Generally, if a South African taxpayer sells shares in a foreign company, he will be hit with South African capital gains tax (CGT) on any gain realised on that sale. However, South Africa provides exemptions from this CGT in certain circumstances, one of which relates to the sale of foreign shares. Providing taxpayers with tax exempt treatment on disposals of certain foreign shares held by them is common practice globally and available in many jurisdictions. The primary aim of the exemption is to make the seller’s country ‘investor friendly’ and to avoid double taxation, since the country in which the foreign company being sold may well also seek to tax the gain on sale.
Currently, the CGT exemption applies where the South African taxpayer, immediately before disposal, has held at least 10% of the equity shares and voting rights in the foreign company for at least 18 months. To be exempt, these foreign shares must be sold to a non-South African resident (which cannot be a ‘controlled foreign company’ ie more than 50% held from South Africa) for at least market value.
However, a proposed amendment in the Taxation Laws Amendment Bill has narrowed the exemption. It provides that the exemption will not apply where foreign shares are disposed of to a ‘connected person’. This amendment, together with other amendments, is aimed at preventing South African resident companies from migrating out of South Africa on a tax-free basis.
Many non-tax driven group reorganisations take place involving a South African shareholder transferring shares in a foreign company to a connected person within the group. In terms of the proposed rules, this transfer would (with effect from June 5, 2015) trigger South African CGT, unless the corporate rules in sections 42 to 47 of the Income Tax apply. However, these corporate rules (which are intended to provide tax neutral treatment for certain group reorganisations) are narrow in scope and only apply in very specific circumstances.
Foreign groups which establish a holding company in South Africa to hold shares in foreign investments should be aware of CGT implications when the South African company disposes of the foreign investment. The South African company must take care not to sell the shares to a connected person, or it will pay CGT. Although a South African ‘headquarter company’ enjoys greater CGT relief than a normal South African company, foreign investors cannot always meet the headquarter company requirements.
South Africa is competing with jurisdictions such as Mauritius to be the holding company location of choice for investments into Africa. Mauritius, however, does not levy CGT on the sale of foreign shares by a Mauritian taxpayer. By narrowing the participation exemption, South Africa will stifle the freedom of foreign investors and make them more cautious about establishing or growing investments in a South African group company.