Dividends withholding tax

June 1st, 2012
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What the new 15% dividend tax means for small business owners

By Nadia Dalvie and Barry Ger

Many were surprised when Finance Minister Pravin Gordhan announced, on 22 February 2012, that the dividend tax rate would be 15% instead of 10% as initially proposed.

Dividend tax has been in the pipeline for some time; the first announcement being made as early as 2007 that secondary tax on companies (STC) would be removed and dividend tax introduced. Since then, legislation has been enacted annually to provide the groundwork for the implementation of dividend tax, which became effective from 1 April 2012. This article examines what the new 15% dividend tax means for small business owners and how it will influence profit distribution decisions made by small business owners.

As a starting point it will be useful to consider why it was necessary to remove STC and introduce dividend tax.

Reasons for removing STC and introducing dividend tax

STC was a tax imposed on companies, at a rate of 10%, on the declaration of any dividends or distributions from those profits declared or deemed to be declared to shareholders of the corporate entity. The payment of the tax was made to the South African Revenue Service (SARS) by the company liable for the tax.

When it was originally introduced, it effectively ‘disguised’ the official corporate tax rate without adversely affecting revenue collection through the effective rate and it provided SARS with an easier method to collect a tax on dividends, at the company level, rather than taxing dividends in the hands of numerous small shareholders.

STC’s downfall, however, was that it was too confusing for international investors since the majority of other countries tax dividends at shareholder level. Further, when comparing corporate tax rates of those countries with South Africa’s combined normal corporate tax rate and STC, it appeared that South Africa’s corporate rate was higher than in those countries, which dissuaded foreign investment. Therefore, to align South Africa with international practice and to make it a more attractive international investment destination, STC was removed and dividend tax was introduced.

Key differences between dividend tax and STC

Although both dividend tax and STC are taxes on dividends, there are substantial differences between them. For example:

  • Dividend tax is a tax imposed on shareholders at a rate of 15% on payment of dividends, whereas STC was a tax imposed on companies, at a rate of 10%, on the declaration of dividends.
  • Dividend tax is categorised as a withholding tax because the tax is withheld and paid to SARS by the company paying the dividend or by a regulated intermediary (ie, a withholding agent interposed between the company paying the dividend and the beneficial owner) and not the person liable for the tax (ie, the beneficial owner of the dividend). STC was paid by the company liable for the tax.
  • STC provided that the dividends declared by certain companies were exempt based on the status of the declaring company. In terms of dividend tax, however, the dividend payments could be exempt from dividend tax depending on the nature or status of the recipient.

(See SARS ‘Introduction to dividends tax’ www.sars.gov.za, accessed 18-4-2012.)

How dividends withholding tax affects small business owners

When a small business owner conducts business through a company that makes a profit, it may be difficult for him to decide how to reward himself for his work. Should he, as an employee of the company, increase his salary or should he, as a shareholder, receive his share of the profits in the form of a dividend? Inevitably, the decision will come down to the tax-saving involved.

This means comparing the tax effect that each payment method has for the business owner and the company, and identifying the payment method that results in the least tax payable. An increase in salary will result in an increase in the personal tax the business owner will pay, but it will also result in an increased tax deduction for the company that employs him. A dividend prior to 1 April 2012 would have resulted in no tax payable by the business owner, but the company that paid the dividend would have been liable for 10% STC. However, since 1 April 2012 things became more complicated.

An example is set out below to illustrate the impact dividend tax has on the bottom line of the company and on the decision of an individual who owns all the shares in the company housing his business about whether to increase his salary or declare a dividend.

Mr L is a South African resident, the sole owner of a law practice that he owns through a company of which he is the sole shareholder. He is in the highest tax bracket of 40%, is younger than 65, takes a monthly salary of R 55 000 from the company and has no other income in addition to the salary. His company has generated profit of R 100 000 during the 2013 tax year, which he wants to distribute to himself. Mr L must decide whether he wishes to include this amount in his monthly salary for February 2013 or whether to declare it as a dividend.

The first step Mr L should take is to determine what taxable income he will receive under the different scenarios. Once this has been determined, the concomitant tax liability can then be calculated. However, since Mr L is the sole shareholder of the company, the tax effects on the company must also be taken into account when making this decision. A decision can then be made as to which scenario has the best overall effect for Mr L and his company.

Scenario A: Declare the R 100 000 as a dividend before 1 April 2012 (STC)

Scenario B: Declare the R 100 000 as a dividend after 1 April 2012 (dividend tax)

Scenario C: Include excess
R 100 000 as salary in

February 2013

In this scenario Mr L’s company declares the excess profit it has generated as a dividend before 1 April 2012, that is, before the implementation of dividend tax. Therefore, Mr L’s company will have to pay STC at the rate of 10% on the dividend it declares. In this scenario Mr L’s company declares the excess profit it has generated as a dividend after 1 April 2012, that is, after the implementation of dividend tax. Therefore, Mr L’s company will have to withhold dividend tax of 15% on the dividend it declares.

In this scenario Mr L’s company pays out the excess profit of

R 100 000 it has generated as an additional salary for Mr L in February 2013. Mr L’s company will therefore receive a tax deduction for the additional salary expense it has incurred in the production of its income.

Taxable income for Mr L:

The dividend received by Mr L will be net of the STC of 10% paid by Mr L’s company. Therefore the dividend will amount to R 100 000 – (R 100 000 x 10/110)
= R 90 909,09

Taxable income for Mr L:

The dividend received by Mr L will be net of the 15% dividend tax withheld by Mr L’s company. Therefore, the dividend will amount to R 100 000 – (R 100 000 x 15%)

Dividend:

R100 000 – (R 100 000 x 15%) = R 85 000

Taxable income for Mr L:

Mr L’s income will be boosted by an additional salary of

R 100 000.

 

 

 

Tax payable by Mr L:

Nil

Tax payable by Mr L:

Dividends withholding tax:

R 100 000 x 15% = R 15 000

Tax payable by Mr L:

Normal tax payable:

R 100 000 x 40%

= R 40 000

Tax effect for Mr L’s company:

The tax effect for Mr L’s company is to pay STC of 10% on the dividend it declares to Mr L as STC was imposed on companies.

 

STC payable:

R 9 090,91

Tax effect for Mr L’s company:

This scenario has no tax effect for Mr L’s company because dividend tax is imposed on shareholders and not the company.

Tax effect for Mr L’s company:

Since the corporate tax rate is currently 28%, this will result in a tax saving of the additional salary multiplied by this rate.

Salary expense deduction:

= (R 100 000)

Tax effect = (R 100 000 x 28%)

= (R 28 000) tax saving for the company

Overall tax effect:

Tax of R 9 090, 91 is paid.

Overall tax effect:

Tax of R 15 000 is paid.

Overall tax effect:

Tax of R 40 000 is paid by Mr L, but Mr L’s company has a tax saving of R 28 000, which means that only
R 12 000 of tax is paid overall.

 

Based on the assumptions set out in the scenarios illustrated above, it is apparent that before the implementation of dividend tax it would have been more beneficial for small business owners to declare dividends. However, subsequent to the implementation of dividend tax, and taking the tax effects of the company into account, the more beneficial option for the small business owner would be to distribute the excess profit as a salary amount.

As illustrated above, where the taxpayer is the sole shareholder of his company, the tax effect of the excess salary expense incurred by the company has a considerable impact on the decision to distribute the excess profit as a salary or dividend. If the excess profit is distributed as a salary, it will be an expense incurred by the company, in the production of its income, and thus deductible for tax purposes by the company. Therefore, even though the normal tax payable by Mr L is higher if the excess profit is distributed in the form of a salary increase, the fact that Mr L is the sole shareholder of the company means that any tax benefit that accrues to the company will ultimately benefit him.

Please note that the outcome and conclusions drawn in the example illustrated above are based on the assumption that the taxpayer is paying tax at the highest tax rate of 40%. The outcome may differ substantially should the taxpayer be paying tax at a lower rate. It is therefore advised that the steps set out in the scenarios above be applied to a taxpayer’s specific circumstances to determine which of the outcomes will be most beneficial before blindly deciding to pay excess profit in the form of a salary rather than a dividend.

Regarding the more practical aspects of dividend tax, according to SARS, from 20 April 2012 taxpayers can request a dividend tax return (DTR02), which is available on SARS e-filing and over the counter at SARS branches. Taxpayers will be required to request the return for a specific transaction period, complete the applicable dividend tax-related data, and submit it to SARS and make payment, where applicable, against the payment reference number (PRN) provided on the return.

In addition, SARS is currently finalising the design and implementation of an ‘end-to-end’ solution that will enable all parties involved in the dividend tax process (issuing company, withholding agents and beneficial owners) to submit the relevant data and make dividend tax payments to SARS.

Lastly, given that dividend tax is here to stay, individuals and companies should familarise themselves with their dividend tax compliance requirements and consider the best method of extracting value from their companies.

Nadia Dalvie CA (SA) BBusSc (Finance CA) (UCT) is a tax consultant at KPMG and Barry Ger BBusSc LLB BCom (Hons) (Taxation) (UCT) is a senior manager at KPMG.

This article was first published in De Rebus in 2012 (June) DR 52.