Abstract
Tax Act”), re-classify dividends earned on “hybrid equity instruments” and “third-party backed shares” as “income” in the hands of the recipient of those dividends. It is currently not clear whether these provisions apply in a cross-border context where a non-resident shareholder receives a dividend from a resident company in respect of the “hybrid equity instrument” or the “third-party backed shares”. Specifically, it is not clear in the current reading of sections 8E and 8EA whether the dividend received from such an instrument is also re-classified for the purpose of applying a Double Tax Agreement (“DTA”) or whether it remains a “dividend” in the recipient’s hands for the purpose of applying a DTA. Given the substantial increase of foreign direct investment inflows to South Africa in recent years, it is essential that the lack of clarity is addressed in order to ensure that South Africa any profits made by non-resident investors in South Africa are subject to the correct tax treatment when the relevant DTA is applied. This study applied a qualitative approach to provide clarity on the practical impact of a re-classification of dividends as income under sections 8E and 8EA in a cross-border context. The study focused on the impact on both the foreign shareholder, and on the South African entity that declares and pays the dividend. The research was performed by adopting doctrinal research, which involved searching through texts such as the Income Tax Act, Explanatory Memoranda published by the National Treasury on sections 8E and 8EA, South African case law relevant to the interpretation of DTAs, textbooks, articles, and other research by reputable authors and tax experts. The provisions of the DTA between South Africa and China (being South Africa’s top trading partner) was referred to in order to provide a practical example. It was concluded that the fact that the DTA does not have rules re-classifying dividends as income where shares contain characteristics of either a “hybrid equity instrument” or “third-party backed share” does not mean that there is a “conflict” between the Income Tax Act and DTA. What this means, rather, is that domestic law should be read together with the DTA and that the provisions of each be applied simultaneously. 5 The result of this would be that the amount is treated as income for DTA purposes as the amount is treated as such under domestic law. However, because the DTA defines dividends as “income from shares”, the most suitable article of a DTA applicable to that amount is the “dividends” article. The other articles of a DTA such as the general “business profits” article as well as the “interest” and the “other income” articles would not be applicable to this amount although the amount is in principle also re-classified for DTA purposes. The application of the aforementioned articles was ruled out on the basis that this amount does not fall squarely within the provisions of these articles.
M.Com. (South African and International Tax)