The big ‘must do’ when claiming foreign tax credits

South African individuals and companies wishing to claim foreign tax credits must ensure they tick all the boxes to be successful.

If the South African Revenue Service (Sars) audits the submission and requests supporting documentation, it is perfectly entitled to disallow the full credit if any boxes were left unticked. This is according to Carmen Westermeyer, speaking during a tax discussion hosted by The Tax Faculty.

The most important criteria, which is often “conveniently” ignored, is that the taxpayer must demonstrate that the foreign tax was correctly paid, that it was not refundable, and that the other revenue authority actually had the authority to levy the tax.

Correcting the error

“It is not enough to show that you paid the tax,” says Westermeyer.

She quotes an example where dividend tax was withheld by the foreign subsidiary of a South African company.

In this instance the company had an investment portfolio in the UK. When the UK subsidiary paid the dividend, it withheld tax at 30%. The South African company wanted to claim credit for the tax, but encountered a problem.

Although correct under UK law, in terms of the Double Tax Agreement (DTA) between the two countries, the withholding tax rate is capped at 15% or 5% depending on the criteria. When the company then submits a foreign tax credit to Sars it cannot claim the full amount paid because the foreign tax is incorrect. The South African company must first recover the tax incorrectly withheld from either Her Majesty’s Revenue and Customs (HMRC) or the withholding company.

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“People seldom consider whether the tax has been correctly raised in the first instance and then they simply want a credit from Sars because it is too much of an effort to argue with the other revenue authority,” says Westermeyer.

The taxpayer could have received a refund but chose not to go that route. “You must show that it was a final tax and that it was appropriately raised.”

Violation of tax treaties

There are also instances where foreign jurisdictions violate the DTA with SA and raise taxes against South African taxpayers when they have no right to. Since the taxes were levied in violation of the treaty the taxpayer has no way to ‘prove’ that the tax was indeed payable.

This could result in double taxation with no relief.

Another key principle is to disclose foreign income on a gross basis. Westermeyer says a South African taxpayer who earns foreign rental income must disclose the gross rental and expenses and not only the profit.

The amount of the credit must be equal to the amount of tax paid on any foreign income that is included in the taxable income. If the taxpayer has an exempt amount, such as the R1.25 million exemption on foreign employment income, or claimed any deductions against the foreign income, the credit that can be claimed will be less.

Correct apportionment

Westermeyer notes that the apportionment of the credit is done by the tax authority. However, the onus is on the taxpayer to check whether it was done correctly.

The rebate is also limited to the amount of tax payable in SA. If the taxpayer paid 30% tax in the foreign jurisdiction, they will only be able to claim 28% (the current corporate income tax rate).

Westermeyer says that, as with most deductions and rebates, it will be necessary to have the required supporting documents on hand should Sars query the claim.

This includes a statement of the tax paid, the name of the tax, the jurisdiction in which it was paid, the law under which the tax was imposed, and whether it was levied by a national, state or local tax authority.

Many people do not have this information, she remarks.

Listen to Boitumelo Ntsoko’s interview with Craig Torr of Crue Invest about how your investments will be taxed in this Money Savvy podcast (or read the transcript here):