South Africa: Is Rental Income Received By A Controlled Foreign Company Subject To South African Tax?

Last Updated: 28 May 2012
Article by Peter Dachs

Most Read Contributor in South Africa, September 2018

Various changes have been made to the controlled foreign company ("CFC") tax rules. The question now arises whether these changes mean that rental income from an operating lease received by a foreign company with South African shareholders gives rise to South African tax under the CFC rules.

In terms of the CFC rules contained in section 9D of the Income Tax Act (" the Act") where more than 50% of the shares in a foreign company are held by South African residents that company qualifies as a CFC. For South African tax purposes an amount equal to the taxable income of a CFC is allocated to the South African resident shareholders unless, inter alia, the income in question is attributable to a foreign business establishment ("FBE") of the CFC. This is essentially a foreign place of business of the CFC.

In terms of section 9D(9A)(iv) of the Act even if the CFC has a FBE, an allocation to its South African resident shareholders will be made in circumstances where the CFC receives rental in respect of any movable property unless the movable property is leased by the CFC in terms of- (aa) an operating lease; and (bb) a lease that constitutes a financial instrument.

The question therefore arises whether, in order to ensure no allocation of income is made under the CFC rules, the lease needs to be both an operating lease and a financial instrument. At first glance it would appear so due to the word "and" which appears between the reference to an operating lease and a financial instrument. However, the provision may be read in a way where any movable property leased by a CFC in terms of an operating lease qualifies for exemption from the CFC rules and, separately, any movable property leased by a CFC in terms of a lease that constitutes a financial instrument also qualifies for exemption from the CFC rules.

In order to answer this question it is necessary to determine the true intention of the legislature. A critical question that arises in this regard is whether an "operating lease" as defined can ever constitute a "financial instrument", as defined. If an "operating lease" cannot constitute a "financial instrument" then it would seem that the provision cannot be read in a manner which requires both of these requirements to be fulfilled in respect of the same lease.

An "operating lease" is defined in the Act as meaning:

"a lease of movable property concluded by a lessor in the ordinary course of business of letting such property if -

(aa) such property may be hired by members of the general public directly from that lessor in terms of such a lease, for a period of no more than five years;

(bb) either -

(A) the cost of maintaining such property and of carrying out repairs thereto required in consequence of normal wear and tear is ultimately borne by the lessor; or

(B) the activities of maintaining and repairing such property that are required in consequence of normal wear and tear are performed by the lessor; and

(cc) subject to any claim that the lessor may have against the lessee by reason of the lessee's failure to take proper care of the property, the risk of destruction or loss of or other disadvantage to such property is not assumed by the lessee."

A "financial instrument" in turn is defined as including:

"(a) a loan, advance, debt, bond, debenture, bill, share, promissory note, banker's acceptance, negotiable certificate of deposit, deposit with a financial institution, a participatory interest in a portfolio of a collective investment scheme, or a similar instrument;

(b) any repurchase or resale agreement, forward purchase arrangement, forward sale arrangement, futures contract, option contract or swap contract;

(c) any other contractual right or obligation the value of which is determined directly or indirectly with reference to -

(i) a debt security or equity;

(ii) any commodity as quoted on an exchange; or

(iii) a rate index or a specified index;

(d) any interest-bearing arrangement; and

(e) any financial arrangement based on or determined with reference to the time value of money or cash flow or the exchange or transfer of an asset."

The Explanatory Memorandum suggests that an operating lease cannot constitute a financial instrument. In discussing the provisions regarding the leasing of movables by an FBE, the Explanatory Memorandum states (pp 108-109), firstly, that "(r)entals derived by a CFC from the leasing of movables will be fully taxable unless the lease is an operating lease or a financial instrument" (my emphasis). It then goes on to say that "the exemption of operating leases covers genuine leasing operations where the lessor substantially bears the economic risk of the assets involved". Such leases are contrasted with "finance leases", which are described as financial instruments and which are excluded from the relief granted "under this dispensation" (that is, in respect of income derived from leasing of movable property) because "these leases will instead be tested under the financial instrument provisions". Under a typical finance lease, explains the Explanatory Memorandum, "the lessee bears the ultimate risk and rewards associated with ownership of an asset"; that is the opposite of an operating lease as defined in the Act.

These observations are reinforced by consideration of, in particular, paragraphs (a) and (e) of the definition of financial instrument.

  • An operating lease as defined is a lease of movable property that must or can be maintained and repaired if necessary. It must therefore be a lease of corporeal property. Certainly that suggests that it is none of the specific instruments mentioned in paragraph (a) of the definition of "financial instrument". Nor could it then be said to be a "similar instrument". The instruments listed in paragraph (a) are all documents evidencing an indebtedness, in most cases the debt being to pay a sum of money to the holder of the instrument; in the case of shares and participatory interests in a portfolio of a collective investment scheme, the instrument can readily be converted into cash. So too it seems that the instruments listed are all capable of negotiation or transfer to third parties, conforming therefore to the ordinary sense of the term "financial instrument". By their very nature, such negotiable certificates and instruments bear little similarity to a contract for the leasing of movable property.
  • Can a contract for the letting and hiring of movable, corporeal property be described as a financial arrangement based on or determined with reference to the time value of money, or cash flow, or the exchange or transfer of an asset? Whether it can be described as a financial arrangement at all is doubtful (contrast a finance lease, which comes very close to a loan to finance the acquisition of an asset); but assuming that hurdle is cleared, it is not an arrangement based on or determined with reference to the time value of money. In so far as the contract involves an obligation to pay a sum of money, there is cash flow involved; and in so far as the property leased is delivered into the possession (but not ownership) of the lessee, it may be said to involve the transfer of an asset. However, if these factors alone were sufficient to bring the contract within the definition of financial instrument, a whole host of agreements would likewise fall within that definition; every sale of an asset, for example, and every deposit of an asset for reward, would constitute a financial instrument.

It therefore seems that the better argument is that an operating lease as defined cannot constitute a financial instrument of the type contemplated in the definition of financial instrument in the Act. In terms of this argument, if a CFC with a FBE leases movable property in terms of an operating lease it should qualify for exemption from South African tax under the CFC rules. This is regardless of whether the lessee is located in South Africa.

It seems that where movable property is leased by a CFC in terms of a lease that constitutes a financial instrument then, in order to escape South African tax under the CFC rules, this must also qualify for the various other requirements relating to financial instruments

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions