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 third in a series of articles, summarises the following topics:
- Exemptions from withholding tax—section 49D
- Foreign person is a natural person who was physically present in South Africa for a period exceeding 183 days.
- Royalty effectively connected to a permanent establishment in South Africa and foreign person registered for tax
- Headquarter companies, section 31, and section 49D
- Section 49D provides that a foreign person will be exempt from withholding tax on royalties if:
- that person is a natural person who was physically present in South Africa for a period exceeding 183 days in aggregate during the twelve-month period preceding the date on which the royalty is paid (section 49D(a);
- the property in respect of which that royalty is paid is effectively connected with a permanent establishment of that foreign person in South Africa if that foreign person is registered as a taxpayer under Chapter 3 of the Tax Administration Act (section 49D(b)); or
- that royalty is paid by a headquarters company for the granting of the use, right of use or permission to use intellectual property to which section 31 does not apply as a result of the exclusions in section 31(5)(c) or (d) (section 49D(c).
- Foreign person is a natural person who was physically present in South Africa for a period exceeding 183 days
Section 49D(a) provides that a foreign person who is a natural person is exempt from withholding tax on royalties if that foreign person was physically present in South Africa for a period exceeding 183 days in aggregate during the twelve-month period preceding the date on which the royalty is paid.
At the same time, the foreign person would be subject to normal tax as a result of falling outside the exemption in section 10(1)(l). Under section 10(1)(l)(i), the exemption does not apply to a natural person who was physically present in South Africa for a period exceeding 183 days in aggregate during the twelve-month period preceding the date on which the royalty was received by or accrued to that person.
Meaning of “day”
In considering whether a foreign person has been physically present in South Africa for a period exceeding 183 days, the meaning of “day” needs to be considered. The word “day” is not defined in the Act and must therefore be given its ordinary dictionary meaning.
A “day” is defined by Lexico.com as follows: “A period of twenty-four hours as a unit of time, reckoned from one midnight to the next, corresponding to a rotation of the earth on its axis.”
Since a day consists of a continuous 24-hour period commencing at midnight, it excludes a part of a 24-hour period. The day of arrival and departure of a person are not considered when calculating the aggregate number of days because they will not
comprise a continuous 24-hour period.
Determination of the 12-month period
Under section 1 of the Interpretation Act 33 of 1957, “month” means a calendar month. In this regard, Van der Westhuizen J stated the following in Ex parte Minister of Social Development & others:
“This Court has as yet not considered the computation of time or time periods. The general common-law rule is that, in the calculation of time, the civilian method is applicable unless a period of days is prescribed by law or contracting parties intended another method to be used. According to the civil computation method, a period of time expressed in months expires at the end of the day preceding the corresponding calendar day in the subsequent month. It is settled law that the commencement of a period of time in curial calculation is governed by the ordinary civilian method where any unit of time other than days is used.”
Twelve-month period preceding the date on which the royalty is paid Under section 49B(2) a royalty is deemed to be paid on the earlier of the date on which the royalty is paid or becomes due and payable. The 12-month period concerned therefore ends on the day before the earlier of the date on which the royalty is paid or becomes due and payable. For example, if a royalty is due and payable on 1 January of year 2, the period of 12 months will run from 1 January of year 1 to 31 December of year 1.
- Royalty effectively connected to a permanent establishment in South Africa and foreign person registered for tax
if the property in respect of which that royalty is paid is effectively connected with a permanent establishment of that foreign person in South Africa and that foreign person is registered as a taxpayer under Chapter 3 of the Tax Administration Act.
The term “permanent establishment” is defined in section 1(1) to mean:
“A permanent establishment as defined from time to time in Article 5 of the Model Tax Convention on Income and on Capital of the Organisation for Economic Co-operation and Development: Provided that in determining whether a qualifying investor in relation to a partnership, trust or foreign partnership has a permanent establishment in the Republic, any act of that partnership, trust or foreign partnership in respect of any financial instrument must not be ascribed to that qualifying investor.”
Paragraph 1 of Article 5 of the Model Tax Convention on Income and on Capital of the Organisation for Economic Co-operation and Development, Condensed Version 21 November 2017 (OECD Model Tax Convention), defines “permanent establishment” as:
“a fixed place of business through which the business of an enterprise is wholly or partly carried on”.
Paragraph 2 of Article 5 states that a “permanent establishment” includes:
a) a place of management;
b) a branch;
c) an office;
d) a factory;
e) a workshop, and
f) a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.
Paragraph 21 of the Commentary on Article 12 of the OECD Model Tax Convention dealing with Royalties states that
“A particular location can only constitute a permanent establishment if a business is carried on therein, and…the requirement that a right or property be ‘effectively connected’ to such a location requires more than merely recording the right or property in the books of the permanent establishment for accounting purposes.”
According to paragraph 21.1, a right or property in respect of which royalties are paid will be effectively connected to a permanent establishment if the economic ownership of that right or property is allocated to the permanent establishment. Such a right or property will form part of the permanent establishment’s business assets. The “economic” ownership of a right or property means the equivalent of ownership for income tax purposes of a separate enterprise, with the attendant benefits and burdens.
The circumstances of each case must be evaluated to determine whether intellectual property for which a royalty is paid is effectively connected to a permanent establishment.
A royalty received by or accrued to a foreign person from a source within South Africa that is effectively connected to that foreign person’s permanent establishment in South Africa is subject to normal tax in the hands of that foreign person because the exemption in section 10(1)(l) is rendered inapplicable by the exclusion in section 10(1)(l)(ii). The latter exclusion applies when “the intellectual property or knowledge or information in respect of which that royalty is paid is effectively
connected to a permanent establishment of that person in the Republic.” The royalty received by the foreign person through a permanent establishment is thus taxed under the normal tax provisions and not the withholding tax on royalties provisions.
Headquarter companies, section 31, and section 49D
A company that meets the requirements set out in section 9I may elect to be a headquarters company for a year of assessment. Included in the incentives available to headquarters companies is the exemption from withholding tax under section 49D(b) on royalties paid to any foreign person for the use, right of use or permission to use intellectual property as defined in section 23I, which are excluded from the transfer pricing provisions in section 31 under section 31(5)(c) or (d).
Section 31 deals with the transfer pricing of specified international transactions.
Section 31(5)(c) stipulates that when a transaction, operation, scheme, agreement or understanding dealing with intellectual property as defined in section 23I(1) has been entered into between a person that is not resident and a headquarter company in which that person grants the use, right of use or permission to use that property to the headquarter company, section 31 will not apply to the extent that:
- The headquarter company grants the use, right of use or permission to use the intellectual property to a foreign company in which it directly or indirectly (whether alone or together with any other company forming part of the same group of companies as that headquarter company) holds at least 10% of the equity shares and voting rights; and
- The headquarter company does not make use of that intellectual property other than granting the use, the right to use or permission to use the property to that foreign company.
Section 31(5)(d) provides that section 31 will not apply when a transaction, operation, scheme, agreement or understanding dealing with intellectual property as defined in section 23I(1) has been entered into between a headquarter company and a foreign
company:
- In which the headquarter company directly or indirectly (whether alone or together with any other company forming part of the same group of companies as that headquarter company) holds at least 10% of the equity shares and voting rights; and
- The headquarter company grants the use, right of use or permission to use that intellectual property to the foreign company.
If section 31 does not apply as provided for in section 31(5)(c) and (d), the exemption in section 49D(c) will apply.
The next article will discuss the liability for the payer and the recipient of South African-source royalties.