Tax residency and deemed disposals

In 2001, South Africa, like many other countries, introduced capital gains tax aimed at levying capital gains tax on the gain made from the disposal of certain assets. When a South African tax resident company redomiciles abroad and changes its tax residency to another tax jurisdiction, such a company ceases to be a tax resident for South African income tax purposes (regardless of whether the assets of such a company are still located in South Africa or whether the company still continues to do business in South Africa or not).

Generally, the cessation of South African tax residency is deemed to be a disposal for capital gains tax purposes and triggers capital gains tax. The Act deems the South African tax resident company to have disposed of all its assets for a consideration equal to their market value. As a result, the deemed disposal is subject to CGT at the prevailing tax rates.

In 2003, South Africa introduced so-called “participation exemptions”, which exempts any foreign dividends declared by non-resident companies to a South African tax resident holding at least 10 per cent of the equity shares and voting rights in such companies from income tax, and includes the exemption from CGT gain on the disposal of equity shares held by a South African tax resident holding a least 10 per cent of the equity shares and voting rights in a non-resident company. The policy rationale for participation exemptions is where a South African tax resident has a meaningful interest in the non-resident company paying the dividend was to encourage capital inflows and to provide an incentive for South African tax residents to repatriate foreign dividends to South Africa.

The issue

Government has noticed an increased use of participation exemptions by South African tax resident shareholders. These erode the South African tax base in instances where a South African tax resident company changes its tax residency to another tax jurisdiction and shares in that company are subsequently sold by South African shareholders, which qualify for a participation exemption. Allowing South African resident shareholders to benefit from a participation exemption on disposal of the shares in a non-resident company that was a resident company when the shares were acquired is against the intended purpose of the participation exemption. It was aimed at encouraging capital inflows and to provide an incentive for South African tax residents to repatriate foreign dividends or capital gains back to South Africa on a tax neutral basis.

Proposed amendments effective 1 January 2021

It is proposed that changes be made in section 9H of the Act to deem a South African tax resident shareholder who holds shares in a South African tax resident company that changes its tax residency to another tax jurisdiction to be deemed to have disposed of all its assets at market value on the day before it ceased to be a South African tax resident and to have reacquired the assets at market value on the day of the exit.

It is currently unknown how the Government proposes to monitor compliance in this regard.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)