PROPOSED CHANGES IN THE FOREIGN TAX POLICY ARENA

1. PROPOSED CHANGES IN THE FOREIGN TAX POLICY ARENA National Treasury Tax Policy Chief Directorate

2. Balancing of Interests (1) 1. Tax Policy should not accelerate the flow of capital offshore. Tax Policy should instead seek to retain capital wherever possible. 2. Capital outflows come in two forms: a) South African business can shift various funds offshore. b) South African business can move their legal personality (i.e., their headquarters) offshore.

3. Balancing of Interests (2) 3. Tax Policy must seek to prevent both the artificial outflow of funds and the artificial outflow of HQ’s. a) Total exemptions from tax in the foreign arena artificially encourage South African businesses to shift funds offshore. b) Uncompetitively high-tax measures in the foreign (and in the domestic) arena artificially encourage South African business to move their HQ’s offshore. 4. Tax measures must be balanced because both concerns are diametrically opposed to one another.

4. The South African Context 1. The balance required in the South African context is particularly troublesome because: a) South African taxpayers have disproportionately large amounts of liquid capital at their disposal. These liquid funds will be quick to capitalise on tax exemptions within the foreign arena. b) As an emerging market, South Africa must utilise a tax system that is more competitive than its industralised brethren or risk the flight of domestic HQs.

5. Current Dividing Line 1. South African companies are not subject immediate tax on their active foreign operations held through foreign subsidiaries (technically referred to as “Controlled Foreign Entities” or “CFEs”). This lack of immediate taxation prevents the outflow of HQ’s. 2. However, the prevention of fund outflow requires, immediate tax for: a) passive CFE portfolio income; and b) CFE income from diversionary transactions.

6. Pro-Competitive Amendments (1) 1. Enactment of a “Participation Exemption”: a) Purpose: To exempt dividends and sale proceeds for foreign shareholdings representing a meaningful “participating” stake in an active company. b) Requirements: (i) The shares must be ordinary shares, or participating preference shares, in a company that does not consist mostly of passive financial instruments; and (ii) The share interest before the transaction must amount to 25 percent of the total (and be held for 18 months for the gain sale exemption).

7. Pro-Competitive Amendments (2) 2) Technical Changes: a) The legislation ignores less than 5 per cent South African shareholders when determining the CFE status of listed foreign companies. b) The legislation reduces the capital gains tax to 10.5 per cent for individual ownership of tainted CFE income. c) The legislation reduces the statutory rate to 13.5 percent for determining whether CFE capital gains are exempt under the designated country exemption.

8. Pro-Competitive Amendments (3) d) The legislation expands the 5-per cent de minimis exception for passive capital gains (i.e., reducing the calculation from gross proceeds to net gain). e) The legislation extends the designated country exception to all dividends flowing through a designed country CFE even if the underlying profits were generated in a non-designated country CFE. f) The foreign dividend legislation eliminates deemed dividend treatment for the sale foreign shares. These sales now fall solely under the capital gains tax.

9. Effective Dates The proposed amendments alter a variety of recently introduced items of legislation introduced over the course of the last 18 months (i.e., the capital gains tax, the residence-based tax, and the foreign dividend legislation). Taxpayer-favourable changes are being incorporated retroactively wherever possible.

10. Liquid Portfolio Syphoning Amendments (1) 1. Currency changes: a) Foreign Equity Instruments. Pursuant to the Capital Gains Tax introduced last April, most foreign non- currency asset sales will exclude currency gain/loss. (i) However, currency gain/loss will be included if that gain/loss arises from foreign equity instruments (e.g., listed foreign shares, listed unit portfolio interests, and commodities listed on an index). (ii) This tax applies equally to all taxpayers, including CFEs.

11. Liquid Portfolio Syphoning Amendments (2) b) Distinguishing between 24I versus capital currencygains/losses. Section 24I versus the capital gains tax regime applies on an taxpayer-by-taxpayer basis. (i) All companies, any trust with a trade, and any individual who trades in currency items are subject to 24I with respect to all their foreign currency assets. (ii) All other taxpayers (e.g., individuals) are subject to the capital gains tax regime with respect to all their foreign currency assets.

12. Liquid Portfolio Syphoning Amendments (3) (iii) Section 24I taxpayers are taxed on their foreign currency at ordinary rates at an annual mark-to- market basis, and all capital gains taxpayers are subject to tax only when converting into and out of a foreign currency. c) Anti-avoidance rules. (i) The list of foreign currency items will be expanded to include commodity forward contracts and commodity option contracts denominated in foreign currency [forthcoming].

13. Liquid Portfolio Syphoning Amendments (4) (ii) Currency losses on loans cannot be deducted if the loan proceeds are used to acquire foreign assets exempt from currency gain. (iii) Currency losses with connected CFE’s cannot be deducted if no corresponding income is included. d) Foreign Currency Definition. The legislation refines the definition of foreign currency to provide priority for permanent establishments. Permanent establishments are exempt from currency taxation with respect to their local currency, and currency movements into and out of a permanent establishment trigger tax.

14. Liquid Portfolio Syphoning Amendments (5) 2. CFE Passive income amendments: a) Narrowing the financial institution exception. The legislation narrows the exemption for financial institutions to ensure that the exception does not cover treasury portfolio operations of intra-group finance CFEs. c) Anti-round tripping clause. The legislation narrows the exemption for financial institutions to prevent more subtle forms of round-tripping (shifts of interest offshore followed by the repatriation of dividends).