South Africa ratified the ‘Multi-lateral Instrument’ (‘MLI’) effective 1 January 2023. The MLI is an international agreement between various countries to amend specific terms of the various countries’ double tax treaties. The document is the culmination of years of work by the OECD, tasked by the G-20 countries some ten years ago, to provide suggestions on addressing international tax avoidance.
The MLI’s introduction brings about various consequences, one of which is for so-called dual-resident companies: incorporated in one jurisdiction yet with their place of effective management in another.
Most of South Africa’s tax treaties determine that a company effectively managed from a country different to where it was incorporated will, for tax treaty purposes, be tax resident in the country where its place of effective management is. South Africa’s Income Tax Act is unique in linking domestic tax residence with treatment under a tax treaty. For domestic tax purposes, the Income Tax Act determines that a company will not be a South African tax resident if an applicable tax treaty determines residence to be in another country. Take, for example, a company incorporated in South Africa that is managed from another country. Where the tax treaty between South Africa and that country determines tax residence of the company to be in the management country (the case for most of our treaties), then, for domestic tax purposes, too, that company will not be a South African tax resident, irrespective its South African incorporation.
In the past, it was common for international corporate groups with strong South African shareholding influence to have a South African-incorporated holding company that was effectively managed from abroad. These structures were popular, as they ensured that the group had an international holding company for tax purposes yet complied with South African exchange controls. Under South African exchange control rules, so-called ‘loop’ structures are not allowed. Those disallowed structures involve South Africans holding South African investments through an offshore structure. In other words, South African shareholders must hold their indirect interests in a South African subsidiary, part of an international group, through a South African holding company.
Exchange control rules, different from tax rules, look to the country of incorporation to determine where a company is a resident. In other words, the company in our example, incorporated in South Africa and effectively managed abroad, would, in terms of the relevant tax treaty, be tax resident abroad yet resident in South Africa for exchange control purposes. As a result, South Africans holding South African investments through that holding company will have the benefits of an international structure for tax purposes while, for exchange control reasons, not contravening the exchange control regulations due to the holding company not being an offshore entity through which South African investments (such as South African subsidiaries) are held.
The MLI has thrown all of this into disarray. In Article IV of the MLI, if accepted by both countries (as is the case for South Africa and many of its treaty partners), tax residence of dual resident companies will no longer be where the company is effectively managed. Instead, dual resident entities will now be resident where the revenue authorities of those countries decide that place of residence to be. Until then, the relief provided for in the relevant tax treaty will be unavailable to the party (our dual-resident company) seeking to rely on it.
The result is dire for the dual-resident company in our example. That entity will no longer be deemed exclusively resident in the other country, meaning that it will no longer be excluded from being a resident in South Africa in terms of its Income Tax Act. This position will last for as long as the two counties cannot agree on where residence is, which can take many years.
Due to exclusive residence no longer determined under a treaty, the result is that a dual resident entity will exist without relief for double taxation available in terms of the relevant tax treaty on which it used to rely. It will also suddenly now, due to operation of law, suddenly be a South African tax resident from 1 January 2023.
Especially in the holding company context, this has severe implications for holding companies. Suddenly, companies in this position are now subject to South African capital gains taxes, its dividend withholding tax regime when declaring dividends and without relief from foreign dividends tax when receiving dividends from abroad.
It is, therefore, advisable for all companies that are possibly resident in more than one country, in terms of whichever criteria, to take urgent advice on the implication of the ratification of the MLI by South Africa.