This article was first published in the fourth-quarter 2013 edition of Personal Finance magazine.
Significant changes to the taxation of income from investments in shares came into effect on March 1, 2012, affecting the 2012/13 tax year and subsequent years. The upshot of the changes has been to align the taxation of local and foreign interest and dividends.
To understand these changes, we need to compare the tax treatment of interest and dividend income from offshore portfolio investments with the tax treatment of similar income from domestic sources.
For the sake of simplicity, the scope of the comparison is restricted to (i) interest income, (ii) dividend income from a share portfolio, and (iii) income distributions from a collective investment scheme (CIS), such as a unit trust fund. The tax treatment discussed applies to income received directly by a natural person who is resident in South Africa for tax purposes.
The use of an investment trust or investment holding company is likely to result in different tax consequences and is not covered.
Local interest
Interest earned from South African sources is taxed subject to the following exemptions:
* Individual taxpayers under 65 years on the last day of assessment: R22 800 in the 2012/13 tax year and R23 800 in the 2013/14 tax year.
* Individual taxpayers over 65 on the last day of assessment: R33 000 in the 2012/13 tax year and R34 500 in the 2013/14 tax year. Assuming an interest rate of five percent, this means that an individual over 65 could, for example, invest up to R690 000 tax-free for the tax year that ends on February 28, 2014 (five percent of R690 000 is R34 500).
Local dividends
With effect from April 1, 2012, a dividends tax of 15 percent is required to be withheld in respect of:
* Dividends from South African-resident companies; and
* Cash dividends from dual-listed foreign companies in respect of their shares listed on the JSE.
Exemptions are available to certain recipients of dividend income, such as South African companies and retirement funds, but South African residents will receive dividends less dividends tax of 15 percent. No deduction is available for any expenses incurred in the process of earning the dividend income.
Definition of a dividend
Shareholders can receive returns from their share investments in various forms:
* Cash dividends (sometimes referred to as a distribution);
* Dividends in the form of assets other than cash (scrip or in specie dividends);
* Free issues of shares (capitalisation or bonus issues);
* Returns of capital; and
* Companies may also purchase their own shares from shareholders (share repurchase or buy-back).
The definition of a dividend is very wide and includes any amount transferred by a South African company to a person in respect of any share in that company, regardless of whether the amount is transferred by way of a distribution or as consideration for the acquisition of a share in that company (share repurchase or buy-back, as above).
However, there are exclusions. Any amount that results in a reduction in the company’s capital (basically, the share capital and share premium or stated capital, subject to special rules) and any return arising from a capitalisation issue is not regarded as a dividend, and other tax rules apply.
Another exclusion applies in the case of general share repurchases in respect of JSE-listed companies. Such repurchases are treated as disposals rather than dividends, so they are not taxed as dividends. Instead, disposal proceeds are subject to the capital gains tax (CGT) rules if the investment was held as a long-term capital investment.
Other share buy-backs may, however, be subject to dividends tax of 15 percent, and the taxpayer will receive the amount after dividends tax has been deducted. Companies are required to inform recipients so that taxpayers can properly account for the distributions received.
Distributions from a local CIS
A South African CIS may earn returns in various forms, such as interest and dividends. The income that a local CIS distributes to its unit holders keeps its underlying form for tax purposes. Accordingly, the holder of a CIS unit will be advised of the nature of the income that makes up the distribution, which could be a combination of local interest and dividends and foreign interest and dividends. Local interest and dividends are taxed as outlined above. Foreign interest and dividends are taxed as set out below. The rules differ if the CIS has not distributed its income within a 12-month period, but this is an unusual occurrence.
Foreign interest (including the foreign interest portion from a local CIS)
The interest is fully taxable. Until February 29, 2012, the first R3 700 of foreign dividends and/or interest was exempted, but this fell away with effect from March 1, 2012 (the start of the 2012/13 tax year).
Foreign dividends (including the foreign dividends portion from a local CIS)
With effect from March 1, 2012, 37.5 percent (15 ÷ 40) of the foreign dividends arising from a portfolio of shares accruing to a natural person is treated as taxable. At the highest marginal rate of 40 percent, this will result in a maximum tax rate of 15 percent (in line with the 15-percent dividends tax on local dividends), and proportionally less at lower tax rates.
JSE-listed shares of foreign companies that are dual-listed are subject to the dividends tax of 15 percent that applies to all local dividends. The only exception to this is in specie dividends, which are treated as foreign dividends and taxed accordingly.
A full exemption from tax on foreign dividends applies where a natural person holds 10 percent or more of the equity shares and voting rights in a foreign company, unless the company is a CIS. (Most foreign CIS’s are regarded as foreign companies for South African tax purposes and income distributions are regarded as foreign dividends.)
A specific prohibition disallows deductions for any expenses that may have been incurred to earn the foreign dividends. This aligns the treatment of local and foreign dividends. Once again, the exemption in respect of the first R3 700 of foreign dividends and/or interest fell away with effect from March 1, 2012.
Distributions from a foreign CIS
Since income distributions from foreign CIS’s are regarded as foreign dividends, again the taxable portion is 37.5 percent and the maximum effective tax rate is 15 percent for individuals taxed at a marginal rate of 40 percent, or less than that if the marginal rates are lower. And again, no deductions are allowed for expenses incurred.
If the foreign CIS invests in interest-bearing securities, the foreign interest income is regarded as part of the distribution and is treated as a foreign dividend. Thus, only 37.5 percent is taxable. Once again, no deductions are allowed for expenses.
Definition of a foreign dividend
Whether an amount received from a foreign company in respect of shares is a foreign dividend depends on the income tax legislation in the country where the company is effectively managed. Where there is no such legislation, one looks to the company law in the country where the company is incorporated.
A specific exclusion relates to payments from a foreign CIS when you redeem or dispose of your units. In this case, the amount received is treated as a disposal. Units held as a long-term investment would therefore be subject to CGT. Previously, although this was not widely known, an amount received from the disposal of units could be treated as a foreign dividend and therefore subject to income tax. This anomaly has been corrected in line with the new tax treatment of local and foreign dividends.
Capitalisation issues are also excluded from the definition of a foreign dividend and are therefore not subject to the maximum tax of 15 percent.
Translation of foreign currency into rands
Natural persons may use either the spot rate of exchange on the date the amount was received or accrued, or the average exchange rate for the relevant year of assessment.
Using the average exchange rate is often the more practical solution, particularly if the taxpayer has numerous transactions in the same currency. But the taxpayer is free to choose, provided that, if the average rate is chosen, it must be used for all foreign currency translations for that tax year. It is not permissible to use the spot rate for some transactions and the average rate for others. However, a different choice can be made for each tax year.
Both the spot rates and the average exchange rates are available on the website of the South African Revenue Service (SARS), www.sars.gov.za
Credit for foreign taxes paid
A rebate or credit against South African tax is allowed for foreign tax paid in respect of foreign income, including foreign interest and dividends. The rebate is limited to the maximum of the South African tax that would have been paid on the offshore income.
In calculating the rebate, the deductions allowed for contributions to a retirement annuity fund, as well as any deductions allowed in respect of medical expenses and donations to public benefit organisations, are required to be apportioned against both the local income and the foreign-source income. This serves to lower the maximum credit allowed for the foreign taxes. The calculation is performed by SARS, and the taxpayer has only to submit the foreign income and tax amounts on the tax return.
Any excess foreign tax not off-set in a particular tax year may be carried forward and claimed against foreign income in a subsequent tax year, for up to seven years. The foreign taxes must be translated into rands at the average exchange rate.
Other forms of income
The following forms of income are subject to their own legislation, an explanation of which is beyond the scope of this article:
* Returns from real estate investment trusts (Reits), which are listed property companies subject to special listing and income tax rules.
* In specie dividends, which are dividends in the form of assets other than cash.
* Capitalisation issues. These are free issues of shares to existing shareholders according to their shareholdings.
* Dividends from companies headquartered in South Africa. A special tax regime applies, to encourage investors to use South African holding companies as gateways for investing in Africa.
* Returns from hybrid instruments. Investments that exhibit both debt and equity features are subject to special anti-avoidance legislation.
* Dividends from controlled foreign companies (basically, these are foreign companies in which South African residents have a shareholding of more than 50 percent).
* Income from restricted equity instruments or employee share incentive schemes.
Summing up
Local dividends received by South African residents are subject to dividends tax of 15 percent and foreign dividends are subject to tax at a maximum rate of 15 percent. Previously, foreign dividends would have been taxed at marginal income tax rates, that is, up to 40 percent. However, the exemption of R3 700 no longer applies and no expenses are allowed as a deduction against the foreign dividend income.
The treatment of offshore interest is largely unchanged except for the removal of the exemption of R3 700.
Offshore investments may be different from the investment vehicles we are used to in South Africa and may give rise to different tax consequences. It makes sense to obtain expert advice where the investment vehicle is not an ordinary listed share, CIS or bank account, or where the investment return is in a form other than a cash dividend or bank interest.
* Kari Lagler is a registered tax practitioner and independent tax consultant.