The new Interest Withholding Tax: What attorneys need to know

May 1st, 2015
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By Barry Ger

On 1 March 2015, a new Interest Withholding Tax (IWT) came into effect in South Africa. From that date, 15% of any interest paid to or for the benefit of a non-resident, from a South African source, must be withheld and the payer of the interest is required to pay the tax over to the South African Revenue Service (Sars).

IWT is among several withholding taxes that South Africa has introduced in recent years. It joins –

  • the long standing royalties withholding tax;
  • a withholding tax on fees paid to foreign sportspersons and entertainers that debuted in 2005;
  • a 2007 withholding tax on proceeds from the disposal of immovable property to non-residents; and
  • the 2012 withholding tax on dividends.

Next year, a withholding tax on service fees paid to non-residents has been mooted.

This article attempts to address some of the most frequently asked questions pertaining to the new IWT. It will especially consider aspects of the new tax that are of relevance to attorneys that advise and assist clients involved in cross-border transactions.

Background

It would be useful, as a starting point, to explain why the IWT was introduced in the first place.

Prior to its introduction, interest payable to foreign lenders was exempt from South African tax unless such lenders actively participated in the South African economy in specified ways. That meant that South African tax could only be levied on interest paid to foreign residents that conducted business in South Africa through permanent establishments (ie, generally fixed places of business in South Africa) or to foreign residents that were present in South Africa for more than six months of the tax year. The underlying rationale for this exemption related to the need to attract capital flows to South Africa.

In 2010 however, the South African government, desperate for new sources of tax revenue, announced a change to this policy. It was noticed that most countries did tax interest paid to foreigners, so there was no need for South Africa to be overly generous in this area. Moreover, concerns were raised that the existing exemption fostered tax avoidance schemes and incentivised the funding of businesses with disproportionate debt over equity. Lastly, local funders complained that foreign debt was needlessly given a tax advantage over local debt. Hence, a decision was taken to tax interest on debt extended by foreigners.

Of course, it is, practically, very difficult to collect tax from non-residents that lack ties to South Africa and, for this reason, a withholding tax was proposed to facilitate ease of administration. Such a tax imposes the obligation for collection or withholding of the tax on the payer of the income as opposed to the recipient. Thus, if the payer is South African, it is easier for the tax authorities to enforce collection of the tax.

Although, the Taxation Laws Amendment Act 7 of 2010 introduced the legislative provisions that imposed the new tax, implementation was delayed for five years to give affected parties time to ready their systems for the withholding obligation.

Notwithstanding this lengthy period, given to businesspeople to prepare themselves for the new tax, there are still lingering questions related to it.

On what interest is the tax levied?

One of the key questions relates to the nature of the interest on which the IWT is levied.

In terms of the legislation, IWT may be imposed on South African sourced interest that is paid to or for the benefit of a foreign person by any person.

The statutory source provisions in the South African Income Tax Act 58 of 1962 deem interest to be from a South African source where that interest is, inter alia, received in respect of the utilisation or application, in South Africa, by any person of any funds or credit obtained in terms of any form of interest-bearing arrangement.

This means that the person paying the interest need not be a South African resident. Interest paid by a non-resident borrower to a non-resident lender may be subject to the IWT, if the non-resident borrower has utilised or applied, in South Africa, the funding obtained from the non-resident lender. This will result in a withholding obligation being placed on a non-resident.

Please note though that, in his February 2015 Budget Speech, Finance Minister Nhlanhla Nene has promised to clarify aspects of the definition of interest in the next round of legislative amendments to the Income Tax Act.

Not all South African sourced interest will be taxed. Exemptions from the IWT include interest payable by –

  • the government of South Africa (in the national, provincial and local sphere);
  • any bank;
  • the South African Reserve Bank;
  • the Development Bank of South Africa; and
  • the Industrial Development Corporation.

Interest payable on so-called ‘listed debt’ is also exempt from IWT, regardless of the nature of the person paying the interest. (It should be noted that these exemptions are subject to some exclusions. In particular, taxpayers attempting to circumvent IWT through back-to-back loans with banks are in for a nasty surprise – the IWT will be levied on such arrangements. Back-to-back loans refers to arrangements under which banks act as intermediaries for funding between foreign lenders and local borrowers.)

In addition, the IWT provisions make allowance for a reduction in the rate of IWT where the provisions of a Double Taxation Agreement so provide. A Double Tax Agreement refers to a treaty between South Africa and another country that allocates taxing rights. Many of South Africa’s double tax agreements reduce the IWT rate – in some cases completely eliminating it. However, the foreign recipient must provide a specific declaration before the payer is permitted to apply the reduced rate. The wording for this specific declaration is available on the SARS website at www.sars.gov.za.

When is the tax levied?

A further tricky question relates to when the tax is levied on the aforementioned interest.

According to the relevant legislation, the IWT provisions will be applicable to interest that is paid or becomes due and payable on or after 1 March 2015.

The meaning of the words ‘due and payable’, however, is not defined in the legislation and is not entirely clear.

It is indicated in the explanatory memorandum to the new legislation, as well as in other documents prepared by the drafters, that the change in wording means that IWT will not necessarily be imposed on accrual of interest (ie, the date when the recipient acquires an unconditional right to the interest).

There is also strong persuasive judicial precedent which indicates that an amount will only become ‘due and payable’ at the time at which payment of the amount is stipulated by the parties.

The difference between when an amount of interest is ‘incurred or accrues’ relative to when the amount is ‘due and payable’ may be illustrated by a vanilla bullet loan arrangement in terms of which interest is calculated at a fixed rate over the period of the loan but is only payable at the end of the term. From an income tax perspective, the interest on the loan will be deemed to have been incurred or to accrue on a yield to maturity basis over the term of the loan. The interest is, however, only ‘due and payable’ at the end of the term of the loan (assuming that the words ‘due and payable’ means at the time at which payment of the amount is stipulated by the parties).

What happens if the tax is not paid?

Failure to comply with the IWT provisions could lead to a tax liability for the party charged with collections of the tax and imposition of penalties and interest on unpaid taxes.

Summary and what attorneys need to know

In summary, attorneys need to be aware of the following important points with respect to the IWT:

  • It is imposed on all South African sourced interest paid to non-resident person subject to certain exemptions – this means that even amounts paid by non-resident clients could be subject to the IWT.
  • Interest from South African banks is exempt from the IWT unless it arises from a back-to-back loan.
  • Double Tax Agreements should be checked to see if they reduce the IWT rate imposed on the interest, but to get the benefit of the reduction, the foreign recipient needs to provide the payer with a specific declaration.
  • IWT will only be imposed on interest that is paid or becomes due and payable. Amounts only become due and payable at a time stipulated by the parties.
  • Penalties and interest can be levied on the payer if the IWT is not withheld.

Barry Ger BBusSc LLB BCom (Honours) (Taxation) (UCT)  is an associate director at KPMG in Cape Town.

This article was first published in De Rebus in 2015 (May) DR 48.

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