The company that I am doing a review on, pays a set amount of money over to a related company. In the receiving company it is marked as distribution. And in the paying company as profit share. Is this amounts dividends and taxable as dividends?
Important:
This answer is based on tax law for the tax year ending 28 February 2018.
Answer:
Whilst we don’t provide guidance on accounting disclosure, we wish to point out that the one company can’t disclose it as a “distribution” (which we assume means a dividend) when the other party discloses it as ‘profit share’ (which we assume is a reduction in the amount of the company’s income before tax). In principle, the nature of the amount (transaction) must be the same.
From a tax point of view the following comments are relevant:
From the facts provided it is clear that at issue is whether the amount in dispute was “received or accrued in respect of services rendered…” If this was the case the amount would be gross income, also remuneration and subject to employees’ tax. This of course is in terms of paragraph (c) of the definition of gross income in section 1(1) of the Income Tax Act.
In terms of the definition, in section 1(1) of the Income Tax Act, a “dividend” means “any amount transferred or applied by a company that is a resident for the benefit or on behalf of any person in respect of any share in that company, whether that amount is transferred or applied by way of a distribution made by…”
In both instances, the Act uses the term “in respect of”. Judge Howie (in the Stevens case) said “…there is no material difference between the expressions ‘in respect of’’ and ‘by virtue of’ in paragraph (c). They connote a causal relationship between the amount received and the taxpayer’s services or employment.” (The reference to paragraph (c) is to the paragraph in the definition of gross income).
We submit that the same principal will apply in this instance. In other words, if the amount accrued to the company in its capacity as a holder of a share (as opposed to a provider of a service as indicated above) the causal relationship between the share and the amount transferred exists and a dividend arises. This would apply to both parties.
On the other hand, if the originating cause is the services rendered, it would not be a dividend.
The neutral citation for the judgment that we referred to is Stevens v CSARS [2006] SCA 145 (RSA).
The fact that the parties treat is as one or the other is irrelevant, as the nature of the amount would be determined in the way explained above.
We didn’t comment on the presumption of purpose (see section 80G of the Income Tax Act). We accept that the members, who are connected persons in relation to each other, will be able to rebut this presumption if a tax benefit arose.
The service offered by us is limited to guidance only and we can’t respond to the “How to make this as tax efficient as possible?” request. Guidance implies that sources or references relevant to your request are provided, but that ultimately your professional judgment is required to be applied to the specific circumstances.
We agree with your comment that taxable income in the company would be subject to normal tax. Since 1 January 2011, a dividend as defined for tax purposes, doesn’t refer to or depend on profits. Whilst not a tax related issue, the same applies from a Companies Act point of view. From the facts, the new company will not have retained income at incorporation.
The considerations are the following:
We accept that, if there is a tax benefit, the parties would be able to rebut the presumption of purpose – see section 80G of the Income Tax Act.
For the amount transferred or applied by a company to be a dividend, it must be in respect of a share in that company. For instance, a payment in respect of services rendered would not be a dividend.
The fact that the company was purchased in their individual capacity and thereafter transferred to another company, is also important – there may be capital gain consequences.
In terms of the draft Rates and Monetary amounts Bill, the rate of dividends tax will increase to 20%. Dividends paid by one RSA resident company to another RSA resident company, are exempt from the dividends tax – section 64F(1)(a). We are not sure, even where the dividend is paid to a beneficial owner and is not exempt from the tax, the ‘effective/ rate of tax would not be more than 40%.