management Division at Stonehage Fleming, says, however, “It is important to note that the details on the proposed changes are not final. There is an opportunity for the public to comment, which may result in amendments before the final legislation comes into effect.”

Meanwhile, Treasury announced that it will make a request to the standing committee on finance for the extension of Covid-19 tax relief measures, including streamlined special tax dispensation for funds established to assist with Covid-19 disaster relief efforts; deferral of the payment of employees tax liability for tax compliant small to medium-sized businesses and a 90-day deferral for the payment of excise taxes on alcohol and tobacco. 

Main Image: Non Res SA

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