Many counties, especially in the more developed and high tax jurisdictions, have promulgated Controlled Foreign Company (CFC) rules to limit the tax-saving opportunities for those who make use of companies in low tax jurisdictions. Section 9D of SA’s Income Tax Act addresses CFCs, defining a ‘resident company’ as one incorporated, established or formed in South Africa, or which has its place of effective management in the country.
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Such a company is subject to taxation in SA, even one incorporated offshore, because it’s effectively controlled from here.
In other words, even if it’s a CFC, such a company won’t be subject to the CFC rules as its income is already subject to SA tax, according to subsection 9D(9)(e). The thrust of the CFC rules is that income from the CFC that’s untaxed in the hands of the beneficial owner, who’s resident in the higher tax jurisdiction, is included in the taxable income in the higher tax jurisdiction.
Without such rules in place, it would be all too easy for affluent taxpayers in high tax jurisdictions to avoid tax. Section 9D(2) provides that, where a taxpayer resident in SA owns more than 50% of the participation rights in a non-resident foreign company, they’ll suffer a proportional ownership percentage of the net income earned by the foreign company in their income.
No tax
There are, however, instances where a SA tax resident won’t be taxed on the income of a CFC in which they have an interest. These are where:
- They have less than 10% of the participation or voting rights in the company.
- The participation rights are held by a resident company of which they’re a shareholder.
- The income of the CFC is attributable to a foreign business establishment. That is, an ‘active’ business, such as a factory, workshop, farm or the like, as opposed to a business set up solely for investment purposes.
- Whenever cross-border tax issues are in play, however, one should be aware of the possible effect of the rules in a double tax avoidance treaty. Under Section 108 of the Income Tax Act, such a treaty, once approved by parliament, has the same force as any other provision of the Income Tax Act. Depending on the wording of the treaty, it may override the CFC rules and thereby provide an exemption in the case of a conflict.
Participation
Note that in cases of an exemption, whether under the Income Tax Act or per treaty, foreign dividends might be tax-free in the hands of a SA tax resident if such dividends fall within the exemption contained in subsection 10(1)(k)(ii)(dd). This is the ‘participation exemption’, and is available to SA residents with more than 20% of the equity shares and voting rights in a foreign company.
In terms of Section 72A of the Income Tax Act, SA residents who own more than 10% of a CFC alone or together with a connected person must furnish a return to the SARS commissioner. Penalties for not doing so are fairly severe.
Peter O’Halloran is head of tax at BDO, Gaborone. Contact him on 00267 390 2779 or at [email protected]. Please state ‘Tax’ in the subject line of your email.
