South African Corporate Income TAX: Reforms on The Horizon
In contrast to many of South Africa’s trading and investment partners, the South African corporate income tax rate of 28% has remained unchanged for more than a decade. In particular, the corporate income tax rate of the United States, the United Kingdom and India have recently been reduced to 21%, 19% and 22%, respectively.
In recognition of the negative impact which the above may have on the relative competitiveness of South Africa in the international market, the 2020 Budget Review announced that government intends to restructure the corporate income tax system over the medium term by reducing the corporate income tax rate while broadening the corporate income tax base. It is believed that the proposed reduction in the corporate income tax rate will encourage entities to expand investment and production as well as reduce potential base erosion and profit shifting.
Accordingly, in future, South African companies may find that they pay corporate income tax at a lower rate, but due to measures to broaden the corporate income tax base, in certain instances, the taxable income of such entity may increase.
We briefly discuss below some of the proposals made in the 2020 Budget Review with a view to broadening the South African corporate income tax base.
1) Minimising tax incentives
The 2020 Budget Review indicates that tax incentives create complexity and inequality and can accordingly compromise the principles of a good tax system. This aligns with the views of the Katz Commission which previously indicated that the range of tax incentives should be narrowed as far as possible. In addition, the Davis Tax Committee previously proposed a detailed review of corporate tax incentives.
Accordingly, the 2020 Budget Review proposes sunset clauses to several tax incentives and indicates that government will undertake a review of tax incentives for purposes of repealing or redesigning those found to be inefficient or inequitable. Relevant proposals in this regard include:
- the introduction of a 28 February 2022 sunset clause for tax incentives relating to airport and port assets, rolling stock and residential units;
- the non-renewal of the industrial policy project tax incentive beyond 31 March 2020;
- the review of the urban development zone tax incentive and the extension thereof for a one-year period; and
- limiting the tax incentives for special economic zones to not extend further beyond the six currently approved special economic zones.
2) Limiting the use of assessed losses
In terms of current law, where the permissible tax deductions of a company exceed the company’s income during a year of assessment, an assessed loss may arise. The company is, in certain instances, permitted to carry forward such assessed loss to the next year of assessment for purposes of offsetting same against taxable income in the succeeding year of assessment.
The 2020 Budget Review indicates that internationally there has been a trend over the past number of years to limit this practice.
In line with the above, it is proposed that a restriction be enacted in terms of which the set-off of assessed losses carried forward be limited to 80% of an entity’s taxable income.
The impact of this proposal may therefore be significant in instances where companies have been operating in a loss position but have reasonable prospects of generating significant taxable income in future.
At this stage, it is proposed for this limitation to enter into force on 1 January 2021, for years of assessment commencing on or after such date.
3) Limiting the deduction of interest expenses
Government has for time some considered measures to address base erosion and profit shifting. A particular form of base erosion and profit shifting by multinational enterprises involves the artificial inflation of company debt (or interest rates applicable in respect thereof) owing to a foreign connected person which is subject to corporate income tax at a low rate. The effect is therefore that the South African entity obtains a substantial interest deduction in circumstances where the income is shifted to a low-tax jurisdiction.
With a view to addressing the above, it is proposed that net interest expense deductions be limited to 30% of earnings. Understandably, the design of this limitation requires great consultation and consideration. National Treasury will therefore release a discussion document in this regard and seek public comments in respect thereof by 17 April 2020.
It is proposed for this limitation to come into force on 1 January 2021 for years of assessment commencing on or after such date.
Although the proposal to reduce the South African corporate income tax rate in the medium term is welcomed to promote economic growth, in light of the concomitant proposals to broaden the tax base, corporates should be careful to celebrate too quickly. In particular, should the proposals as set out above enter into force, many companies may potentially find themselves in a position where they pay significantly more income tax – despite an actual lower corporate income tax rate.
It is therefore important to keep abreast of the above-mentioned proposals and the enactment thereof and to obtain the necessary advice to ensure to what extent the enactment thereof may have an effect on South African companies.
Tax Specialist from PKF Cape Town
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