Double Taxation Agreements- when are they consulted?

The South African tax system is a residence-based system. This means, essentially, that South African tax residents will be subject to South African tax on their worldwide income, whilst non-residents for tax purposes will be taxed in South Africa on all income that is derived from a South African source[1], to the extent that a double taxation agreement (“DTA”) between South Africa and the country of which the non-resident is a resident, or the domestic laws of South Africa provide otherwise. A DTA is typically in place to avoid double taxation of the same income in different countries. It should be noted that South Africa does not have a DTA in place with every single country, but a list of which DTA's are in place is available on the South African Revenue Services' website.

When is a DTA consulted?

It is necessary to consider a DTA in the following instances:

-      where there is a conflict between South Africa and the other country as to the residency of the entity (i.e. both countries regard such entity as a resident for tax purposes) (residency conflict);

-      where there is a conflict in either country as to in which country the source of income and/or capital is derived (i.e. both countries regard a specific income and/or capital stream to be from a source within their respective countries) (source conflict); and/or

-      where there is a conflict between the countries where one country regards itself having the right to tax a resident on such resident’s worldwide income (including foreign income) notwithstanding that such foreign income was sourced in the other country. 

The DTA would be considered to determine and resolve any of the above-mentioned conflicts.

It follows that, in order to determine the South African tax consequences of contemplated cross-border transactions, we need to establish whether the persons partaking in the transactions are South African residents for tax purposes, as well determine the South African tax consequences for the South African tax residents. Should we determine that some of the parties are non-residents for tax purposes, we will need to consider whether any source of potential income and/or capital could be derived, or deemed to be derived from, a South African source, with the result that South Africa may have a right to tax such South African sourced income despite such income being earned by a non-resident for tax purposes. 

South African tax residency

In accordance terms of section 1 of the Act, a “resident” (for tax purposes) is defined, briefly, in respect of a natural person, anyone who is ordinarily resident in South Africa (i.e. they regard South Africa as their true, permanent and real home, where they will as a matter of course naturally return to from their worldwide wanderings, etc) or a natural person who meets the requirements of the "physically present" test, whilst in respect of a person (other than a natural person), a resident is one "which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic".

It should be noted that this will not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.

Should the person be regarded as a resident for tax purposes, then such resident will be liable to income tax in South Africa on their worldwide income, except where the DTA provides otherwise.

Should the person be regarded as non-resident for tax purposes in South Africa, then such non-resident person shall only pay tax on their South African sourced-income, except where the DTA provides otherwise.

Should the DTA not provide guidance to the resident/non-resident as to where the income must be taxed, or whether the person is or is not in fact a resident for tax purposes in terms of domestic law, then the DTA usually provides for "tie breaker rules" as well as mutual agreement procedures, in terms whereof the countries concerned will usually consult with each other concerning the tax residency of the person and/or how the income streams will be treated for tax purposes in each respective country.

In the absence of a DTA between the countries concerned, there is a possibility that the income streams will be subject to income tax in both countries concerned, with no relief afforded save for as provided for in domestic law.

Conclusion

It is essential to plan correctly before investing offshore, creating companies offshore and/or earning income offshore. It may come as quite a shock to receive a tax bill from two countries, in respect of the same income! Your tax consultant should be able to advise you on your offshore investments and/or opportunities, but ensure that you seek specialist advice prior to commencing such offshore activity to ensure that you are adequately informed and prepared. De Beer Attorneys would be pleased to be of assistance with your international taxation requirements and advice.

*This article has been prepared by the writer, Natalie Macdonald-Govender, and is for information purposes only and should not be regarded as legal advice. This article may contain errors and/or omissions- if you find any please inform the writer .

[1]The Act, section 1“gross income”, in relation to any year or period of assessment, means—

(i)             in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or

(ii)            in the case of any person other than a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such person from a source within the Republic,during such year or period of assessment, excluding receipts or accruals of a capital nature,