South Africa: Controlled Foreign Companies: Look Before You Leap

Last Updated: 21 June 2018
Article by Carmen Gers

Most Read Contributor in South Africa, September 2018

Section 9D of the Income Tax Act, 1962 (the "Act") is aimed at South African residents who directly or indirectly hold more than 50% of the total participation (broadly speaking shares) or voting rights in a foreign company. A foreign company in this context is classified as a controlled foreign company ("CFC").

In terms of section 9D, the "net income" of the CFC is included in the relevant resident's income in proportion to the resident's effective participation rights in that CFC, thus resulting in the resident being subject to tax on such notional income "imputed" to it.

The calculation of the "net income" of a CFC is prepared by treating the CFC:

  1. as a resident for certain specified sections of the Act, which include the Eighth Schedule to the Act, containing the capital gains tax ("CGT") provisions; and
  2. as a taxpayer for provisions that do not refer to the resident status of a taxpayer. 

There are various CFC-specific exemptions and exclusions, over and above those applicable by virtue of the other provisions of the Act. 

Aspects often overlooked in performing the "net income" calculation

Residents that hold investments in offshore subsidiaries (qualifying as CFCs) often overlook the South African tax implications that may result from such a foreign investment. We consider below a few of these aspects that often arise and which are preferable to consider prior to any transactions being entered into. 

Offshore mergers/reorganisations

One of the aspects often encountered resulting in unforeseen South African tax consequences, is where a reorganisation takes place in relation to offshore companies qualifying as CFCs. Specifically, many foreign jurisdictions have rules permitting the tax-free merger of companies. However, as this merger necessarily has the effect of terminating the existence of at least one of the companies, a number of South African tax implications may arise for such companies in their capacity as CFCs. This includes that the CFC disposes of all its assets and ceases to be a CFC and the disposal of shares by the CFC holding the shares in the CFC ceases to exist, with the resultant CGT implications potentially arising on more than one level.

It is prudent for residents to take advice prior to the implementation of such offshore restructures as it may be possible for such transactions to fall within the corporate rules in the Act, often with minimal changes required to the transaction steps, thus resulting in the transaction being implemented on a tax neutral basis from a CFC perspective.  

Ceasing to be a CFC

Section 9H(3)(b) of the Act finds application where a CFC ceases to qualify as such. A CFC in this context is deemed to have disposed of each of its assets on the day before it ceased to be a CFC for market value proceeds, thereby triggering adverse CGT implications (assuming the assets are held on capital account and the assets have increased in value). 

Such assets may include shares held in another offshore company (which may or may not be a CFC). In this context, it is important to take note of the manner in which the "base cost" in such shares must be determined.

Paragraph 20(1)(h)(iii)(aa) and (bb) of the Eighth Schedule of the Act sets out the method for determining the base cost in this regard. 

Specifically, the base cost in an asset (being an interest in a CFC ("CFC1")) held directly by another CFC ("CFC2"), is determined as the sum of:

  • the expenditure actually incurred in respect of the cost of acquisition of creation of that asset; and
  • an amount equal to the proportional amount of the net income of CFC1 and of any other CFC, in which CFC1 and CFC2 directly or indirectly have an interest and which would have been included in the income of CFC2, had it been a resident during any year of assessment, reduced by the amount of any exempt foreign dividend distributed by CFC1 to CFC2.

Broadly speaking, the base cost in the shares in CFC1 (held by CFC2) would thus include the acquisition costs, plus the "net income" of CFC1 and any other CFCs in which it holds a proportional interest which would have been included in CFC1/CFC2's income had they been resident.

Interest income

Another aspect often overlooked is the question of interest deductibility where a CFC operates as a "group treasury company" ("Treasury CFC") and cash is pooled in the CFC.

Where excess cash from "Group CFCs" is pooled (essentially placed on loan with Treasury CFC) and that CFC pays interest to the respective Group CFCs, section 9D9(fA)(i) of the Act would exclude from the net income of the Group CFCs any interest received from Treasury CFC and, similarly, section 9D(2A)(c) would prohibit a deduction of the interest paid by Treasury CFC in determining its "net income". However, when Treasury CFC places such excess funds on deposit with a bank in respect of which it earns interest, no exemption applies and the interest must be included in Treasury CFC's "net income".  

Foreign exchange differences

Similar issues arise in respect of exchange differences, as is explained by way of the following example:

  • Treasury CFC raises loan funding from a bank in order to provide loan funding to Group CFCs. To ensure that it is not exposed to currency movements from an economic perspective, Treasury CFC borrows from the bank in the same currency as that in which it will advance a loan to Group CFC (for example, in Euros);
  • assuming Treasury CFC's functional currency is USD, the loan owing by Treasury CFC to the bank and the loan owing to Treasury CFC by the Group CFC (which are both denominated in Euros) would qualify as exchange items for purposes of section 24I of the Act;
  • on translation of such exchange items to Treasury CFCs functional currency, assuming Treasury CFC realises an exchange loss on the loan advanced to the Group CFC, such exchange loss cannot be deducted by Treasury CFC in the determination of its "net income" in terms of section 9D(2A)(c)(ii) of the Act, as the exchange difference arises in respect of an exchange item between CFCs that form the same "group of companies";
  • however, the translation of the corresponding loan owing by Treasury CFC to the bank in these circumstances should result in an exchange gain, for which no exemption exists as it is a loan owing to a third party which must thus be taken into account in determining the CFC's "net income".

Conclusion

To avoid unforeseen South African tax consequences resulting from the provisions of section 9D of the Act, taxpayers must pay careful attention to these rules. In particular, considering the intricacies surrounding the tax treatment of CFCs, it is important for South African residents to seek advice at the outset, and also prior to such CFCs entering into restructure transactions of any nature, since it may be a matter of making certain adjustments to a commercial transaction to ensure that such transaction complies with the specific rules which have been included in the Act to provide relief in a CFC context (within a group of companies).

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

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

Authors
 
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
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
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

Mondaq.com (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 www.mondaq.com

To Use Mondaq.com 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.

Disclaimer

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.

General

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