Passive holding companies now taxed
The Revenue Laws Amendment Act, 2008 inserts a Section 9E into the Income Tax Act. The new section deals with the concept of "passive holding companies". It is linked to the conversion of secondary tax on companies to dividend tax and will be effective from the same date as will be the provisions that introduce dividend tax.
The passive holding companies regime has arisen from a perception that individuals may choose to earn passive income, such as dividends, in a company rather than in their own hands, for tax reasons. It is possible to defer the imposition of dividend tax, if dividends are received and accumulated by a company, rather than being received directly by individuals in the first instance. The 28% company income tax rate, as opposed to the 40% maximum marginal income tax rate for individuals, has also been identified as offering an arbitrage opportunity.
The new provisions seek to eliminate the abovementioned practices. Passive holding companies will be taxed 10% on dividends received (as would an individual shareholder) and 40% (instead of 28%) on other revenue. The income that has been taxed as part of the passive holding companies regime will not then be subject to dividend tax when it is distributed.
A company will constitute a passive holding company if more than 80% of its gross income is from financial instruments and five or fewer South African resident natural persons (together with any of their connected persons) directly or indirectly have more than a 50% interest in that company. This is a more objective approach than was proposed in early drafts of the legislation. If a company forms part of a group of companies, then the calculation as to whether more than 80% of gross income is from financial instruments, will be done with reference to the group as a whole.
There are certain exclusions from the passive holding companies regime, such as listed companies and their groups, banks, long and short term insurers, collective investment schemes, public benefit organisations, recreational clubs, foreign companies and venture capital companies.
Any shareholder or director of a passive holding company that it regularly involved in the management of its overall financial affairs, will be personally liable in respect of any tax, additional tax, penalty or interest for which it is liable. There is also provision for estimated assessments if SARS does not believe that a passive holding company has paid its tax liabilities in full.
*Tim Desmond is a director of tax and commercial departments at Garlicke & Bousfield