The draft treaty between Mauritius and South Africa applies to normal tax, to withholding taxes on royalties and on foreign entertainers and sportsmen and the secondary tax on companies (which has been abolished). Although dividends tax has not been expressly included in Article 2 of the draft treaty, Mauritius has been advised by SARS that it will form part of the treaty, which Mauritius has implicitly accepted.
(a) Mutual agreement on residence
The most significant change brought about by the draft treaty concerns companies that are tax resident in both Mauritius and South Africa. In terms of the OECD Model Tax Convention tie breaker rules, double taxation of dual residents companies is resolved by ensuring that the company is tax resident in the State in which its “place of effective management” is situated. A South African incorporated company which is effectively managed in Mauritius would thus, in terms of the OECD tie breaker rules, be deemed to be tax resident in Mauritius and South Africa would lose its "taxing rights”. One of the perceived “abuses” of the 1997 Mauritius/South Africa treaty is by companies incorporated in Mauritius that purport to be effectively managed there, but are in fact run from South Africa. That is the case where significant functions that benefit the Mauritian company’s operations take place in South Africa.
Under the draft treaty the draft dual-residence tiebreaker rules provide that the competent authorities of the two states shall endeavour to determine by mutual agreement the Contracting State of which such person shall be deemed to be resident for the purposes of the treaty. This “mutual agreement procedure” as a manner for determining the tax residence status of a taxpayer is contemplated by the commentary on Article 4 of the OECD Model Tax Convention. The alternative provision provides that, in endeavouring to come to agreement on where the taxpayer shall be deemed to be resident, regard must be had to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. Where it is clear as to where the company is in fact effectively managed, such a provision would bring about no change. Accordingly, companies that are currently incorporated in Mauritius and are clearly managed there will not be affected by this provision. In a case where both South Africa and Mauritius believe that a company is incorporated in and purportedly effectively managed in Mauritius, and is also managed in South Africa, South Africa may wish to assert that the company is resident in South Africa. Unless South Africa and Mauritius can agree on where the company is resident, it will be a resident, for treaty purposes, of both countries and taxable in both countries. The contracting states are not required to grant the dual resident entity treaty benefits.
There is no obligation on the competent authorities to reach an agreement on the residency of an entity and it is probably practical to assume that the chances are remote of reaching agreement swiftly or even at all. The competent authority of Mauritius, for example, would, in principle, not have an active interest in coming to a mutual agreement where this would involve losing its taxing rights to South Africa. The fate of a dual resident company is that there is the potential for it to suffer tax in both countries but the effect of this could be ameliorated by any applicable domestic exemptions or credits (such as section 6quat). However, because Mauritius is a low tax jurisdiction, domestic relief for foreign tax paid is unlikely to offset the disadvantage of being subject to tax in both states (especially in light of the repeal of the tax sparing clause).
The practical effect of the above is that the dual resident company will be denied the benefits of the treaty and be subject to double taxation in South Africa and Mauritius if no agreement is reached between the two contracting states regarding the residence of the company. A binding arbitration process as per the current provisions of the OECD is not applicable under the proposed treaty.
Some consequences of the draft treaty are:
- It may force companies to stop creating dual residence situations. The draft treaty will necessitate taxpayers to relook their position as it places the onus on them to ensure that they structure effective management and substance of their entities so as to avoid double taxation. Since the Mauritian tax rates are lower than those in South Africa, it could imply that South African companies will also be unable to benefit from the section 6quat rebate if effective management is deemed to be in South Africa. The double taxation impact could result in decreased South African FDI into Mauritius – albeit minimal.
- The draft treaty widens South Africa’s tax net as it increases South Africa’s ability to identify Mauritian companies that should be regarded as resident here, given the way in which they in fact operate.
- The draft treaty may also help to bring into the tax net certain Mauritian branches of South African companies, in that, if the branch houses the company’s only activity, it may be possible to claim that the company is dual resident by virtue of incorporation in South Africa and effective management in Mauritius.
- The draft treaty does not affect Mauritian companies that clearly have their effective management in Mauritius.
(b) Withholding rates
Interest: Under the current treaty, interest paid out of South Africa to a Mauritian beneficial owner would not be taxable in South Africa. Under the draft treaty, the amount that South Africa is able to withhold on interest paid to a Mauritian beneficial owner has increased from nil to 10% of the gross amount of the interest. Mauritius does not currently impose a withholding tax on interest paid. South African lenders to Mauritian borrowers would thus not be negatively affected by the amendment of the interest article, while on the other hand Mauritian lenders to South African borrowers would be affected.
Dividends: In terms of the draft treaty, dividends tax will be withheld at a 10% rate unless the beneficial holder of the dividend holds at least 10% of the capital of the company paying the dividends, in which case the tax will be 5%.
Royalties: In terms of the draft treaty, the amount that South Africa is able to withhold on royalties paid to Mauritius has increased from nil to 5%. The above withholding tax rates will have an impact on Mauritian financing or IP licensing entities that derive Interest or royalty income from South Africa.
(c) Capital Gains Tax (CGT) Carve-Out for Property Rich Companies
As noted above, apart from being a low tax jurisdiction in which to operate, Mauritius has also been a favourable base for investing into South African land rich companies. The draft treaty provides that capital gains earned by Mauritian tax residents could be subject to South African CGT if the gain is from the disposal of shares in a South African company holding immovable property - a “land rich” company. This will have an impact on Mauritian companies that currently hold South African based investments in the mining or property sector. Thus the capital gains article of the draft treaty repeals the so called “CGT cut out” clause as it specifically provides that a country may tax gains derived from the alienation of shares deriving more than 50% of their value directly or indirectly from immovable property situated in that country.
However, this gives rise to the potential for investors to channel this type of investment through companies in other countries that still have a treaty with South Africa that still have CGT cut out clause. This was the case for example with the previously South Africa/Netherlands treaty. However, the South Africa/Netherlands DTA has been renegotiated and is awaiting signature and so is South Africa/Luxembourg DTA. It is also worth noting that the South Africa/Austria DTA and 18 other DTAs that have a zero rate on interest and/or royalties and those that do not have 13(4) of OECD are under renegotiation. These renegotiations will ensure Changes in ownership of shares in Mauritian land rich companies prevent the incentive to change the ownership to residents in other treaty countries now that there is South African CGT on disposal.
(d) Tax Sparing
The draft treaty no longer includes a tax sparing clause. Rather, it allows for relief in the form of a foreign tax credit.
(e) Exchange of information on tax matters and assistance in the collection of taxes
The 1996 tax treaty has a limited version of exchange of information provision that does not extend to bank secrecy. The draft tax treaty contains the latest OECD standard for the exchange of taxpayer information on tax matter as set out in article 26 of the OECD MTC. This will assist in the auditing of South African residents domiciled in Mauritius. The treaty also contains provision relating to assistance in tax collection of taxes.
(f) Remarks and Recommendations
There is no doubt that the draft treaty (if ratified) will put Mauritian companies in a less beneficial position vis-à-vis South Africa than is currently the case. This is so, specifically in the context of dual-resident companies, loans to South African borrowers and investments in companies owning immovable property in South Africa. However, this does not necessarily mean that the use of Mauritian companies is no longer beneficial in international structures.
It should be noted that treaty shopping can never be entirely stamped out and the chances are that some multinationals may look to other tax treaties to avoid having to pay CGT. One must bear in mind that the withholding taxes in the draft treaty are still lower than the normal South African holding tax rate. Where there is an entity in a third county either from which the Mauritian incorporated dual resident entity is receiving payments or to which it is making payments, being a dual resident could offer the advantage of the ability to cherry pick treaty rates. The dual resident company may thus be able to avail itself of either the tax treaty that South Africa has with a third country or of the tax treaty that Mauritius has with the third country. In these circumstances, since the “mutual agreement procedure” has to be initiated by the taxpayer, where the taxpayer takes advantage of other treaties, it would be difficult for such a taxpayer to initiate the mutual agreement procedure. In the absence of a specific fact scenario it is difficult to predict the extent to which the ability of a dual resident to “cherry pick” could lead to revenue leakage for South Africa, but it is a matter to be borne in mind during future risk profiling of Mauritian structures.
The withholding tax rates provided for in the draft treaty are still lower than the normal South African withholding tax rates. Although headquarter companies enjoy exemptions from these withholding taxes, headquarter companies cannot be used for investment into South Africa. Foreign investors would thus still prefer investing into South Africa via Mauritius, or they could look for another suitable jurisdiction to act as holding company jurisdiction for investment into Africa, including South Africa.
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