SA Tax Developments – The Latest TLAB

This past weekend was jam-packed with much excitement and anticipation (and not just because the Springboks barely managed to secure a win over Argentina). On 31 July 2023, the South African Revenue Service (“SARS”) and National Treasury released a whole bunch of important tax documents for stakeholder engagement and public comment.
As you may recall, on 22 February 2023 the South African Minister of Finance delivered his annual Budget Speech. Essentially, the Draft Taxation Laws Amendment Bill 2023 (“TLAB”) addresses aspects mentioned in the Budget Speech and provides relevant stakeholders (including the public) an opportunity to examine the proposed amendments and additions to the legislation. Today we summarise some of the crucial amendments.

The South African CFC rules are complex but essentially where a foreign company is majority owned (or controlled by way of voting rights) by South African (“SA”) tax residents (companies or individuals) you have a CFC, which can be subject to SA tax. One of the exemptions available for a CFC is the FBE exemption, which says that a foreign company that has a legitimate foreign business, does not have to attribute its income and gains to its SA shareholders. Lately, Government has started noticing that CFCs are retaining their management functions but outsourcing their “primary functions”, i.e. the legitimate business part, to other countries and even back to South Africa, and on top of that, being paid for it offshore. (A recent case that had everyone abuzz was the Coronation case which deals exactly with this issue).

The FBE has multiple requirements but specifically mentions the location of “primary operations”. Now, it is being proposed that a CFC’s important functions (i.e. its “primary operations”) for which the CFC is being compensated, should either be carried out by the CFC itself or carried out by another CFC in the same group of companies that is located in the same country as the first CFC in order to qualify for the FBE.

So, in a nutshell, the outsourcing of primary functions would only be allowed by a FBE if it is outsourced to another CFC within the same country as the first CFC. The amendment will take effect from 1 January 2024 and will apply to all foreign tax years of CFC’s ending on or after 1 January 2024.

At its core, the purpose of PN 31 was to offer a concession to taxpayers that accrue interest income, by granting them a deduction in respect of the expenditure incurred in the production of interest without the taxpayer having carried on a trade (essentially SARS was being nice by offering a deduction provided the requirements were met). However, some taxpayers started abusing this tax deduction concession in various naughty ways.

Of course, SARS then announced its intention to withdraw PN 31 on 16 November 2022 (and let’s just say this caused a lot of sensation).

Under the new proposal, (which will take effect from 1 January 2024), companies which form part of the same “group of companies” will be allowed to deduct expenditure incurred in the production of interest income accruing from another group company, provided certain requirements are met.

According to SARS these requirements will eliminate tax leakage where funding is raised by one group company for purposes of another group company (for productive purposes). And as you may have deduced, if funds are used within the group for non-income producing purposes no deduction may be claimed.

Back in 2016 SARS brought in anti-avoidance rules for low-interest or interest-free loans to trusts – the infamous section 7C. The idea was to prevent the tax-free transfer of wealth to trusts using interest-free loans, advances or credit. Essentially, the low-interest or no-interest portion of a loan is considered a deemed donation (so donations tax is payable).

In determining the donated amount, by looking at what SARS wants the interest to be, the SARS “official rate” of interest is used which could either be applicable to Rand denominated or foreign denominated loans. The official rate refers to the Reserve Bank repo rate for Rand denominated loans, and its equivalent for foreign denominated loans, for instance the Bank of England’s interbank lending rate for GBP loans.

Under the new proposal, SARS has clarified what to do with a foreign-denominated loan as well as loans which relate to the purchase of a primary residence. SARS has now set out that, for loans denominated in a foreign currency (i.e. not in Rands), the deemed donation will be calculated by translating the foreign amount to Rands by applying the spot rate on the last day of the year of assessment of that trust (28 February) or company.

In addition, where a loan is made to a trust and the trust uses that money to fund the purchase of a primary residence (that will be used by the lender, or spouse of the lender, as their primary residence throughout the period during the year of assessment), an exclusion from the application of the anti-avoidance measure already applies (good news!). It is proposed that the definition of primary residence be amended to align with the wording set out in the Eighth Schedule.

The above-mentioned changes will come into effect on 1 January 2024 and apply to any amount owed by a trust or company in respect of a loan, advance or credit provided to that trust/company before, on or after that date.

Where an individual ceases their South African tax residency, two split years of assessment are created within one tax year. Practically, the individual is forced into two years of assessment. Year 1 being the time from 1 March to the day before the individual ceases their SA tax residency (the resident year) and the next year which begins from the date of ceasing tax residency to 28 February of the following year (Year 2 or the non-tax resident year).

As you may or may not know, in the event of the above (for individuals) the annual interest exemption is already being apportioned, and the annual capital gains tax exclusion is limited. Under the new proposal, in order to avoid any inconsistencies, where an individual’s year of assessment is less than twelve months, the annual contribution limit to Tax Free Investments (which is currently R 36 000) will now also be apportioned.

Additionally, in respect of retirement fund contributions the deduction allowed to be claimed will be limited to R 350 000 in a year of assessment. As you may have guessed by now, this amount will also be apportioned where an individual’s resident year of assessment (Year 1) is less than twelve months.  These changes will come into effect as from 1 March 2024.

As can be seen from the amendments discussed above, tax legislation is constantly changing in an attempt to address (and re-address) inconsistencies, problem areas as well as general provisions and principles. It is important to take part in the legislation process and comment when asked to do so. Public comments will close on 31 August 2023 at close of business.

If any of the amendments discussed above raise red flags for you, or if you’d like to discuss how the changes could impact your business, do reach out

Today’s newsletter was a team effort by the Regan van Rooy International Tax ladies. For any queries or comments you are welcome to contact Liane who will happily assist, email her at lbouwer@reganvanrooy.com