SOUTH AFRICAN REVENUE SERVICE


INTERPRETATION NOTE NO. 2

DATE:1 FEBRUARY 2002
ACT:INCOME TAX ACT, 1962 (the Act)
SECTION:SECTION 9E(5A)
SUBJECT:FOREIGN DIVIDENDS - DEDUCTIBILITY OF INTEREST

1.Background

Foreign dividends which were received by or accrued to on or after 23 February 2000, or which accrued before 23 February 2000, but were received on or after this date, are subject to income tax in the hands of all residents. Interest incurred in purchasing shares in respect of which the dividends accrue would normally not qualify for deduction in terms of section 11(a) and 23(g) of the Act. Section 9E(5A) of the Act, however, provides for a special deduction in order to alleviate the problem.

The purpose of this Note is to provide guidance regarding a resident who is a natural person and a portfolio investor in relation to the deduction of interest expenditure. A portfolio investor is any person that holds less than ten per cent of the equity share capital of a company.

This section overrides the "trade" requirement to a certain degree in that it allows a resident to deduct interest actually incurred in the production of income derived from both exempt and taxable foreign dividends.

2.The Law
2.1

In terms of section 9E(5A)(a) of the Act a resident will be allowed a deduction from taxable foreign dividends derived during any year of assessment, any interest actually incurred in the production of foreign dividends as defined in section 9E. This will apply notwithstanding the provisions of sections 11(a) and 23(g) of the Act, but subject to certain limitations and conditions.

  • The amount of interest deductible for a particular year of assessment is limited to the amount of income derived from foreign dividends during that year of assessment.
  • The excess interest may qualify as a deduction in the following year of assessment against taxable foreign dividends. The excess amount must, however, first be reduced by the amount of exempt foreign dividends that accrued during that year. The amount remaining after the deduction of the exempt foreign dividends is carried forward to the following year of assessment and qualifies as interest actually incurred during that year of assessment. [Section 9E(5A)(b)]
  • If for any year of assessment the amount of exempt foreign dividends is equal to or greater than the amount of excess interest, then the balance of excess interest carried forward to the following year of assessment is equal to R Nil.

Income derived from foreign dividends is equal to the amount of gross foreign dividends less the amount of foreign dividends exempt from tax in terms of the provisions of sections 10(1)(i)(xv) and 10(1)(k)(i).

2.2 Foreign dividends, (i.e. taxable foreign dividends and foreign dividends exempt from tax in terms of section 9E(7)) are included in "gross income" in terms of paragraph (k) of the definition of "gross income".
2.3 Foreign dividends which are taxable in terms of section 9E are excluded from the exemption for dividends in terms of section 10(1)(k)(i).
2.4

A natural person is entitled to a basic exemption in respect of interest and foreign dividend income which would otherwise not be exempt from tax. The exemption must first be applied to taxable foreign dividends and then to any other interest income and taxable dividends (other than taxable foreign dividends). [Section 10(1)(i)(xv)]

For the 2001 year of assessment the basic exemption amounts to R3 000 for natural persons under 65 years of age and R4 000 for natural persons who are 65 years of age or older.

In respect of the 2002 year of assessment the basic exemption amounts to R4 000 for natural persons under 65 years of age and R5 000 for natural persons who are 65 years of age or older.

2.5 The following exemptions provided for in section 9E(7) are of particular importance to a resident that is a natural person and a portfolio investor:
  • shareholding of less than 10% in a company listed on the Johannesburg Stock Exchange [Section 9E(7)(c)]
  • foreign dividends declared from profits already subject to normal tax in the hands of the shareholder [Section 9E(7)(e)(ii)]
  • foreign dividends declared from profits that arose from dividends declared by a South African resident company [Section 9E(7)(e)(iv)]
  • foreign dividends declared from profits that were derived from foreign dividends exempt in terms of section 9E(7) [Section 9E(7)(f)]
3.Examples

Example 1: 2001 year of assessment

Ms A is ordinarily resident in South Africa, 50 years of age and unmarried. She elected to be taxed on the net amount of her foreign dividends i.e. the amount of the dividend received by her after the deduction of foreign withholding taxes.

R
Gross foreign dividends (taxable and exempt) 10000
Basic investment income exemption [section 10(1)(i)(xv)] 3000
Foreign withholding tax payable in respect of gross foreign dividends Nil
Exempt foreign dividends [section 9E(7)] 1000
Interest income earned Nil
Interest actually incurred in the production of foreign dividends (taxable and exempt) 15000

Calculation of the amount of interest deductible in terms of section 9E(5A)(a):

R
Interest expenditure 15000
Plus: Balance of interest carried forward from the previous year of assessment [section 9E(5A)(b)]    Nil
Total amount of interest available for deduction in the current year of assessment 15000
Less: Allowable interest (Deduction limited to the amount of income derived from foreign dividends - see note) 6000
Excess interest 9000
Less: Exempt dividends (R1 000 + R3 000) 4000
Balance of interest carried forward to the 2002 year of assessment [section 9E(5A)(b)(ii)] 5000

Calculation of taxable income derived from foreign dividends

R
Gross foreign dividends [section 9E(3)] 10000
Less: Gross foreign dividends exempt in terms of section 9E(7) [section 10(1)(k)(i)] 1000
Less: Basic interest and dividends exemption [section 10(1)(i)(xv)] 3000
Income derived from foreign dividends 6000
Interest expenditure [section 9E(5A)(a)] 6000
Taxable income derived from foreign dividends    Nil

Note:
Calculation of income derived from foreign dividends

R
Gross foreign dividends [section 9E(3)] 10000
Less: Gross foreign dividends exempt in terms of section 9E(7) [section 10(1)(k)(i)] 1000
Less: Basic interest and dividends exemption [section 10(1)(i)(xv)] 3000
Income derived from foreign dividends before deductions 6000

Example 2:

Refer to the spreadsheet attached. The purpose of this example is to illustrate how the amount of excess interest must be carried forward on an annual basis.

ISSUED BY LAW ADMINISTRATION

Example 2: Calculations of taxable foreign dividends for individuals:

Year of assessment Ref 2001 2002 2003 2004
R R R R R R R R
Gross foreign dividends (Para (k) of the definition of gross income) 16000 11000 17000 30000
Less: Exempt foreign dividends(s 9E(7)) A 6000 1000 2000 Nil
Less: Basic exemption B 3000 4000 4000 4000
Income derived from foreign dividends C 7000 6000 11000 26000
Less: Deductible interest 7000 6000 11000 15000
Calculation of deductible interest:
Interest incurred during the year (s 9E(5A)) 20000 8000 15000 15000
Plus: Excess interest carried forward from previous year    Nil 4000 1000    Nil
Total interest D 20000 12000 16000 15000
Limited to income derived from foreign dividends (C) 7000         6000         11000         26000        
Taxable income derived from foreign dividends    Nil    Nil    Nil 11000
Excess interest (D - C) 13000 6000 5000 Nil
Less: Exempt foreign dividends (A + B) 9000 5000 6000 4000
Balance carried forward 4000 1000    Nil    Nil



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