Double taxation agreements are generally aimed at relaxing tax rules in order to stimulate trade between countries, and although these treaties are negotiated bilaterally, they remain subject to different interpretations.
The treaty between South Africa and the Netherlands has been to the courts in both countries this year, mainly to determine when a country is allowed to withhold dividend tax when companies pay dividends to foreign shareholder companies.
This could mean the difference between paying no dividend tax or at least 5% tax on dividends flowing into or out of the treaty countries. This is significant for South Africa, mainly because far more multinationals enter the country through the Netherlands than enter the Netherlands through SA, says Osman Mollagee, international tax partner at PwC.
Could mean the loss of millions for SA
When dividends flow out of South Africa this could mean losses of millions of rand for the fiscus if the treaty does not provide for a withholding tax on dividends.
In January the Dutch courts found in favour of ArcelorMittal, a South African company receiving dividends from the Netherlands. ArcelorMittal argued that it was entitled to the full dividend and that no dividend withholding tax should be levied.
The concept of ‘most favoured nation’ seems to be the tiebreaker – as has now been confirmed by all three levels of the Dutch judicial system as well as the Cape Town tax court.
Mollagee explains that South Africa did not have a dividend withholding tax up until 2012. Therefore, its double tax agreements did not make provision for it.
Before its implementation in 2012 all the existing – roughly 80 – treaties had to be renegotiated to make provision for a withholding tax on dividends when there was a flow between the treaty countries.
Mollagee says the South African government was reluctant to allow a zero percent withholding rate. “Our basic rule is 20% (initially 15%) withholding [tax] and the most lenient rate is 5%.”
SA’s Kuwait problem
There is currently only one country that still directly qualifies for the zero withholding rate on dividends – Kuwait. Although SA has renegotiated its treaty with the country, the treaty has not been ratified since it was signed about five years ago.
This is where the most-favoured-nation concept enters the debate. The treaties between two other countries – Sweden and the Netherlands – do not provide for a tax exemption on dividend payments, although they have the most favoured nation clause in their treaties with SA.
“This is basically a treaty provision where the treaty countries agree that they have negotiated and agreed on the treaty provisions, but if any country [SA, Sweden or the Netherlands] gives another country a better deal, they also want that better deal.”
Since Kuwait gets the better deal on the dividends withholding rate, Sweden and the Netherlands also insist on the better deal.
“The existence of the Kuwait treaty with the zero rate on dividends automatically gives Sweden and the Netherlands the better deal even though the zero rate is not stated in their treaties with SA,” says Mollagee.
Comedy of errors
Keith Engel, CEO of the South African Institute of Tax Professionals, says the South African government suffered from “a comedy of errors”.
The Kuwait treaty with the zero rate by itself is of little consequence. Hence, the lack of urgency for change. “However, a most-favoured-nation clause in the Netherlands treaty – in conjunction with the Swedish treaty – turned deadly for SA given the potential large outflows,” says Engel.
It is unclear why or how the clause appeared in the first place since it is very rare in the SA network, says Engel.
However, as Mollagee points out, as soon as the Kuwait treaty is ratified, Sweden and the Netherlands will automatically stop benefitting from the zero rate.
Earlier this month (June 2019) the Cape Town tax court found in favour of a multinational in the Netherlands that argued on the same principle as ArcelorMittal that SA is not entitled to withhold tax from the dividend it received from a South African company.
Sars to appeal
Mollagee says the tax court is the “lowest court” and that the South African Revenue Service (Sars) still has the opportunity to take the decision to a higher court on appeal.
He says PwC tax experts are “pretty confident” that if Sars does appeal to a higher court, that court will come to the same conclusion that the highest Dutch court has already come to.
Should the tax court’s decision stand, South African companies that have been withholding dividend tax and paying it to Sars may well be in line for refunds.
Mollagee says PwC is aware of several companies who have already asked for refunds.
Engel says treaties can be “dangerous”, especially given the slow pace of changing clauses once they are in place.
“Many will watch the outcome of this case closely.”