German investors welcome SA STC abolition but tax advisors say withholding tax between the countries

30 October 2007 PricewaterhouseCoopers

Like most international tax advisors, Michael Hartmann, PricewaterhouseCoopers tax partner in Germany, welcomes the abolition of Secondary Tax on Companies in SA. "STC was not a typical tax concept and as German investors did not receive a credit for it, the tax increased their cost of doing business in SA. The move to a withholding tax on dividends is far more acceptable in the international tax arena."

The tax treaty between Germany and SA provides for a withholding tax on dividends going both ways when STC ultimately ends of 7,5%. Serge de Reus, international PwC tax partner from the Netherlands, presently based here, says that this is a bit on the high side. "Most tax treaties including most treaties between Germany and its other trade partners are 0-5% so we would like to see this coming down."

Hartmann describes the German tax system as quite overregulated and until very recently, highly taxed. "We can see some parallels with SA that made us unable to compete for foreign funds in Europe. Our effective 40% did not entice foreign investors, and other things being equal, they would chose to set up operations in other European countries where the average tax rate sits at around 25%. Legislation passed this year will take our company rate down in 2008 to 15% and with local municipal taxes, the effective corporate rate will sit in a far more attractive 29-31% range."

One tax feature found in Germany that SA does not yet offer, is the fiscal unity concept where profits and losses of various subsidiaries can be pooled and offset against each other to form one tax group. De Reus says that he understands that SA authorities are considering this concept which is seen in many jurisdictions in the world. "Not having this facility puts SA on the back foot particularly when it comes to the financing of acquisitions. If a holding company in SA is used as acquisition vehicle, the interest expenses on the borrowings of such a vehicle are currently not deductible. A pooling concept and/or allowing the interest deductions would alleviate this inequitable situation so that SA groups are able to compete with foreign groups which can benefit from a deduction for interest expenses."

The interest capping concept is one seen in Germany but not in SA. Hartmann explains this rule caps or limits interest expense deductions to a maximum of 30% of EBITDA (earnings before interest, tax, depreciation and amortisation) of a company and group. "This policy hits multinationals that have failed to allocate debt charges equally throughout the group and have structured funding so as to maximise interest expense deductions. German authorities tried to limit abuses by the thin capitalisation rules which restricted interest deductions on loans from related parties, but this did not close all the gaps, so they moved to the all-encompassing interest cap. This tool is now being used by several fiscal authorities, introduced in Denmark this year and very recently in Italy a similar rule was proposed."

Hartmann says this new rule will have a major effect on the structuring of merger and acquisition activities and existing highly leveraged deals may even have to be restructured with regard to the debt component. "We are also seeing a drop in target company valuations and takeout premiums are coming off as a result of this new tax legislation." De Reus agrees in principle that the interest cap rule is an equitable one as it prevents shopping around for favourable tax jurisdictions but it can have severe consequences for companies and he ideally would not like to see it in SA.

Both Germany and SA are feeling pressure from revenue authorities when it comes to transfer pricing. "This is in line with a worldwide trend where companies are now required to provide detailed documentation explaining how they arrive at transfer prices of goods and services, as each authority wants to maximise the tax base in its own jurisdiction," says Hartmann.

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