One of the welcome announcements by the Minister of Finance in his budget speech delivered in February this year, pertained to a potential further relaxation of the Financial Surveillance Department of the South African Reserve Bank's (“SARB”) prohibition against so-called “loop” structures. However, this came with a caveat, this relaxation (or possibly scrapping) would coincide with amendments to the tax laws to curtail the mischief that loop structures attempt to prevent.
A loop structure is, broadly, a structure where a resident of the Common Monetary Area (“CMA”) holds an investment in a foreign vehicle which, in turn, holds an investment in the CMA. Note that this investment could be in the form of a share or loan. The SARB regards this type of transaction as a contravention of the Exchange Control Regulations in that they result in or have the potential to result in the direct or indirect export of capital abroad to a non-resident company or other relevant non-resident trust or entity for the ultimate benefit of a resident.
In terms of the SARB's current policy, these structures are only permitted in limited circumstances as provided for in the Exchange Control Manual for Authorised Dealers and subject to approval being obtained for such an investment from the CMA resident's authorised dealer.
The draft Taxation Laws Amendment Bill (“DTLAB”) was released for public comment on 31 July 2020 and details the proposed tax amendments alluded to in the budget speech.
AMENDMENTS IMPACTING ON CONTROLLED FOREIGN COMPANIES
Amendments to section 9D of the Act
A controlled foreign companies (“CFC”) is defined in the Income Tax Act, 1952 (“Act”) simplistically, as a foreign company where South African residents hold more than 50% of its shares. In the event of the CFC rules finding application, a notional “net income” calculation must be performed for such company at the end of its “foreign tax year” in accordance with the provisions of section 9D of the Act and the proportional amount of such “net income” must be included in the income of the South African residents in proportion to the participation rights held.
Section 9D contains CFC specific exemptions which may be applied in performing the “net income” calculation. CFCs may also benefit from the normal dividend exemption contained in section 10(1)(k) of the Act. Thus, a CFC holding shares in a South African company would benefit from an exemption in respect of any dividends received. In terms of the DTLAB, the exemption for dividends will not apply to CFCs but a proportion (calculated by the number 20 to 28) must be included in the CFCs “net income”.
In this context, it is relevant to note that this potential tax would be suffered in addition to dividends tax to which the dividend declared by the South African company to the CFC would already have been subject (subject to the application of any applicable double tax agreement). Further, whilst in performing a CFC “net income” calculation, a foreign tax credit may be claimed in accordance with section 6quat of the Act for foreign taxes suffered. It does not appear that such credit will be available for South African taxes suffered ie, the dividends tax suffered in respect of the dividend declared by the South African resident company to the CFC.
According to the Explanatory Memorandum to the DTLAB, the proposed amendment is intended to ensure that CFC structures are not used as tax planning opportunities for South African individuals.
Amendment to the participation exemption
The DTLAB further proposes that the participation exemption in paragraph 64B of the Eghth Schedule to the Act should not apply to the sale of shares in a CFC, to the extent that the value of the assets of that CFC is derived from assets directly or indirectly located, issued or registered in South Africa.
On the basis that the proposed amendments do not contain any thresholds, it seems that these changes will impact not only on “loop” structures which are currently prohibited, but also to permissible loop structures falling within the SARBs specific parameters and for which approval may have been obtained.
The proposed amendments will come into operation on 1 January 2021 and apply in respect of dividends received or accrued to any CFC during any foreign tax year commencing on or after that date, and in respect of the disposal of shares in CFCs on or after that date.
Originally published by ENSafrica, August 2020
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