What is Annexure C anyway?

It’s coming round to that time of year where the South African tax community is talking about “Annexure C”. We, as tax professionals, are expected to know all about Annexure C, but what if you don’t know what it is about, or what it’s an Annexure to and don’t want to embarrass yourself at dinner-parties?  Well, then this newsletter is for you!

Every year in February, the SA Minister of Finance makes his Budget Speech and also announces new tax proposals to fine-tune the legislation to help his budget. Along with the Budget Speech, the Budget Review document is published which provides more details about the tax proposals mentioned and is avidly read by tax techies. The technical tax proposals are found in Annexure C of the Budget Review. Aha!  And then who contributes to Annexure C? Well, the National Treasury calls on the public, tax practitioners, and taxpayers to submit any tax technical proposals that they believe should be included. The tax technical proposals are, of course, not to be confused with tax policy proposals which are found in Chapter 4 of the Budget review, but let’s not worry about that today.

In early December 2022, various bodies, including the prestigious and well-informed South African Institute of Tax Practitioners (“SAIT”) submitted proposals for the current Annexure C. Below is a summary of some of the international tax proposals that were submitted:

Limiting the application of dividend exemptions in loop structures

Provision under consideration: section 9D(2A)(d)

SA individuals who hold shares in an SA company are subject to 20% dividend tax. However, where an SA individual holds shares in a Controlled Foreign Company (“CFC”) via a loop structure, the withholding tax rate on the dividends paid by the CFC to a SA company may be reduced by the relevant tax treaty and further any foreign dividend received from the CFC could be exempt from income tax in terms of section 10B of the Income Tax Act.  Clearly, the SA revenue wouldn’t like this, i.e. where tax on SA dividends could be reduced by flowing through an offshore structure or loop.

Thus in the last Budget Review, section 9D was amended with the intention to ensure that loop structures do not create a tax leakage from the SA tax base so that the 20% dividend withholding tax would apply even where an SA dividend flows through a loop. The intention of the amendment was to apply to only individuals and trusts who hold shares in a CFC but the amendment was extended to SA companies that hold shares in CFCs.

The proposal is that it be clarified that section 9D(2A)(d) does not apply where the shareholder of a CFC is an SA resident company. Furthermore, the inclusion rate should be amended to 20/45.

Amendments to the “deemed treasury operations” and “captive insurer” provisions

Provision under consideration: Section 9D(9A)(a)(iii)(aa) and (bb) read with section 9D(9A)(b)(iii) and section 9D(9A)(b)(iv)

The calculation of the net income of a CFC is subject to certain exemptions, in particular, the foreign business establishment (“FBE”) exemption found in section 9D(9)(b), which is further subject to the so-called diversionary rules in section 9D(9A). A closer look into section 9D(9A)(a)(iii)(bb) provides that exchange differences from a financial instrument should be included in the calculation of net income regardless of the FBE exemption unless the financial instrument is attributable to the principal trading activities of the FBE (i.e. bank, insurer, etc…) unless the principal activities constitute  “treasury operations” or “captive insurer”. Section 9D(9A)(b)(iii) and (iv) contain very broad provisions that deem activities of a FBE to be “treasury operations” or those of a “captive insurer”. The interpretation of the provisions of section 9D(9A)(b)(iii) and (iv) could deem a FBE whose principal trading activities are that of a manufacturer, to be a “captive insurer” or “treasury operations”. It has now been proposed that the deeming provisions should be limited to circumstances where the principal trading activities of the FBE are similar to those of a “treasury operation” or “captive insurer”.

Application of the FBE definition to Real Estate Investment Trust (REIT) income tax legislation

Provision under consideration: Section 9D(1), definition of FBE

The foreign business establishment (“FBE”) exemption provides that a CFC will have an FBE where the CFC has a fixed place of business in a foreign country, which is suitably staffed and equipped to carry out the operations of the business. In addition, sub-paragraphs (b) to (e) of the FBE definition deems mines, construction sites, farms, and fishing to be a FBE without necessarily meeting requirements of the FBE definition (i.e., suitably staffed or suitably equipped). The reasoning for the deeming provisions has been that it would be difficult to fabricate the substance of mines, construction sites, etc in a foreign country.

However, the FBE definition and its deeming provisions do not cater for SA REITs that own and operate the letting of rental properties situated outside SA, which could lead to them giving rise to potentially unwarranted SA tax. The proposal is that a sub-paragraph is included in the FBE definition, which would state “an immovable property and buildings outside the Republic used for rental activities carried on by that CFC”, which would essentially allow REITs to have a FBE.

Hopefully, this is enough to hold your head high over your Christmas canape chit-chat, the next interesting discussion will be when we see which of the submitted Annexure C proposals will flow through to the Budget Review in February 2022.

Should you have any questions on the current SA legislation, or anything else, please contact us.