Introduction

In February 2007, the Minister of Finance announced the intended replacement of Secondary Tax (“STC”) on Companies with a new dividends tax (“DT”). The intended implementation date of the new DT is expected to be late 2010 and the new tax introduced in two phases.

The first phase, being the dropping of the STC rate to 10%, has been completed. The second phase has been underway since 8 January 2009, when the proposals were promulgated into law.

Proposed DT rules

The introduction of the new DT rules is being done in a novel fashion, necessitated by the complexity of the landmark changeover from the current STC regime. The new rules are therefore quite unique in that they are law to the extent that the new sections have been promulgated but will only be effective in the medium term.

The 2009 Tax Amendments, recently promulgated, contain the latest refinements and amendments to the new DT rules and there has been significant movement from those previously published.

The new DT is therefore a work in progress and by this time next year, there will have been further refinement and changes. One needs to understand the reasons for the implementation of this new tax in such a fashion.

Roll out

The prolonged rollout period is essential for several reasons. Wide and lengthy consultation is required for this significant reform of our tax system, the many practical problems of the new tax need to identified, especially those during the transition period, for example the phasing out of the STC credits the new administrative obligations to be imposed on taxpayers must be understood and prepared for, double tax treaties (“DTT’s”) have to be renegotiated, to cater for the new withholding tax and both the legislators and taxpayers require a prolonged period to internalise and understand all the effects- intended and unintended - of the changes.

The implementation date of the DT may seem to be in the distant future but taxpayers should beware. It is in their interests to understand and get to grips with the new tax without delay and not fall into the time honoured South African tradition of leaving everything to the very last minute.

Administration issues

The DT contains many hidden administrative problems, not the least of which is the placing of the burden of collection and administration of the tax upon the company declaring the dividend and its regulated intermediaries. The new tax is primarily contained in eleven new sections, being sections 64D to 64N, but spirals out into other areas of the Act affecting the taxation of foreign dividends and their current income tax and STC credit treatment. Several new anti-avoidance provisions accompany the introduction of the DT.

Accounting, reporting and internal control systems need to change and companies need to consult with their IT and accounting departments sooner rather than later. Of course, preparations are dependent upon a full understanding of the DT and how it will affect different corporate entities, like long term insurers and collective investment schemes.

Structure

The DT is a tax on the shareholder, as opposed to STC, which is a tax on the company - triggered by the declaration of a dividend. On the effective date, the maximum effective corporate tax rate will drop from 34,55% to 28%, thereby increasing after-tax distributable reserves but dividends (apart from particular exemptions) will be taxed in the hands of shareholders at the rate of 10%.

The affect on other areas of the Income Tax Act include a host of new definitions, including a new, much simplified dividend definition, a new contributed tax capital (“CTC”) definition to replace that of equity share capital, the introduction of a new value extraction tax, amendments to the taxation of foreign dividends and the treatment of foreign loop dividends, the introduction of new dividend stripping rules and transitional rules for the phasing out of STC credits. The new dividend definition provides that any return to a shareholder in respect of a share that is not a return of CTC will be a dividend. Companies therefore need to accurately determine the amount of their CTC. The aforementioned are by no means exhaustive, and there are more implications to be considered.

Work in progress

This new tax is a work in progress and it is certain that by this time next year, there will be further changes. Taxpayers are advised to come to terms with the new tax, keeping in touch with the changes as they appear and as the new tax is further refined. In brief, the withholding of the dividend tax will take place at two levels, namely at corporate level and at regulated intermediary level. A regulated intermediary includes a collective investment scheme in securities and a central securities depository participant in respect of listed uncertificated shares. Special rules apply for asset-in-specie dividends for listed and unlisted companies.

Withholding

Various exemptions exist, including South African company to South African company dividends and dividends distributed to retirement annuity funds and public benefit organisations. A withholding of DT will therefore be done either by the company declaring a dividend or a regulated intermediary. If an exemption exists so that DT is not withheld, the obligation to withhold shifts to the recipient company or regulated intermediary.

Generally speaking, there will be no liability to withhold DT if the company or regulated intermediary receives a declaration of exemption from the beneficial owner of the share. Nominees holding shares must communicate closely with the beneficial owners for the submission of declarations where the beneficial owner is either exempt from tax, or subject to DTT relief. Provision is made for DTT relief and the submission of a declaration that DTT relief applies will allow a withholding at a reduced rate. It is expected that DTT relief will not drop the rate to below 5%.

Declaration forms

Declaration forms for exemption or DTT relief must be submitted by specified dates and in the absence of the forms being submitted timeously, an automatic withholding of DT will result. Beneficial owners will then have to follow a rather cumbersome refund process where the dividend tax has been incorrectly withheld.

Refunds

The refund process must be initiated within three years after payment of the dividend, or else the refund will be forfeited. Refund rules are slightly different in their application for companies and regulated intermediaries, but of importance, the beneficial owner cannot look directly to SARS for a refund, but must claim a refund from either the company, or the regulated intermediary.

In respect of a company, a refund may be made either out of future DT and if that is not possible, the company must apply to SARS for a refund in order to refund the shareholder. A regulated intermediary has no right of recovery against SARS and shareholders can only expect refunds from the regulated intermediary out of future dividends paid.

This makes the refund process a protracted one, with adverse cash flow implications for the shareholder. Forewarned is forearmed and shareholders should have systems in place to ensure all declarations are submitted timeously. It is obvious that there will be significant practical problems in the implementation of the refund process, as currently proposed and I suspect further refinements to be made in this area.

STC credits

The phasing out of STC credits is a very important part of the transitional proposals and shareholders and companies face significant financial disadvantage if they do not fully utilise whatever credits they have before a five year cut-off period (from the effective date of the new DT) expires. The STC credits process follows the principle that STC and the new dividend tax should not be levied more than once on the same profit stream. In the result, once the new DT regime kicks in, provision is made for STC credits to be attached to dividends declared by a South African company to another South African company. The attached STC credits however will only be valid if certain declarations are made by the distributing company to the recipient company. To the extent that the distributing company does not provide prescribed notification to the recipient shareholder company, not only will the recipient shareholder company not receive the STC credit (for use against the on-distribution of the dividend received), but the distributing company will nevertheless lose its STC credit.

Other issues

Unlisted companies should note that the person that controls or is regularly involved in the overall financial management of the company and is a shareholder or director will be personally liable for the dividend tax, additional tax, penalties or interest. A new value extraction tax will replace the current section 64C deemed dividend rules. Significant new dividend stripping rules will apply when the new dividend tax kicks in.

Where to from here?

So what can taxpayers do in preparation for the new tax? At the very least they need to understand how the new DT will work, the associated changes to the Income Tax Act and how the change will affect their businesses. Accounting, reporting and internal control systems need to be reviewed and changed accordingly to meet the new administrative and reporting burdens. Although the effective date appears distant, there is much to be done in preparation.