Kuwait Approves Protocol Amending Double Tax Agreement with South Africa

Kuwait Ratifies Protocol to Double Tax Agreement with South Africa

On 18 September 2024, Kuwait ratified the long-pending protocol (Protocol) to the 2004 South Africa-Kuwait double tax agreement (DTA). The Protocol, originally signed on 1 April 2021 and approved by South Africa’s National Assembly on 31 August 2022, introduces significant changes to the taxation regime between the two countries, especially concerning South Africa’s Dividend Withholding Tax (DWT). This development has raised concerns about the potential retroactive application of the new DWT rate, which could have far-reaching consequences for companies and shareholders relying on favorable tax rates under the Kuwait, Sweden, and Netherlands DTAs.

The South Africa-Kuwait DTA, prior to the Protocol, provided a 0% DWT rate on dividends paid to qualifying Kuwaiti shareholders. This provision was particularly attractive for investors, encouraging cross-border investments. Additionally, the DTA included a Most-Favored Nation (MFN) clause, allowing Swedish and Dutch shareholders to benefit from the same 0% rate, creating a highly favorable tax environment for nonresident investors from these countries.

However, South Africa’s National Treasury has long sought to amend this arrangement. Since the introduction of DWT on 1 April 2012 (replacing the Secondary Tax on Companies), the Treasury has pushed to renegotiate multiple DTAs that had zero withholding tax rates. Most protocols revising these treaties were implemented by 2008, but the South Africa-Kuwait Protocol remained pending until Kuwait’s ratification in September 2024.

The Protocol will officially enter into force once both countries exchange ratification instruments through diplomatic channels. However, Article 2(2) of the Protocol specifies that its provisions "shall take effect from the date on which a system of taxation on dividends declared at the shareholder level is implemented in South Africa," which is effectively April 1, 2012.

Retroactive Application and Its Challenges

The most controversial aspect of the Protocol is the potential retroactive application of the revised DWT rate. According to the Protocol's language, the 0% DWT rate previously applied under the South Africa-Kuwait, Sweden, and Netherlands DTAs would no longer be valid from 1 April 2012, the date South Africa introduced DWT.

This has sparked significant debate in tax and legal circles. The question revolves around whether the Protocol was intended to apply retroactively or if the wording is merely a residual clause from earlier negotiations predating the introduction of DWT.

South African companies that relied on the 0% DWT rate under these DTAs could face substantial tax liabilities if the South African Revenue Service (SARS) enforces the revised rate retroactively. Companies may also be required to pay penalties and interest for non-compliance, even though they acted in good faith based on the previous interpretation of the DTAs.

Impact on the Most-Favored Nation Clause and Shareholders

The MFN clause in South Africa’s DTAs with Sweden and the Netherlands ensured that Swedish and Dutch shareholders could enjoy the same 0% DWT rate as Kuwaiti shareholders. With the ratification of the Protocol, this favorable treatment will end.

Going forward, once the Protocol enters into force, dividends paid to qualifying Kuwaiti, Swedish, and Dutch shareholders will be subject to the default 20% DWT rate, unless a lower rate is agreed upon in a separate treaty or exemption. While most DTAs allow reduced rates between 5% and 15%, the complete elimination of the 0% rate will significantly alter investment dynamics.

This development could discourage foreign investors who previously relied on the MFN clause and enjoyed tax-free dividends. Companies with shareholders from these jurisdictions will now have to reassess their dividend policies and tax planning strategies to comply with the new regime.

Retroactivity and International Treaty Law

The retroactive application of tax treaties is a contentious issue under international law. Treaties are generally applied prospectively, unless explicitly stated otherwise. Many legal experts argue that retroactive enforcement could conflict with the principle of non-retroactivity, a fundamental concept in international treaty interpretation.

In South Africa’s case, applying the Protocol retroactively to 1 April 2012 would not only raise legal questions but also expose SARS to potential court challenges from affected companies. Companies could argue that they reasonably relied on the 0% DWT rate for over a decade, and any attempt to claw back taxes would be unfair and legally questionable.

SARS’s Potential Response and Risks for Taxpayers

Although SARS has not yet indicated whether it will attempt to recover unpaid DWT retroactively, there is a possibility that it might interpret the Protocol strictly. If SARS enforces the higher DWT rate from 1 April 2012, companies that distributed dividends without withholding taxes would need to recalculate their liabilities and potentially refund shareholders for over-distributed dividends.

However, enforcing the Protocol retroactively may result in administrative challenges and reputational risks for SARS. South Africa’s courts may view retroactive tax enforcement as unconstitutional or inequitable, which could lead to legal disputes and further delays in implementing the Protocol.

Business Implications and Investor Concerns

The Protocol's ratification could create uncertainty for foreign investors in South Africa. Companies that have previously benefited from the MFN clause under the Sweden and Netherlands DTAs will need to revisit their tax strategies. Foreign shareholders may demand higher post-tax returns, leading to increased pressure on South African companies to restructure their dividend policies.

Additionally, companies may need to engage with tax advisors and prepare for possible audits or investigations by SARS. Proactive engagement with SARS and preemptive tax compliance measures will be essential to avoid penalties and disputes.

Conclusion

The ratification of the Protocol to the South Africa-Kuwait DTA represents a significant shift in South Africa’s international tax framework. While the elimination of the 0% DWT rate aligns with the South African government’s broader tax policy objectives, the potential retroactive application raises serious legal, financial, and administrative concerns.

Investors and companies will need to monitor developments closely and seek professional tax advice to navigate the new landscape. If SARS seeks to apply the Protocol retroactively, affected parties may have to challenge the interpretation in court to avoid substantial liabilities.

Ultimately, how SARS handles the enforcement of the revised DWT rate will determine whether the transition is smooth or contentious. For now, companies and investors must prepare for increased compliance requirements and explore ways to mitigate potential risks under the amended DTA.