Withholding tax on royalties—SARS Interpretation Note 116, part 2
Source information: SARS INTERPRETATION NOTE 116, dated 23 April 2021 and the INCOME TAX ACT 58 OF 1962, SECTIONS 49A to 49H
The 40-page SARS Note provides guidance on the interpretation and application of sections 49A to 49H related to withholding tax on royalties.
This article, the second in a series of articles, summarises the following definitions:
Scientific, technical, industrial or commercial knowledge or information
Levy of withholding tax on royalties
Paid by any person
Paid
Due and Payable
Meaning of “to or for the benefit of any foreign person”
To the extent the amount is from a source within South Africa
“Scientific, technical, industrial or commercial knowledge or information”
Under section 49A, any amount received by or accrued to a person for imparting or undertaking to impart any knowledge or information of a scientific, technical, industrial, or commercial nature constitutes a royalty.
A payment received by or accrued to a person for “making known” scientific, technical, industrial, or commercial knowledge or information will constitute a royalty.
A distinction must be drawn between circumstances in which a person is paid for the service of conveying knowledge that is already in the public domain and those in which a person is paid for sharing knowledge that is not generally available. With the former, the payment will generally not constitute a royalty, while with the latter, the payment will generally constitute a royalty. The facts of a particular case will determine whether the distinction can be easily made or whether it will require a more complex analysis.
For example, an amount paid to a foreign lecturer to deliver a paper on specific tax treaties and the OECD Model Convention is likely to be remuneration for services rendered and not a royalty. In contrast, an amount paid to a person for knowledge that is not in the public domain, for example, a trade secret, regardless of whether it is registered, or a combined fee paid for knowledge of a trade secret and holding sessions in South Africa during which such knowledge is conveyed and questions regarding its application and utilisation are dealt with, will generally constitute a royalty.
In making a determination whether a particular amount is a royalty, it is necessary to consider all the detailed facts.
A service agreement under which a party undertakes to use customary skills to execute the work differs from an agreement falling within paragraph (b) of the definition of “royalty”, in which a person undertakes to impart knowledge or information to another person. The Commentary on the OECD Model Tax Convention provides some guidelines for distinguishing between payments for the supply of know-how and payments for the provision of services. These guidelines can be useful in determining whether a payment is made for imparting knowledge or information or rendering services and hence whether it falls inside the definition of “royalty” in section 49A.
“Levy of withholding tax on royalties”
In order for an amount to be liable to withholding tax on royalties:
• There must be an amount.
• The amount must constitute a royalty.
• The amount must be paid by any person.
• To or for the benefit of any foreign person.
• To the extent that the amount is regarded as having been received by or accrued to that foreign person from a source within South Africa under section 9(2)(c), (d), (e) or (f).
These requirements and the computation of the amounts of withholding tax on royalties are considered below.
Withholding tax on royalties is a final tax currently levied at the rate of 15% of the amount meeting the requirements listed above. The rate of 15% may be altered by legislative amendment, or the Minister of Finance may announce a new rate in the national annual budget which is effective on the date mentioned in the announcement.
In the latter case, the new rate continues to apply for 12 months from that date, subject to Parliament passing legislation which gives effect to the announcement within that 12-month period.
When a person withholds an amount of withholding tax on royalties as contemplated in section 49E(1), that person is, for the purposes of withholding tax on royalties, deemed to have paid the amount so withheld to or for the benefit of a foreign person. Withholding tax on royalties is therefore levied on, and withheld from, the gross amount of the royalty.
“Paid by any person”
Under section 49B(2) the payment of the royalty is deemed to be made on the earlier of the date on which it:
• is paid; or
• becomes due and payable
“Paid”
An amount can be paid in a variety of ways, including in cash, in kind, in the form of a set-off or by agreeing that the amount may be retained as a loan. There is generally little difficulty in determining the date of payment when expenditure is paid in cash, which in practice is often the case with royalty payments. However, the date of payment can be more difficult to establish when payment is in a form other than cash, and in these instances the importance of the facts of the particular case should not be lost sight of.
ITC 1688 (a tax court case) set out some useful principles for determining the date of payment when payment is in the form of a set-off, cheque40 or by way of a loan. In this case the appellant company declared two dividends to the sole holder of its shares on 2 March 1992 and 5 March 1993, respectively. Payment of these dividends was not made in cash or by cheque. Rather, the resolutions declaring the dividends provided that payment of the
dividends would be effected by crediting the holder’s loan account. Journal entries were duly effected, giving credit to the holder of the shares, but the holder’s loan account was credited only on 31 July 1993.
Similarly, royalties may have accrued to a recipient and be payable as opposed to paid. Payment by way of agreeing to retain the amount as a loan must be distinguished from an accrual. The former means the amount will have been paid, and therefore withholding tax will be triggered, while a mere accrual, which is not a payment, will not trigger withholding tax on royalties. The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2012, in discussing the rationalisation of withholding taxes on payments to foreign persons and the changes to withholding tax on royalties, stated the following:
“[A] mere accrual will no longer be the basis for withholding. In line with the new Dividends Tax, the trigger date for withholding will now be the date that a sum is paid or becomes due and payable.”
“Due and Payable”
The words “due” and “payable” have been considered in various judgements.
In CIR v Janke45 Stratford J cited the following observation of Searle J in Stafford v Registrar of Deeds:
“It is clear that the word ‘payable’ is sometimes construed as meaning ‘payable at a future time’ or ‘in respect of which there is a liability to pay’. It is also true that it is sometimes used to mean ‘payable immediately’ or ‘actually due and presently demandable’”.
In Singh v C: SARS, Olivier JA stated the following:
“The word ‘payable’ can have at least two different meanings, viz. ‘. . . (a) that which is due or must be paid, or (b) that which may be paid or may have to be paid . . . The sense of (a) is a present liability—due and payable—. . . (b) . . . a future or contingent liability.”
An amount may be due under a contract (dies cedit) but not payable (dies venit). An amount will be payable only when the time for payment arrives. For an amount to be “due and payable”, the amount must not only be owing, but a person must have the right to claim payment of it.
Meaning of “to or for the benefit of any foreign person”
The phrase “to or for the benefit of any foreign person” requires withholding tax on royalties to be levied on royalties paid to a foreign person beneficially entitled to it and royalties paid to another person for the benefit of a foreign person. As a result, the royalty need not be paid directly to the foreign person but can also be paid to, for example, the foreign person’s nominee, representative, or agent.
The withholding obligation is placed on the PAYER of the royalty and not the person that receives it for their own benefit or, generally, that receives it on behalf of another.
If a royalty is paid to a trust, there are a number of factors to consider when determining whether the payment is to or for the benefit of a foreign person, such as whether the trust itself is resident in South Africa or a foreign person, the type of trust, whether the beneficiaries are resident in South Africa or elsewhere, and whether the income is vested in beneficiaries.
The position with discretionary trusts can practically be complicated as a result of the interaction between the withholding tax provisions and section 25B. This arises because sometimes when the payer pays the royalty, or it becomes due and payable, it appears as if it is for the benefit of the trust. However, depending on whether and when the trustees exercise their discretion, this can change in that that section 25B deems the amount to have accrued to the beneficiary, and therefore it is for the beneficiary’s benefit and not the trust.
For example, a resident discretionary trust receives a royalty during the year of assessment. After receiving the royalty but before the end of the trust’s year of assessment, the trustees exercise their discretion to vest the royalty in the beneficiary.
Section 25B(1), read with section 25B(2), deems the amount to have accrued to the beneficiary and not the trust. Accordingly, it is the identity of the beneficiary that must be considered when assessing whether the royalty is “to or for the benefit of a foreign person”. The complexity arises because section 25B can deem the amount to have accrued to the beneficiary after it was actually paid to the trust, and while the trust in this example is a resident, the beneficiary in whom the royalty was vested may not be a resident.
“To the extent the amount is from a source within South Africa”
Under section 49B(1)(a), the amount of any royalty that is paid to or for the benefit of a foreign person is liable to withholding tax on royalties to the extent it is regarded as having been received by or accrued to that foreign person from a source within South Africa under section 9(2)(c), (d), (e), and (f).
Under sections 9(2)(c), (d), (e), and (f), an amount is received by or accrued to a person from a source within South Africa if it:
• constitutes a royalty that is attributable to an amount incurred by a person that is a resident, unless the royalty is attributable to a permanent establishment which is situated outside South Africa;
• constitutes a royalty that is received by or accrues to the person for the use or right of use of or permission to use in South Africa any intellectual property as defined in section 23I;
• is attributable to an amount incurred by a person that is a resident and is received or accrues for the imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information, or the rendering of or the undertaking to render, any assistance or service in connection with the application or utilisation of such knowledge or information, unless the amount received or accrued is attributable to a permanent establishment52 which is situated outside South Africa; or
• is received by or accrues to the person for the imparting of or the undertaking to impart any scientific, technical, industrial or commercial knowledge or information for use in South Africa, or the rendering of or the undertaking to render, any assistance or service in connection with the application or utilisation of such knowledge or information.
A foreign person may receive royalty payments from a source within and outside South Africa. The “to the extent” wording in section 49B(1)(a) means that only the royalty from a source within South Africa will be liable to withholding tax on royalties. For example, an American franchising company might license its intellectual property to a franchisee based in South Africa as well as to franchisees based in other countries. Royalties will therefore be payable to the franchisor for the use of the intellectual property in South Africa and for use outside South Africa. In this scenario, only the royalty for the use of the intellectual property in South Africa will be liable to withholding tax under section 49B(1)(a), since the source of this income is within South Africa under the specified source rules. If a single payment was received or accrued from a source within and a source outside South Africa, an apportionment would be required.
The next article will discuss exemptions from withholding tax under Section 49D.