Section 9D of the Income Tax Act houses the South African “controlled foreign company”, or “CFC” regime. The provision’s aim is to effectively impute the income of a foreign company into the hands of its South African shareholders where South African shareholders own a majority of the shares in that company. In other words, where more than 50% of a non-resident company’s shares are held by South African taxpayers, that company’s notional taxable income is imputed into the hands of the SA shareholders, and taxed in their hands as though the income of the foreign company (the CFC) had accrued to them directly.
The provision is at its core aimed at addressing tax avoidance exacted by South African tax residents setting up companies in so-called “low tax jurisdictions” (notably Mauritius) to effectively escape South African income tax on passive income. Take as example a Mauritian tax resident company which is wholly owned by a South African tax resident individual. Where that company holds various interest-bearing deposits, those deposits will only be taxed at 3% in Mauritius, with the profits distributed thereafter to the South African individual as a tax-free dividend. (Mauritius does not levy a dividends withholding tax like South Africa.) The effective tax rate, excluding the effect of the SA CFC legislation, is therefore 3% on the interest earned.
By virtue of the SA CFC provisions though, the interest received by the Mauritian company will be deemed to have accrued directly to the SA individual, and therefore taxed at the prevailing SA income tax rates, which may be as high as 45%. The CFC provisions therefore provide that the South African Revenue Service may effectively ignore the fact that the Mauritian company is a separate taxpayer. The sole relief available is that the SA taxpayer is afforded a credit for taxes already suffered in Mauritius. In other words, the tax payable in SA is reduced by the taxes already paid in Mauritius, but which will be of little solace for the SA taxpayer given the insignificant amount of taxes paid on the income stream by the CFC in Mauritius.
Various exceptions exist in terms of which the CFC provisions in section 9D will not apply. These include primarily if the CFC’s taxes domestically will be equal to at least 75% of the amount that would have been chargeable had that CFC been an SA company (in other words, the CFC is therefore not situated in a “low tax jurisdiction”). The other notable exception that may generally apply is where the CFC has credible substance present in the country in which it is tax resident, in other words it employs people there, has an equipped office, etc.
The CFC regime presents a complex piece of legislation, once again emphasising the fact that businesses expand their activities abroad at their own peril if they do so without seeking proper tax structuring advice first.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)