TaxNewsFlash-Africa

October 21, 2009
No. 2009-12

South Africa: New Controlled Foreign Company (CFC) Rules

In terms of South African controlled foreign company (CFC) rules, South African tax residents holding a majority stake in a foreign company could be subject to tax on the income of the foreign company, unless the income is attributable to suitably staffed and equipped business premises located outside South Africa. This exception is known as the foreign business establishment (FBE) exemption.

Under current law it is clear that the FBE exemption will not apply if the business premises are staffed with employees of a company other than the foreign company itself. Although not quite as clear, the FBE exemption could potentially not apply if the premises itself or equipment belong to another company.

These rules have been perceived to be impractical on the basis that South Africans doing business overseas would for good commercial reasons use more than one entity to carry on business in a foreign country. However, the FBE exemption could potentially force each entity to employ its own staff and acquire its own premises and equipment, thereby leaving South African businesses at a cost disadvantage.

In 2006 Treasury recognised this problem and legislation was passed enabling the South African Revenue Service to issue rulings allowing foreign businesses to share staff and equipment under certain conditions without affecting negatively on the FBE exemption. In a further development, the latest tax amendments tabled on 1 September 2009 would, under certain conditions, allow foreign businesses to share premises, staff, and equipment without jeopardizing the FBE exemption and without having to go through the rulings process.

Currently, the FBE exemption also will not apply to income of the foreign company from transactions with related South Africans. The purpose of this exception is to subject South African residents to tax on income diverted through foreign jurisdictions so that tax would be paid in the foreign jurisdiction rather than in South Africa. However, tax observers believed this rule operated unfairly in situations when income was diverted for reasons other than tax avoidance.

In 2006 Treasury accepted this argument, and acknowledged that tax avoidance would most likely not be the motive when income is diverted through jurisdictions with comparable taxes to South Africa. Legislation was passed enabling the South African Revenue Service to rule that diverted income subject to comparable foreign taxes is not subject tax in South Africa.

In terms of the latest tax amendments, the income of CFCs subject to comparable foreign taxes is now expressly exempt from South African tax without having to obtain a ruling. However taxpayers will still have to determine for themselves, by applying a prescribed formula, whether the foreign taxes are comparable to South African tax.

When income is derived in a jurisdiction with taxes which are less than comparable, the South African Revenue Service has the authority to rule that the income is not taxable in South Africa if certain specified business reasons justifying presence in that jurisdiction exist.

For more information, contact a tax professional with KPMG in South Africa:

Geraldine Kaldelis, +27 (11) 647 5843, geraldine.kaldelis@kpmg.co.za

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