On 21 June 2024, the Constitutional Court ruled in favour of Coronation confirming that its foreign subsidiary indeed conducted its primary operations in Ireland and therefore would qualify for the foreign business (FBE) exemption under the South African controlled foreign company (CFC) rules in South Africa.
The crux of the Coronation matter revolved around identifying the "primary operations" of the CGFM Coronation Global Fund Managers (Ireland) Ltd’s (CGFM) business and determining if these functions were outsourced.
The case between Coronation and SARS stands as a pivotal moment in South African tax law, influencing the interpretation of the current CFC regulations.
Future amendments to Section 9D of the South African Income Tax Act may still redefine a FBE. Following the ruling on Coronation’s case by the Supreme Court of Appeal (SCA) in 2023, South Africa’s Draft Taxation Laws Amendment Bill of 2023 proposed amending the definition of FBE to require all "important functions" as opposed to the be performed internally, not outsourced.
Following comments and discussions with regulatory bodies and tax advisors regarding this proposed amendment’s far-reaching implications, the proposal was postponed pending the outcome of the Constitutional Court’s judgement.
It remains to be seen whether National Treasury will again propose any amendments to section 9D post the recent judgement.
At this stage, taxpayers would be wise to assess the operations of CFCs relying on the FBE exemption. It's crucial to verify that these companies do not outsource their primary operations and genuinely perform these functions themselves.
Background
Coronation, a prominent South African taxpayer, oversees various subsidiaries, including CGFM based in Ireland. SARS assessed Coronation and contended that the net income of CGFM, as a CFC, should be included in the taxable income of Coronation, its South African parent company in terms of section 9D of the Income Tax Act. As of March 31, 2024, the total impact of the lawsuit amounted to R794 million.
In brief, section 9D states that a CFC’s net income is attributed proportionally to a South African resident who directly or indirectly hold a qualifying amount of participation or voting rights. However, exceptions exist, notably for income derived from a FBE, aiming to exclude such income from the South African tax base. A FBE is characterised by having a fixed place of business located outside South Africa, which includes a dedicated facility equipped and staffed appropriately to conduct its core operations.
Tax Court Ruling
Coronation contested SARS’s decision in the Tax Court, asserting that CGFM qualified as a FBE and should therefore be exempt from taxation. The Tax Court ruled in Coronation’s favour, determining that CGFM fulfilled the FBE criteria and was eligible for the tax exemption.
SCA Ruling
SARS appealed the Tax Court's decision to the SCA, which subsequently overturned the initial ruling. The SCA held that CGFM did not satisfy the FBE requirements, thereby mandating that Coronation include CGFM’s net income in its taxable income.
The SCA interpreted CGFM's business to be investment management. It argued that if CGFM had outsourced all their primary operations, then their fixed place of business in Ireland lacked the necessary personnel and infrastructure to conduct these operations.
Furthermore, the Court reasoned that if these outsourced functions are pivotal to CGFM's business, defining its fundamental nature, then CGFM cannot be considered as conducting its primary operations in Ireland.
Constitutional Court Ruling
In a historic decision, the Constitutional Court overturned the SCA’s ruling, declaring that CGFM’s activities primarily focus on fund management rather than investment management.
According to the Constitutional Court, a CFC's business is defined by its actual operations. CGFM's business plan, submitted with its license application, outlined an outsourced model where it handles specified fund management functions directly. It outsources investment management trading activities to competent third parties, while maintaining overall supervision and regulatory responsibility.
This determination qualified CGFM for the tax exemption under the FBE rules confirming that the "primary operations” were performed by CGFM in Ireland. This judgment establishes a crucial precedent in South African tax law, particularly influencing the interpretation and application of CFC rules and economic substance requirements for tax exemptions.
Importance of the Ruling
The ruling clarifies the application of FBE exemptions, ensuring that legitimate business activities conducted abroad do not automatically subject companies to South African taxation. This provides assurance to South African companies engaged in global operations that they can structure their activities abroad without losing tax exemptions, thus promoting competitiveness.
Additionally, the ruling emphasizes the importance of accurate tax assessments by SARS, safeguarding businesses against undue tax burdens resulting from misinterpretations. Furthermore, the decision may influence future legislative changes to ensure that tax laws align with international business practices.
Conclusion
The Coronation case stands as a landmark decision that clarifies crucial aspects of the CFC rules and supports the competitiveness of South African businesses globally. This ruling promotes a fairer tax environment and provides a vital reference for accountants and tax professionals in South Africa navigating complex international tax landscapes.
Disclaimer
The information provided in this article is for general informational purposes only and does not constitute legal, tax, or financial advice. Readers should consult with a tax advisors before making any decisions based on the content of this article. The authors and publishers are not responsible for any actions taken as a result of reading this article.
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