Budget 2017 announced an increase in dividends tax, from 15% to 20%. This tax increase is effectively borne almost exclusively by South African individuals, and should be seen for what it is: a further tax on “wealthier” individuals.
The increase in dividends tax was explained in the budget review on the basis that, given that the maximum marginal income tax rate for individuals is increased to 45%, if the dividend withholding tax were not also increased, this would increase the arbitrage opportunity for some individuals to pay themselves with dividends rather than salaries. This demonstrates that the focus was on high income earners, as the driving force behind the change.
The proposed change has also far broader consequences, however. It does not only affect the currently employed workforce, who may seek to channel their income through a company. For example, this change also affects retired people who invest in shares, who would now pay one-third more tax (an increase of 5% is one-third of the current rate of 15%). It is also not a change that is restricted to individuals who would fall within the “top tax bracket”, but would rather apply to all individuals, including low income earners who may, for example, hold shares as part of a broad based black economic empowerment scheme. This change is accordingly potentially detrimental to broad based share ownership.
It is also important to note that there are already specific anti-avoidance measures in place, to address the situation where an attempt is made to disguise income as “dividends”, for example exclusions from the normal dividends exemption rules, as well as a specific “restricted equity instrument” regime. In the circumstances, one has to question whether this amendment is indeed necessary, to address the purported potential “mischief” that might otherwise arise.
While one might consider that dividends tax is a tax on companies, and so of general application (and not only punitive to South African individuals), this is not the case, for the following reasons:
- South African companies are exempt from dividends tax
- Non-resident shareholders are, in most instances, able to take advantage of tax treaty relief. This means that the maximum withholding tax that they would pay would be as set out in the relevant tax treaty, and increases to the South African dividends tax rate would not affect them.
The proposed dividends withholding tax of 20% is also surprising, given that there is a “standard” rate of 15% for other withholding taxes (royalty withholding tax, interest withholding tax and tax on foreign entertainers and sportspersons). This potentially gives rise to an arbitrage opportunity of a different kind.
If these withholding tax rates were to diverge, it would actually make sense for the dividends tax to be at a lower rate than that on royalties or interest. This is because a corporate payer would typically receive an income tax deduction at 28% for royalties and interest paid, versus a royalty or interest withholding tax of only 15%, resulting in a net loss to the fiscus in relation to these payments, whereas dividends are paid from the “after tax” profits of the company, without any tax deduction available for dividends, resulting in a net collection by the fiscus. In the circumstances, it appears anomalous that the withholding tax on dividends should be higher, encouraging the use of other cross-border revenue streams that actually erode the tax base.
Written by Patricia Williams, Tax, Bowmans