ARTICLE 23

Elimination of Double Taxation

This Article describes the manner in which each Contracting State undertakes to relieve double taxation. The United States uses the foreign tax credit method under its internal law, and by treaty. South Africa exempts many classes of foreign source income under its law. Where, however, it does tax, it also uses the foreign tax credit method to relieve double taxation.

Paragraph 1

The United States agrees, in paragraph 1, to allow to its citizens and residents a credit against U.S. tax for income taxes paid or accrued to South Africa. By referring to "South African tax", which is defined in Article 2 (Taxes Covered) to mean the covered South African taxes, paragraph 1 also provides that South Africa's covered taxes are income taxes for purposes of the U.S. foreign tax credit. This result is based on the Treasury Department's review of South Africa's laws.

The credit under the Convention is allowed in accordance with the provisions and subject to the limitations of U.S. law, as that law may be amended over time, so long as the general principle of this Article, i.e., the allowance of a credit, is retained. Thus, although the Convention provides for a foreign tax credit, the terms of the credit are determined by the provisions, at the time a credit is given, of the U.S. statutory credit.

Subparagraph (b) provides for a deemed-paid credit, consistent with section 902 of the Code, to a U.S. corporation in respect of dividends received from a corporation resident in South Africa of which the U.S. corporation owns at least 10 percent of the voting stock. This credit is for the tax paid by the South African corporation on the profits out of which the dividends are considered paid.

For purposes of the Secondary Tax on Companies ( ? STC ? ), a corporate taxpayer may ? write up ? its assets prior to making a distribution, increasing its ? distributable profits ? . Such a write-up raises concerns under the realization requirement of section 1.901-2(b)(2) of the regulations. Such a write-up, however, would not be normal accounting or business practice. Therefore, this feature of the tax is unlikely to alter its predominant character as that of an income tax in the U.S. sense. Because the write-up would constitute a voluntary increase in the base on which the STC is imposed, however, the increased amount of tax on any such write-up that did occur would be non-compulsory under section 1.901-2(e)(5) and, therefore, would not be a creditable amount.

As indicated, the U.S. credit under the Convention is subject to the various limitations of

U.S. law (see Code sections 901 - 908). For example, the credit against U.S. tax generally is limited to the amount of U.S. tax due with respect to net foreign source income within the relevant foreign tax credit limitation category (see Code section 904(a) and (d)), and the dollar amount of the credit is determined in accordance with U.S. currency translation rules (see, e.g., Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits and other inter-year adjustments. When the alternative minimum tax is due, the alternative minimum tax foreign tax credit generally is limited in accordance with U.S. law to 90 percent of alternative minimum tax liability. Furthermore, nothing in the Convention prevents the limitation of the U.S. credit from being applied on a per-country basis (should internal law be changed), an overall basis, or to particular categories of income (see, e.g., Code section 865(h)).

Paragraph 2

Paragraph 2 provides special rules for the tax treatment in both States of certain types of income derived from U.S. sources by U.S. citizens who are resident in South Africa. Since U.S. citizens, regardless of residence, are subject to United States tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in South Africa may exceed the U.S. tax that may be imposed under the Convention on an item of U.S. source income derived by a resident of South Africa who is not a U.S. citizen.

Subparagraph (a) of paragraph 2 provides special credit rules for South Africa with respect to items of income that are either exempt from U.S. tax or subject to reduced rates of U.S. tax under the provisions of the Convention when received by residents of South Africa who are not U.S. citizens. The tax credit of South Africa allowed by paragraph 2(a) under these circumstances need not exceed the U.S. tax that may be imposed under the provisions of the Convention, other than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause of paragraph 4 of Article 1 (General Scope). Thus, if a U.S. citizen resident in South Africa received U.S. source portfolio dividends, and South Africa taxed the dividend, the foreign tax credit granted by South Africa would be limited to 15 percent of the dividend -- the U.S. tax that may be imposed under subparagraph 2(b) of Article 10 (Dividends)

• even if the shareholder were subject to U.S. net income tax because of his U.S. citizenship. With respect to royalty or interest income, South Africa would not be required to allow a foreign tax credit even if it taxed the income, because its residents are exempt from U.S. tax on these classes of income under the provisions of Articles 11 (Interest) and 12 (Royalties).

Paragraph 2(b) eliminates the potential for double taxation that can arise because subparagraph 2(a) provides that South Africa need not provide full relief for the U.S. tax imposed on its citizens resident in South Africa. The subparagraph provides that the United States will credit the income tax paid or accrued to South Africa after the application of subparagraph 2(a). It further provides that in allowing the credit, the United States will not reduce its tax below the amount that is taken into account in South Africa in applying subparagraph 2(a). Since the income described in paragraph 2 is U.S. source income, special rules are required to resource some of the income to South Africa in order for the United States to be able to credit South Africa's tax. This resourcing is provided for in subparagraph 2(c), which deems the items of income referred to in subparagraph 2(a) to be from foreign sources to the extent necessary to avoid double taxation under paragraph 2(b). The rules of paragraph 2(c)

apply only for purposes of determining U.S. foreign tax credits with respect to taxes referred to in paragraphs 1(b) and 2 of Article 2 (Taxes Covered).

The following two examples illustrate the application of paragraph 2 in the case of a U.S. source portfolio dividend received by a U.S. citizen resident in South Africa. In both examples, the U.S. rate of tax on residents of South Africa under paragraph 2(b) of Article 10 (Dividends) of the Convention is 15 percent. In both examples the U.S. income tax rate on the U.S. citizen is 36 percent. In Example I, assume the South African income tax rate on its resident (the U.S. citizen) is 25 percent (below the U.S. rate), and in Example II, assume the South African rate on its resident is 40 percent (above the U.S. rate).

Example I Example II Paragraph 2(a)

U.S. dividend declared $100.00 $100.00 Notional U.S. withholding tax per Article 10(2)(b) 15.00 15.00 South Africa taxable income 100.00 100.00 South Africa tax before credit 25.00 40.00 South Africa foreign tax credit 15.00 15.00 Net post-credit South Africa tax 10.00 25.00

Example I Example II Paragraphs 2(b) and (c)

U.S. pre-tax income $100.00 $100.00 U.S. pre-credit citizenship tax 36.00 36.00 Notional U.S. withholding tax 15.00 15.00 U.S. tax available for credit 21.00 21.00 Income resourced from U.S. to South Africa 27.77 58.33 U.S. tax on resourced income 10.00 21.00 U.S. credit for South African tax 10.00 21.00 Net post-credit U.S. tax 11.00 0.00 Total U.S. tax 26.00 15.00

In both examples, in the application of paragraph 2(a), South Africa credits a 15 percent U.S. tax against its residence tax on the U.S. citizen. In example I the net South African tax after foreign tax credit is $10.00; in the second example it is $25.00. In the application of paragraphs 2(b) and (c), from the U.S. tax due before credit of $36.00, the United States subtracts the amount of the U.S. source tax of $15.00, against which no U.S. foreign tax credit is to be allowed. This provision assures that the United States will collect the tax that it is due under the Convention as the source country. In both examples, the maximum amount of U.S. tax against which credit for South African tax may be claimed is $21.00. Initially, all of the income in these examples was U.S. source. In order for a U.S. credit to be allowed for the full amount of South African tax, an appropriate amount of the income must be resourced. The amount that must be resourced depends on the amount of South African tax for which the U.S. citizen is claiming a U.S. foreign tax credit. In example I, the South African tax was $10.00. In order for this amount to be creditable against U.S. tax, $27.77 ($10 divided by .36) must be resourced as foreign source. When South African tax is credited against the U.S. tax on the resourced income, there is a net U.S. tax of $11.00 due after credit. In example II, South African tax was $25 but, because the amount available for credit is reduced under subparagraph 2(c) by the amount of the U.S. source tax, only $21.00 is eligible for credit. Accordingly, the amount that must be resourced is

limited to the amount necessary to ensure a foreign tax credit for $21 of South African tax, or $58.33 ($21 divided by .36). Thus, even though South African tax was $25.00 and the U.S. tax available for credit was $21.00, there is no excess credit available for carryover.

Paragraph 3

Paragraph 3 provides the rules for the South African double taxation relief. Under this paragraph, United States taxes (i.e., the United States taxes listed as covered taxes in Article 2 (Taxes Covered)) paid by South African residents in accordance with the Convention will be allowed as a credit against the South African taxes payable by that resident. Two conditions are specified. U.S. taxes imposed solely by reason of citizenship under the saving clause of paragraph 4 of Article 1 (General Scope) are not covered by this rule. South Africa's obligation with respect to such taxes is dealt with in paragraph 2. The paragraph also specifies that the South African credit shall not exceed the percentage of the South African tax due before the credit, which is the same as the ratio of the U.S. source income in respect of which the credit is being claimed to total South African income.

Relation to Other Articles

By virtue of the exceptions in subparagraph 5(a) of Article 1 (General Scope) this Article is not subject to the saving clause of paragraph 4 of Article 1. Thus, the United States will allow a credit to its citizens and residents in accordance with the Article, even if such credit were to provide a benefit not available under the Code.