By Xolani Jadezweni, Individual Tax Compliance Consultant at BDO SA
The Income Tax Act (the Act) amendments as it relates to the tax exit charges on interests in immovable property is of interest, especially in light of the recent amendments to the double tax treaty between South Africa (SA) and Mauritius (concluded on 17 May 2013). Residents of SA are taxed on their worldwide income which includes capital gains tax on the disposal of most categories of assets, whereas non-residents are taxed in South Africa on SA sourced income. Non-residents are subject to capital gains tax on, among others, the disposal of immovable property in SA and any “interest” in immovable property in SA.
These amendments resulted from the Tradehold Ltd case in which a SA incorporated company moved its place of effective management from SA to Luxembourg. It retained an office in SA and one of the directors continued to operate on its behalf from that office. Tradehold (under the law applicable then) was a resident of SA under domestic rules as it was incorporated in SA, and a resident of Luxembourg under Luxembourg law and, in terms of the DTA, by reason of its place of effective management in Luxembourg. Tradehold ceased to be a SA resident and was deemed to have disposed of its assets, with the exception of immovable property in the Republic and assets attributable to a permanent establishment in the Republic, on 1 July 2002, the day prior to the date on which it ceased to be a resident. SARS did not levy the exit charge on 1 July 2002 as the South African office constituted a permanent establishment and the assets were attributable to that permanent establishment. On 29 January South Africa. The Act at the time contained a secondary trigger to catch assets excluded from the primary trigger which imposed an exit charge on:
“...an asset of a person who is not a resident, which asset ... ceases to be an asset of that person’s permanent establishment in the Republic otherwise than by way of a disposal contemplated in paragraph 11…”
Tradehold’s assets ceased to be an asset of a permanent establishment in South Africa when the director left South Africa. However, Tradehold then still qualified as a resident as a result of its SA incorporation. As it was not “a person who is not a resident” at that time, no exit charge could be levied. The definition of “resident” was amended (with effect from 26 February 2003) to exclude a person deemed to be exclusively a resident of another country under a double tax treaty.
Certain double tax treaties allow for the complete non-taxation of capital gains arising from the disposal of an interest in immovable property situated in South Africa. This may occur firstly if South Africa does not levy an exit charge in respect of interests in SA immovable property upon cessation of a company’s SA residency and secondly because South Africa may not tax the company when it disposes of its interest in an immovable property-rich entity (i.e. an interest in immovable property) if it is no longer resident in SA due to the narrow interpretation of the concept of ‘immovable property’ that applies for purposes of some double tax treaties. Accordingly, SA loses economically. It is this loophole which National Treasury sought to close down by the amendments to the Act.
During the relevant year of assessment in the Tradehold case, the Act’s primary exit charge trigger applied to:
- A person who ceased to be a resident;
- A controlled foreign company that ceased to a controlled foreign company; or
- A resident person who ceased to be a resident due to the application of a double taxation agreement.
One of the amendments (introduced retrospective to 8 May 2012) determined that, in addition to the person being deemed to have disposed of its assets on the day prior to ceasing to be a resident, the person’s year of assessment is also deemed to have terminated on that day. The Act imposes an exit charge on a capital or income gain when a resident person ceases to be resident during a year of assessment due to the deemed disposal at market value of the various assets for which this section provides. Similar capital or income gains will be imposed as a result of the deemed disposal at market value of the various assets if a resident company ceases to be a resident or a company becomes a headquarter company during a year of assessment or a controlled foreign company (CFC) ceases to be a CFC in relation to a resident during a foreign tax year of that CFC. As the disposal is deemed to be made before the taxpayer ceases to be a resident, a double tax agreement between the taxpayer’s new country of residence and South Africa that exempts the taxpayer from a capital gains exit charge in SA, should be ignored. The amendment aligns with SARS and National Treasury’s agenda to tax gains on the disposal of certain shares held in SA companies, which is also evident from the newly amended double tax treaty between South Africa and Mauritius. The amended treaty now provides that the taxing rights in relation to shares held by a Mauritian company in a South African company are given to South Africa if the South African company derives more than 50% of its value from immovable property located in South Africa. The amendment and re-negotiation of the treaty with Mauritius are strong indications that South Africa is serious about securing its taxing rights to gains derived from a South African source.