Foreign company( No physical presence in SA) gives South African company sole distribution rights to sell their tea and other products in South Africa. For the sole distribution rights of the foreign products, a fee must be paid to the foreign company
Important:
This answer is based on tax law for the tax year ending 28 February 2020.
Answer:
As we have indicated in the first response, the most important issue is to determine what the nature of the payment is.
We cannot determine whether it is a payment for technical services, knowhow or a royalty.
As defined, in section 49A of the Income Tax Act, “royalty” means “any amount that is received or accrues in respect of—
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the use or right of use of or permission to use any intellectual property as defined in section 23I; or
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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.”
Because the other party is not a resident of the RSA, as we accepted in our first guidance, you will then also have to look at the double taxation agreement between the RSA and the other country, unless the other party is not a resident of a treaty country. The treaty may well contain its own definition of a royalty which may differ from the one above.
But more importantly, in addition to dealing with the taxing rights in respect of royalties, it will also, more likely than not, deal with the rates of taxes that apply.
The withholding tax on royalties is dealt with in sections 49A – 49H of the RSA Act (or Part IVA). If the RSA has a taxing right, the withholding tax will be in terms of section 49E of the RSA Income Tax Act. Section 49F deals with when the payment of the tax.
In my view there was no obligation to withhold the tax in this instance. I will however start with some general comments and specific comments to answer your questions.
Some general comments:
In principle, the withholding tax on royalties, must be levied and is calculated at the rate of 15 per cent of the amount of any royalty that is 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 the Republic in terms of section 9(2)(c), (d), (e) or (f) – section 49B(1) of the Income Tax Act.
It is the foreign person to which a royalty is paid, who is liable for the withholding tax on royalties – see section 49C(1) of the Act.
Section 49E(1) provides that any person making payment of any amount of royalties to or for the benefit of a foreign person must withhold an amount of withholding tax on royalties from that payment. This creates the withholding obligation.
Section 49E(3) applies where the foreign person qualifies for a rate lower than 15%. It reads as follows:
The rate referred to in section 49B(1) must, for the purposes of that subsection, be reduced if the foreign person to or for the benefit of which the payment contemplated in that subsection is to be made has-
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by a date determined by the person making the payment; or
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if the person making the payment did not determine a date as contemplated in paragraph (a), by the date of the payment,
submitted to the person making the payment a declaration in such form as may be prescribed by the Commissioner that the royalty is subject to that reduced rate of tax as a result of the application of an agreement for the avoidance of double taxation.
Important here is the requirement that the declaration must be submitted, by the foreign person, to the person making the payment, before payment is made. And then, if no declaration was received from the foreign person, the 15% rate must apply and the person paying the royalty must withhold the tax. A refund can then be applied for.
The declaration, as the Act currently reads, is not required for every payment and has no expiry date. There is a draft Bill out that proposes to change that and to introduce a 2 year period.
The form (Withholding Tax on Royalties Declaration (WTRD)), available on the SARS website, must be used for this declaration. Before this form was available, the declaration could have been made in any format. It only required the detail, i.e., that the treaty provides for a reduce rate and that the beneficial owner is a resident of the treaty country.
Once the person making payment of the royalty, received the declaration, the royalty could be paid and no amount withheld from the payment.
The form IT27 is used for a refund of the withholding tax. Whilst it may contain some of the detail required, it does not contain a declaration that that the royalty is subject to a reduced rate. The Act requires the form to be one that may be prescribed by SARS. Whilst the WTRD was made available on 04 March 2015, it has not been prescribed by SARS yet. The draft interpretation note, that you referred to, may well be the first time that the form is prescribed by SARS.
The person liable for the tax:
I have already indicated that it is the foreign person who is liable for the withholding tax on royalties – see section 49C(1). In terms of section 49F(1), the foreign person must then make payment of this tax by the last day of the month following the month during which the royalty was paid. This applies unless the tax has been paid by any other person. Where the person making payment of a royalty has withheld an amount, that person is then deemed to have paid the tax to the foreign person – see section 49B(4). In such an instance, the tax would have been paid by another person.
Factually, the tax is not payable by the foreign person (or is payable at the rate of zero percent).
Withholding agent:
In the Tax Administration Act, withholding agent means a person who must under a tax Act withhold an amount of tax and pay it to SARS – see section 156 of the Act.
It is also so that, in terms of section 157(1) of the Act, a withholding agent is personally liable for an amount of tax withheld and not paid to SARS; or which should have been withheld under a tax Act but was not so withheld.
Penalties:
Currently, no administrative non-compliance penalty can be levied by SARS – this non-compliance has not been listed in a public notice.
An understatement penalty can be levied if there is, or was, an understatement. For purposes of the ‘understatement penalty’, “understatement” means any prejudice to SARS or the fiscus as a result of—
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failure to submit a return required under a tax Act or by the Commissioner;
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an omission from a return;
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an incorrect statement in a return;
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if no return is required, the failure to pay the correct amount of “tax”; or
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an “impermissible avoidance arrangement”.
The right of the RSA to tax the royalty:
Because the royalty is paid, by a resident of the RSA to a resident of a treaty country, one must first determine whether the RSA has a right to “tax” the royalty.
Paragraph (1) of Article 9 is relevant and reads as follows:
“Royalties arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State, if such royalties are subject to tax in such other State.”
The first point is that the treaty doesn’t make provision for a lower rate, or for a rate of zero percent.
It is clear that the RSA will have no right to tax the royalty, arising in the RSA, if it is paid to a “resident of the Federal Republic” (being any person who is resident in the Federal Republic (subject to unlimited tax liability) for the purposes of German tax) and if such royalties are subject to tax in Germany. In this instance the RSA is the source state.
The above is confirmed by SARS in their document.
This means that the withholding tax on royalties is also not payable by the resident of the Federal Republic of Germany. And more importantly, that the person paying the royalty had no obligation to get a declaration from the foreign person (in Germany). The German resident is not liable for the tax and there is also no reduced rate.
This assumes that the other requirements, see the paragraphs below, of Article 9, still applies. It was declared as such in the IT27.
(3) The provisions of paragraph (1) shall not apply if the recipient of the royalties, being a resident of a Contracting State, has in the other Contracting State in which the royalties arise a permanent establishment with which the right or property giving rise to the royalties is effectively connected. In such a case, the provisions of Article 4 shall apply.
(4) Royalties shall be deemed to arise in a Contracting State when the payer is that State itself, a land, a political subdivision, a local authority or a resident of that State. Where, however, the person paying the royalties, whether he is a resident of a Contracting State or not, has in a Contracting State a permanent establishment in connection with which the obligation to pay the royalties was incurred, and the royalties are borne by the permanent establishment, then the royalties shall be
deemed to arise in the Contracting State in which the permanent establishment is situated.
(5) Where, owing to a special relationship between the payer and the recipient or between both of them and some other person, the amount of the royalties paid, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the recipient in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions of this Agreement.
You are welcome to contact me if you have any questions in this regard.