Interest withholding tax – are you ready for 1 January 2015?
October 19, 2014
In just over 3 months’ time, the interest withholding tax ("IWT”) will come into effect - more than four years after the initial release of legislation governing the IWT provisions. The provisions appear to be fairly straightforward and the parties likely to be affected by the IWT should by now be prepared for the impact which the IWT will have. However, there are aspects of the law which might not have been fully considered to date. A few of these aspects are explored below.
The starting point is the taxing provision contained in section 50B of the Income Tax Act No. 58 of 1962 ("the Act”). In order for the IWT to apply, there must be interest which is from aSouth African source in terms of section 9(2)(b) of the Act which is paid by any person to or for the benefit of any foreign person (our emphasis).
What exactly is "interest” for purposes of the IWT?
By way of background, the definition of "interest” contained in the initial legislation released in respect of the IWT included interest as defined in section 24J of the Act as well as deemed interest as contemplated in section 8E. These references were subsequently deleted.
In terms of current legislation which will become effective on 1 January 2015, the term "interest” is not defined. This is surprising since one would expect the provisions to contain a definition of the very element which they seek to tax.
In the report of the Standing Committee on Finance dated 11 September 2013, it was indicated that the IWT provisions will apply to common law interest and that "as a general rule of interpretation, in the absence of a specific definition or cross reference to section 24J, the common law definition will apply”. This comment itself is not binding on the South African Revenue Service, nor is it law.
We note that "interest” is defined in the Act in section 24J. In addition, section 50B of the Act refers to section 9(2)(b) of the Act. Section 9(2)(b) of the Act applies exclusively to interest as defined in section 24J. On this basis, the interest subject to the IWT may be interest as defined in section 24J.
The issue is that the scope of the "interest” definition contained in section 24J of the Actextends beyond common law interest. In particular, the definition specifically includes any discount or premium in respect of a financial arrangement as well as compensation payable by a borrower to a lender in terms of any lending arrangement. In addition, the provisions of section 24J of the Act deem repurchase agreements and resale agreements to be interest bearing. Qualifying repurchase and resale agreements are effectively treated as loans and the differential between the sale price and resale price of the underlying asset constitutes interest for purposes of section 24J of the Act.
Therefore, given the lack of the definition of "interest” in the IWT provisions, the scope of the IWT provisions could extend wider than the legislator may have anticipated – i.e. to payments made in respect of financial arrangements entered into at a discount or a premium, lending arrangements, as well as repurchase and resale agreements.
Can the IWT apply to non-residents?
The IWT provisions apply to South African sourced interest which is paid to or for the benefit of a foreign person by any person.
The statutory source provisions in section 9(2)(b) of the Act deem interest as defined in section 24J to be from a South African source where that interest is, inter alia, received in respect of the utilisation or application in South Africa by any person of any funds or credit obtained in terms of any form of interest-bearing arrangement.
Interest paid by a non-resident borrower to a non-resident lender may be subject to the IWT where the non-resident borrower has utilised or applied in South Africa, the funding obtained from the non-resident lender. This will result in a withholding obligation being placed on a non-resident. The impact of transactions such as these entered into between non-resident counterparties may not have been considered from a South African withholding tax perspective. Failure to comply with the IWT provisions could lead to an IWT liability and, inter alia, the imposition of penalties and interest on unpaid taxes.
In addition, although details pertaining to the administrative requirements relating to the IWT have not been released, the impact of the above will likely result in non-residents having to register as South African taxpayers in order to submit IWT returns to the extent that the administrative provisions pertaining to the IWT are similar to those of the dividends tax. This may increase the tax compliance burden on non-residents. For example, a non-resident may be required to register as a taxpayer in order to submit an IWT return in instances where the non-resident in question is not required to make payment of any IWT.