Non-residents tax-sparing clauses

Integritax (SAICA) revisited for Int'l Tax Planning LLM Course
2009/10/03

Non-residents 650. Tax-sparing clauses December 1998 Tax-sparing is a concept encountered in numerous double taxation treaties, nearly always when one party to the treaty is a "developed country" and the other a "developing" or "emerging" one. Sometimes, however, the signatories agree to reciprocal sparing concessions.


Tax-sparing usually applies to categories of income such as dividends, interest and royalties; in other words, what would be called "passive investment income" in South Africa. In some cases, however, it is applied to "active" income as well.

Most tax treaties provide that residents of one country will be taxed on passive income arising in the other country at a particular rate. This rate usually varies between about 10% for interest and 15% for dividends, with royalties falling somewhere in that range. When a tax-sparing agreement forms part of the treaty, it is invariably accompanied by tax concessions in the form of credits offered by the "developing" or "emerging" country. If a resident of the "developed" country earns passive income from a source in the other country, which then grants a tax credit in respect of that income, the "developed" country undertakes to impose tax on its subject as if the subject had actually been taxed in the emerging country. That is, the credit is allowed twice; once in the "developed" country and once in the "developing" country. The incentive for taxpayers in the "developed" country to invest in the other country is obvious.

For example, say, a taxpayer resident in D, the "developed" country, earns royalties from a source in E, the "emerging" country, a country with which it has a double taxation treaty which contains a tax-sparing clause. The gross royalties amount to 10 000, which in F attract tax of 2 000. At the same time E gives the taxpayer a tax credit of 2 000 as part of an incentive package to encourage investment. D, in calculating the tax payable by the taxpayer, will arrive at the total tax owing and then deduct 2 000 as a credit as if it had actually been paid to E. In so doing, D is clearly encouraging its subjects to invest in F.

There are variations on this theme. For example, Germany (which has several tax-sparing agreements), allows a credit against the foreign income at the German tax rate, even though the actual tax rate in the other country may be less. To illustrate this by example:

R
Domestic income 80 000
Gross foreign royalty income
foreign tax paid 2 000) 10 000
Taxable income 90 000
Tax at 45% (the German corporate rate)
40 500
Less tax-sparing credit at 45%
(instead of the actual 2 000)
4 500
Tax payable 36 000


Section 788(5) of the Income and Corporate Taxation Act in the UK specifically provides for tax-sparing agreements in tax treaties.

Tax-sparing provisions appear in only two of South Africa’s double taxation agreements. The agreement with Mauritius operates in favour of Mauritius, while that with Romania benefits residents of both countries. (There is a sparing clause in the agreement with Israel, but it only applies to the now defunct Undistributed Profits Tax.) Perhaps the scarcity of this concept has to do with our strange position of being partly developed, partly emerging and partly developing.

Incidentally, South Africa now has over 40 tax treaties, almost as many as the Netherlands, which has historically been the world leader in offshore tax planning. Perhaps our potential as a tax haven will finally be recognised soon.

Deneys Reitz

IT Act:S 108