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Troubling new interpretation of tax credits and deductions on foreign income

Taxpayers may bear the full brunt of double taxation without relief.
The proposed changes will put South African tax residents at a disadvantage, and with an unsatisfactory remedy at their disposal. Image: Moneyweb

The latest draft interpretation note issued by the South African Revenue Service (Sars) on the handling of tax credits and deductions on foreign-sourced income raises serious concerns.

The South African Institute of Tax Professionals (Sait) says the proposed changes mean taxpayers may bear the full brunt of double taxation without relief in certain instances.

Current provisions in the Income Tax Act to alleviate double taxation will effectively be “nullified”, it said in a submission. South Africans working and operating abroad generally get a tax credit for tax paid on foreign income.

A double taxation agreement often limits the right of the source country to tax income if the income is earned by a tax resident of the other country.

However, in certain instances, foreign jurisdictions – in violation of their tax treaty with South Africa – do tax South African tax residents on income earned within the foreign jurisdiction.

Beatrie Gouws, head of strategic development at Sait, explains that section 6quin of the Income Tax Act previously provided for tax credits when the foreign country levied tax on the same income that was also taxed in SA. The section also allowed for a deduction when the tax was levied wrongfully.

‘Relief’ reinterpreted

The section was deleted in 2016, but taxpayers were still granted relief under section 6quat. Sars now wants to change its interpretation of the relief granted.

Joon Chong, partner at Webber Wentzel, says some African tax authorities do not have the right to charge any withholding payments because the South African company does not have a permanent establishment in that country.

In a clear violation of the tax treaty, they do levy tax – mainly to increase their own revenue. However, in order to claim relief, the payments must be “proved to be payable” in terms of the tax treaty.

Since the taxes were levied in violation of the treaty the taxpayer has no way to “prove” that the tax was indeed payable.

“Proved to be payable” means that the treaty allows the foreign country the taxing rights on the income earned. If the individual spent more than 183 days working in the foreign country, then the amount can be taxed in that country, but if it was fewer than 183 days then there are no taxing rights on the income earned.

If income tax or a withholding tax was levied nonetheless, there is no proof that it was supposed to be paid. This pits the individual or company against the foreign tax authority that overstepped their bounds.

Gouws says that with the latest interpretation of the section by Sars, taxpayers will no longer be granted relief if the tax was levied unlawfully.

The only “relief” for taxpayers is to approach Sars to intervene on their behalf through the “competent authority mechanism” – meaning that Sars has to take up the battle with the foreign tax authority.

“Sars can use its discretion whether it will take on the battle on your behalf to rectify the situation,” says Gouws. “If Sars does not take action, it is not their loss, but the loss of the taxpayer.”

Chong says Sars is aware of countries, such as Tanzania and Kenya, which are acting in violation of the tax treaties they have with SA. That is why section 6quin was initially introduced: to deal with the violations.

The subsequent introduction of section 6quat, after 6quin was scrapped, has been interpreted in a similar manner until now. Chong believes the reason behind the change is that Sars no longer wants to bear the cost when the revenue authority in a foreign country violates the treaty.

“This is an unsympathetic approach [towards South African taxpayers] adopted by Sars.”

Gouws says the proposed changes are of concern because they put South African tax residents at a disadvantage with an unsatisfactory remedy at their disposal.

“The draft ruling now seems to suggest that foreign taxes wrongfully imposed in these circumstances will no longer be deductible because the taxes themselves are not proved to be payable.”

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SARS is doing the the right thing here. This is good news for most SA tax payers. I would not categorise this news as ‘Troubling’ but rather as reassuring. I certainly do not support foreign governments effectively stealing SA tax revenue.

How is this reassuring?

“The only “relief” for taxpayers is to approach Sars to intervene on their behalf through the “competent authority mechanism” – meaning that Sars has to take up the battle with the foreign tax authority.

“Sars can use its discretion whether it will take on the battle on your behalf to rectify the situation,” says Gouws. “If Sars does not take action, it is not their loss, but the loss of the taxpayer.””

Why would SARS intervene? Both tax authorities have taken their cut. It’s the taxpayer’s loss.

Maybe I’m understanding this too simply.

The Kenyan tax authorities have no right to tax a South African tax resident in certain circumstances. Currently they do with no consequences. The cost is currently borne by South Africa by essentially not enforcing the tax treaty and not claiming tax which is rightfully owed to SARS.

Surely this can not be allowed to continue. SARS has the right to levy income tax in these circumstances and not the foreign tax authority. SARS is not at fault here, rather it is the foreign tax authority which needs to be challenged even if by those who are themselves being incorrectly taxed in those jurisdictions.

Hi Adrian,

Here’s the issue: “If Sars does not take action, it is not their loss, but the loss of the taxpayer.”””
SARS is going to tax you, even if the rogue tax authority has levied an illegal tax on you. So SARS gets its cut. There is no incentive for SARS to take the rogue tax authority to task since SARS already has taken your tax. So no reward but time and cost for SARS to help the tax payer recover their loss.

Do not be surprised. The ANC gangsters are desperate for cash with no growth and the skilled and/or rich fleeing the failing country. Do you know what it costs to fly by private jet to Egypt with champagne and caviar to kill the time?

The other one that is hard to understand is how the tax credit works on foreign dividends (which after an exclusion are taxable income in SA.

So the USA withholds 15% tax on say R100,000 dividends.

So the way I get it, the R100,000 is included in taxable income, one gets an exemption of 25/45 meaning R44,444 is included in taxable income. Calculate tax as normal and then that R15,000 paid to US should be a tax credit.

But the credit is limited to ratio : foreign taxable income / total taxable income as % of gross tax payable before rebates. What has not worked the same in any year for me is how that limit is applied. It seems like foreign capital gains are not treated as foreign but local when they do that limit.

I am not sure, but think foreign tax paid not allowed this year should carry forward to future years, but never see that amount on my assessments.

Another reason not to invest or work in Africa.

End of comments.

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