A paradigm shift — withholding tax on dividends

2008-06-25 00:00

In his 2007 Budget speech, the minister of Finance announced reforms to the way in which dividends are to be taxed.

The reforms entail an eventual scrapping of Secondary Tax on Companies (STC) and the introduction of a withholding tax on dividends.

The first phase of the reforms started in October 2007 with the reduction of the STC rate to 10% and a tightening of the definition of “dividend”.

The withholding tax on dividends will be introduced in the second phase after several double tax treaties have been renegotiated — most likely in 2009.

An important point to note is that all STC credits on dividends accrued will expire. The date of expiry has not been announced, but it is widely expected that the credits will expire when the withholding tax is introduced.

STC was a peculiarity of the South African tax system, and the introduction of the withholding tax is likely to achieve consistency with international practice.

This change has been particularly welcomed by foreign investors, who found the STC system rather complex and who found that they were unable to avail themselves of any tax relief provided by the relevant tax treaties.

Because STC is a tax imposed on the company declaring the dividend, and not the shareholder, the shareholder could not use the provisions of the double tax treaty to reduce the effective amount of tax payable.

The withholding tax rate will remain at 10%, but it will be a final tax and will be applied to all distributions (capital or revenue), except if the distribution represents a return on capital.

No withholding tax applies to dividends declared to income-tax-exempt entities, such as registered public benefit organisations and retirement funds.

It is expected that dividends will be taxed only when profits reach the individuals, trusts, non-resident shareholders or closely-held companies.

For non-resident shareholders, the withholding tax rate of 10% may be limited by the application of a double tax treaty.

Even though the liability for the withholding tax will fall on the shareholder, the company declaring the dividend will still be responsible for the payment of the tax on behalf of the shareholders, similar to the manner in which the employees’ tax system works.

The onus is, therefore, on the company paying the dividend to be aware of the status of each shareholder, and withhold either the correct amount of tax or none at all.

This will especially be a problem where the shares in the company are widely-held, and where shares are held by nominees or private companies.

The company declaring the dividend will be held liable for any tax not withheld incorrectly, so it is imperative that systems are implemented for the identification of shareholders.

Companies should rather err on the side of caution and seek professional advice and guidance once the legislation is promulgated.

Shabashni Manohar

Senior Consultant, Tax and Legal

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