The governments of South Africa and Mauritius signed a revised agreement for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income ("DTA") on 17 May, 2013. At the earliest, the agreement may come into effect on 1 January 2015, but the implementation date depends on the length of time that it will take South Africa and Mauritius to complete the necessary ratification procedures.

Once instruments of ratification are reciprocally conveyed to the respective governments, this new agreement will replace the current DTA between the two countries.

The new DTA is less advantageous in certain respects than the existing DTA. Whether or not the new DTA will prove a sufficient incentive for taxpayers to change any existing structures that involve Mauritian companies, will depend on the circumstances. For many investors currently making use of Mauritian-based structures, it should be “business as usual”, despite the changes to the DTA.

However, reviews of any situations in which Mauritian companies are being used to invest into South Africa, or into other countries from South Africa, are recommended.

Notable changes contained in the revised DTA

The revised DTA represents an interesting mixture of the Organisation for Economic Development ("OECD") and the United Nations Model Convention, and a lot of attention was clearly given by the drafters of this DTA to formulating its provisions. While there are many differences between the current and future Mauritius/ South Africa DTAs, arguably the most notable changes are as follows:

• the elimination of "place of effective management" as the so-called tie-breaker test, or test to determine in which country persons other than individuals should be considered tax resident for treaty purposes. The place of effective management test is to be replaced with a mutual agreement procedure between the competent authorities;
• the expansion of source-based taxation with the enlargement of the treaty concept of permanent establishment to include the "furnishing of services through employees… or other personnel" as well as "the performance of professional services or other activities of an independent character";
• the elimination of capital gains tax relief where a resident of one treaty state disposes of shares in a property-rich company located in the other treaty state;
• increases in the permissible rates of withholding tax that can be levied on cross-border payments of interest and royalties;
• the elimination of tax sparing relief for persons not deemed to be resident in Mauritius; and
• the inclusion of the latest OECD recommended provisions relating to the exchange of taxpayer information.

Residence test

There have been substantial changes to Article 4, which affect where a taxpayer is subject to tax on the basis of the taxpayer's residence.

In a significant departure from the current regime under the existing DTA, the determination of exclusive residency for dual resident persons other than individuals will no longer be determined by their "place of effective management". This test is to be replaced by a discretionary regime in which the two tax authorities must agree on the residence for treaty purposes of a juristic person that is considered tax resident in both South Africa and Mauritius under the domestic laws of these countries.

This mode of settlement is referred to as the "Competent Authority Procedure" and is concluded by bilateral negotiations between the respective tax authorities. Should South Africa and Mauritius fail to reach agreement on this issue, the person concerned will be considered to be outside the scope of the treaty (other than in regard to the Exchange of Information provisions). Both countries could then apply their tax laws to the taxpayer concerned.

This provision has sparked a lot of media interest and a generally negative reaction. While it may well impact on some taxpayers adversely, this should be the exception rather than the rule.

While economic double taxation is unlikely to arise if the treaty cannot conclusively determine the issue of tax residence (because SA will give a foreign tax credit for any Mauritian tax suffered), no taxpayer will wish to face the uncertainty and administrative burden of this type of competent authority procedure. Nor will any taxpayer wish to file tax returns in two different countries or lose the benefits of any tax treaty relief the taxpayer may currently be enjoying.

Resorting to competent authority procedures in this context is not the OECD’s recommended approach for the tie-breaker test. However, the OECD has explicitly sanctioned this option as an acceptable one, and recommends that the following factors be considered by the competent authorities of the countries involved, in making their determination:

• the place where meetings of the company’s Board of Directors or equivalent body are usually held;
• the place where the chief executive officer and other senior executives usually carry on their activities;
• the place where the senior day to day management of the person is carried on;
• the place where the person’s headquarters are located;
• which country’s laws govern the legal status of that person;
• where its accounting records are kept; and
• whether determining that the legal person is a resident of one of the contracting states but not for the other would carry the risk of an improper use of the provisions of the DTA.

Assuming that South Africa and Mauritius will follow the OECD’s recommendations with regard to consideration of the factors listed above, their analysis of the place of residence of an entity under the competent authority procedure will be very similar to any current analysis generally applied for tax treaty purposes under the place of effective management tie-breaker test.

In the context of South African treaties, this approach to resolving questions of residence for companies is certainly neither unique to the new Mauritius/ South Africa DTA, nor even very unusual. It is currently to be found in 13 of South Africa’s existing DTAs, including, in the African context, our treaties with Botswana, Nigeria and Uganda. It is also found elsewhere in the world, for example in the UK's treaties with US, Canada and the Netherlands.

The new tie-breaker test highlights the importance for companies that wish to be treated as tax residents in Mauritius to ensure that they are not effectively managed (and consequently tax resident) in South Africa. However, the need for this is nothing new. If a Mauritian incorporated company is currently effectively managed in South Africa, it will be South African tax resident both under South African domestic law and in terms of the existing Mauritius/ South Africa DTA. If a Mauritian incorporated company is not effectively managed in South Africa, then there are no grounds for SARS to consider the company to be tax resident here. If SARS contends that a Mauritian company is effectively managed here, but Mauritius does not believe this to be the case, then even under the existing DTA, a dispute between the two countries as to where the relevant taxpayer has its place of effective management will be triggered, which would need to be resolved by the competent authority process.

The bottom line is that significant South African tax risks already exist, and will continue to exist under the new DTA, if a Mauritian company is unable to prove that its top level operational and strategic management factually takes place in Mauritius and not in South Africa. We recommend that structures making use of Mauritian incorporated companies be re-visited to ensure that these companies are really effectively managed in Mauritius, assuming that Mauritian tax residence is the objective, to minimise existing risks as well as any future risk under the new version of the DTA.

We also recommend that if Mauritian incorporated but South African tax resident companies are being used, then clarity should be obtained from Mauritius prior to 2015 that the Mauritian Revenue Authority is in agreement that these companies are resident in South Africa and not in Mauritius for treaty purposes.

We anticipate that the new treaty provisions will make taxpayers more aware than they may previously have been of the dangers of unintentionally locating effective management of any Mauritian incorporated company in South Africa. The new tie breaker test is also likely to make an intentional strategy of using a Mauritian incorporated, but South African managed, company less attractive.

Permanent establishment

The treaty concept of permanent establishment, a prerequisite for source based taxation of in-country profits, has also been expanded in the revised DTA to include the "furnishing of services through employees… or other personnel" as well as "the performance of professional services or other activities of an independent character" where such activities continue within a contracting state for a period or periods exceeding in the aggregate 183 days in any 12 month period commencing or ending in the fiscal year concerned.

The inclusion of services from employees is a standard UN Model treaty provision, and both provisions referred to above were also included in other recent DTAs such as the agreement entered into with the Democratic Republic of the Congo. In terms of the UN Model Convention commentary, it is recognised that this provision, designed to favour the collection of taxation on source income in developing countries, should be restricted and the six month or 183 day limitation was therefore suggested in the 2011 draft.

Unless the six month threshold is exceeded, South Africa will not be able to levy the proposed withholding tax on service fees (likely to be introduced on 1 March 2014) on fees paid to Mauritius.

Capital gains tax

In one of the most significant changes to be brought in by the revised DTA, the new capital gains article allows a contracting state to tax capital gains derived from the disposal of shares in property-rich companies (i.e. shares deriving 50% or more of their value from immoveable property located in the other contracting state). The 50% threshold will not be applied in practice to Mauritian sellers, however, as long as the domestic law in South Africa continues to exempt non-residents from capital gains tax on sales of South African shares unless 80% or more of the value of those shares is attributable to immovable property located in South Africa. However, once South Africa’s domestic law allows capital gains tax to be levied, the new DTA will not preclude this.

This is likely to have a major impact on existing and planned foreign investments being made into the South African mining and property sectors. Using a Mauritian holding company to hold shares in SA mining or real estate companies will no longer be tax efficient once the new DTA is in force. Consideration should be given now to changing these structures where commercially feasible.

Withholding taxes

The significant changes to the withholding tax articles in the DTA include an increase in the withholding tax cap on interest from 0% to a rate of 10%, and an increase in the withholding tax rate that may be levied on royalties from 0% to 5%.

In the case of dividends tax the reference to "secondary tax on companies" ("STC") is retained under the heading of "Taxes Covered", and no explicit reference is made to dividends tax. However, SARS has made clear in a Binding General Ruling that dividends tax will be covered under all South Africa’s treaties whether or not mentioned explicitly.

The dividends tax article in the new DTA is largely left unchanged. One positive change is the reduction of the default rate from 15% to 10% for distributions to persons other than a beneficial owner who holds 10% of the share capital of the company.

Summary

The revised DTA represents a shift in favour of the South African tax authorities who will have undoubtedly gained at the expense of the Mauritian Revenue Authority if and when this agreement is ratified. This will be the case in particular in regard to the South African capital gains tax impact on Mauritian companies that currently hold South African based investments in the mining or property sectors and the South African withholding tax impact on Mauritian financing or IP licensing entities that derive interest or royalty income from South Africa. The potential for a long delay prior to the revised DTA coming into force should, however, provide sufficient time for most taxpayers that are adversely affected to respond to the envisaged changes.

Written and compiled by Anne Bennett at Webber Wentzel.