Taxation of “outgoing licences” (i.e. where a South African licensor grants a licence to a foreign licensee) is regulated by the tax laws of the licensee country, our Income Tax Act and the applicable Double Tax Agreement (DTA).
The tax laws of most countries impose a withholdings tax on “outgoing” royalty payments. For example, s35 of our Income Tax Act imposes a 12% withholdings tax on royalties paid to foreign licensors. However, this withholdings tax is typically reduced by DTAs. For example, the ZA/US DTA reduces withholdings tax to 0%, while the ZA/Botswana DTA reduces this tax to 10%:
ZA/US DTA (Article 12):
- Royalties derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State.
ZA/Botswana DTA (Article 12):
- Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.
- However, such royalties may also be taxed in the Contracting State in which they arise, and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties.
Withholdings tax is imposed on the foreign licensor by the tax authorities of the licensee country, and paid by the licensee on the licensor’s behalf.
Accordingly, where a South African licensor grants a Botswana licensee a licence in consideration for a royalty of R100,000, the South African licensor is subject to Botswana tax in the amount of R10,000.
Turning now to our Income Tax Act: R100,000 accrues to the South African licensor. Typically, taxes paid to foreign tax authorities trigger s6quat rebates. However, s6quat(1) provides that:
“6quat(1) Subject to the provisions of subsection (2),a rebate determined in accordance with this section shall be deducted from the normal tax payable by any resident in whose taxable income there is included-
a) any income received by or accrued to such resident from any source outside the Republic other than any foreign dividend contemplated in paragraph (d); which is :
Applying the principles in Millin v CIR 1928 (AD) 207, the “source” of royalty payments in “outgoing licences” would generally be considered South African. Section 6quat(1) rebates are therefore not available to the licensor.
As a fallback position, the South African licensor may seek to rely on parallel credit provisions incorporated in the relevant DTA. For example, Article 23(3) of the ZA/US DTA provides that:
“United States taxes paid by South African residents in respect of income taxable in the United States, in accordance with the provisions of this Convention, other than taxes that may be imposed solely by reason of citizenship under paragraph 4 of Article 1 (General Scope), shall be deducted from the South African taxes due according to South African fiscal law. Such deduction shall not, however, exceed an amount which bears to the total South African tax payable the same ratio as the income concerned bears to the total income taxable in South Africa.”
However, the “credit provision” in Article 22 of the ZA/Botswana DTA (“Elimination of Double Taxation”) does not apply in addition to s6quat:
“1. Double taxation shall be eliminated as follows:
(b) In South Africa, subject to the provisions of the law of South Africa regarding the deduction from tax payable in South Africa of tax payable in any country other than South Africa, Botswana tax paid by residents of South Africa in respect of income taxable in Botswana, in accordance with the provisions of this Convention, shall be deducted from the taxes due according to South African fiscal law. Such deduction shall not, however, exceed an amount which bears to the total South African tax payable the same ratio as the income concerned bears to the total income.”
Barred from claiming the parallel credit in the DTA, the South African licensor’s final option is to claim deductions in terms of s11(a) of our Income Tax Act (i.e. the general deduction formula). However, s11(a) requires the expenditure to be incurred “in the production of income” and withholdings tax is generally considered to be triggered only after income has been produced. As such, it is doubtful whether deduction of the Botswana withholdings tax may be claimed in terms of our general deduction formula.
The unexpected outcome is that, up to now, despite paying R10,000 in tax to the Botswana tax authority, the South African licensor is additionally liable to SARS in the amount of R29,000 (i.e. R100,000 x 29%). In other words, the effective tax rate imposed on South African licensors in such instances is currently R39%!
To ameliorate this situation, s6quat was revised in November 2007 by adding subsection (1C):
“(1C) For the purpose of determining the taxable income derived by any resident from carrying on any trade, there shall be allowed as a deduction from the income of such resident so derived the sum of any taxes on income (other than taxes contemplated in subsection (1A)) proved to be payable by that resident to any sphere of government of any country other than the Republic, without any right of recovery by any person other than a right of recovery in terms of any entitlement to carry back losses arising during any year of assessment to any year of assessment prior to such year of assessment.”
But here is the rub: whereas s6quat(1) provides for a deduction “from the normal tax payable”, subsection (1C) provides a deduction from “income” – subsection (1) is a rebate, whereas subsection (1C) is a deduction. To illustrate the difference with reference to our Botswana example: where royalty receipts fall within the ambit of s6quat(1) or a parallel credit provision in a DTA, the South African licensor would be liable for R19,000 in South African tax (i.e. (R100,000 x 29%) – R10,000), yielding an effective combined tax rate of 29%. However, applying s6quat(1C), the South African licensor pays South African tax calculated as follows:
|ZA Tax payable:||R26,100|
Yielding an effective combined tax rate of 36.1%.
This problem is not confined to licences with Botswana. Similar issues are potentially triggered by the DTA credit provisions between South Africa and Ethiopia, Ghana, Swaziland, Tanzania, Belarus, Brazil, Bulgaria, Kuwait, Malaysia, New Zealand, Oman, Turkey, Ukraine and the UK.