taxes good 88.
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Given the Israeli propensity to invest and trade abroad, we continue a series of occasional articles on possible economic opportunities and tax issues for Israelis with overseas interests. In this article, we review South Africa, in particular its preparations for the soccer World Cup in 2010. Our remarks are very general and experienced professional advisors should be consulted in each country in specific cases.
The South African scene: South Africa returned to the international fold following democratic elections of 1994. It is known as the rainbow nation as it unites people of diverse backgrounds. It now has the largest economy is Africa and GDP is growing strongly at around 4.5 percent annually. The exchange rate of the rand currency has stabilized at around R7=US$1. In short, the emerging resource-rich South African economy is buoyant and major social and Aids problems are now being addressed.
Furthermore, in 2010, South Africa will host the FIFA World Cup and needs to ready itself now. In October 2006, the Finance Minister, Trevor Manuel announced plans to increase government expenditure by R80 billion ($11b.) over the next three years. Of this, R15b. ($2b.) will be spent on 10 soccer stadiums and surrounding infrastructure and the balance will be spent on environmental and human development projects. Therefore, the governmental Tenders Steering Committee finds it has a substantial budget and has begun arranging tenders.
All this presents a golden opportunity for Israeli investors and businesses. In the area of homeland security, Israelis will find they are not alone in the field and that South Africa has other needs, as well.
Senior South African government officials have indicated they will give priority in tenders to companies that comply with the letter and the spirit of South Africa's Black Economic Empowerment legislation. This requires affirmative action to involve Black people in economic matters. In addition, bidders may be favored if they will stay on in South Africa after 2010.
Will there be tax in South Africa?
Tax breaks are currently being legislated for World Cup business participants. There is expected to be an income tax exemption and VAT refund credits for FIFA sponsors in stadiums and other key locations used to host the World Cup - this is referred to as a "tax- free bubble." There will apparently also be an income tax exemption for foreign (non-South African) individuals. Further details will be available once these bubble benefits are enacted into law in South Africa.
What happens if your company is not an exempt sponsor?
If you use an Israeli company, it will be taxable in South Africa (as well as in Israel) if it has a "permanent establishment" (PE) in South Africa, according to the South Africa-Israel tax treaty. A PE includes a fixed place of business such as a branch; a dependent agent; a construction or assembly project; or the maintenance of "substantial equipment" of the Israeli company in South Africa for more than six months. A PE pays South African "normal tax" at a rate of 34% on its South African source income. The Israeli company will also report to the Israeli Tax Authority on that income but the credit for 34% South African tax should eliminate the liability to Israeli company tax (29% in 2007) on the South African income.
Any excess foreign tax credit (34% South African tax minus 29% Israeli tax equals 6% excess in this example) may be used in the following five tax years against other income of the same type from the same country (South Africa).
South African companies pay South African "normal tax" on their worldwide income at a rate of 29% as well as a Secondary Tax On Companies (STC) at a rate of 12.5% when dividends are paid. The STC is a tax on the company, not its shareholders. The resulting South African corporate tax rate on distributed income is 36.8%. If an Israeli resident company or individual invests in the shares of an active South African company, they should be able to defer Israeli tax until they receives a dividend from the South African company. At that time, the Israeli tax would generally be 25% of the dividend paid resulting in a combined South African and Israeli tax burden of 52.8%. If an Israeli resident individual holds under 10% of the South African company, the Israeli tax will be 20% of the dividend paid, resulting in a combined South African and Israeli tax burden of 49.44%.
But please note that if an Israeli company (not individual) holds at least 25% of a South African company, the Israeli company may choose to pay the regular rate of Israeli company tax (29% in 2007) on its share of the pre-tax profit of the South African company and claim a credit for the corporate taxes paid in South Africa - this should eliminate altogether the Israeli company tax if the South African company paid South African corporate taxes of 36.8%.
What about VAT and import taxes?
The standard rate of VAT in South Africa is 14%. There is no free trade agreement between South Africa and Israel, but there is a Trade, Development and Cooperation agreement between South Africa and the European Union, which has reduced South African import taxes for EU products.
What about finance?
South African exchange control limits apply to local borrowings by a South African company to the following:
* 300% of owner equity and loans if the company is 100% foreign-owned.
* 133% of owner equity and loans if the company is 75% foreign-owned.
* No limit if the company is under 75% foreign-owned.
In addition, interest expenses will be disallowed for South African tax purposes if the debt:equity ratio exceeds 3:1 or if the rate of interest exceeds an acceptable rate under detailed rules. There is generally no South African withholding tax on outbound payments of interest unless the lender does business in South Africa.
Are capital gains taxed?
South Africa generally imposes capital gains tax at a rate of 14.5% on companies and 10% on individuals. However, if you are not resident in South Africa you should be exempt from this tax unless the assets sold are fixed property or a 20% interest in a property company or assets of a PE (see above). Nevertheless, Israeli resident sellers will be liable to Israeli capital gains tax at a rate of 20% (post 2003 holdings under 10%) or 25% (most other post 2003 gains) less a credit for South African tax, if applicable.
What about individuals?
Israeli residents may be exempt under the Israel-South Africa tax treaty if they spend less than 183 days there in the tax year and are employed by a non-South African firm that does not charge their salary to any PE (see above) in South Africa. Where no exemption applies, individuals are taxed in South Africa at rates of 18%-40%. Foreign employees of foreign employers may not be taxed in South Africa on any housing benefit if various conditions are met, according to a recent court case. Israeli residents who relocate to South Africa will be taxable in Israel after deducting certain expenses and crediting South African tax. South African residents are taxed in South Africa on their worldwide income (just as Israeli residents are). "Tie breaker" rules in the Israel-South Africa tax treaty help prevent double taxation due to dual residency - for example, olim who are dual residents will be treated as Israeli residents rather than South African residents. Employers and employees each contribute 1% of salaries to the Unemployment Insurance Fund unless the employer is required by law or contract to repatriate the employee upon termination of the employment contract in South Africa. In Israel, detailed tax and national insurance rules and rates and apply to Israeli residents relocated to South Africa - specialist advice should be obtained. Also note that South Africa imposes a 20% estate tax and donations tax on South African residents; non-residents pay estate tax on South African assets but are exempt from the donations tax.
The South African real estate market is also booming.
There is a South African transfer tax on fixed property - for individuals the rate is up to 8%. Net rental income derived by Israeli resident individuals is taxed at rates of up to 40% in South Africa and up to 48% in Israel less a credit for the South African tax. Alternatively, Israeli resident individuals may choose to pay tax in Israel at a rate of 15% of the GROSS rental income less Israeli tax depreciation (2%-4% per year on a straight line basis) but without any credit for the South African tax - if this proves more worthwhile.
To sum up, South Africa is an emerging country that is often overlooked. World Cup fever has already arrived and major tenders offer substantial opportunities for Israeli concerns. As always, specialist legal and tax advice must be obtained in each country.
Leon Harris is an International Tax Partner at Ernst & Young Israel. Steven Slom is an Israeli and South African lawyer and Chairman of the Israel-South Africa Chamber of Commerce.