Residency is where the decision-making lies
‘Effective management’ of an entity is key, and so is the definition of the term
IN DETERMINING whether a company is a “resident” of SA and therefore taxed on its worldwide income it is necessary to analyse the definition of “resident” in section 1 of the Income Tax Act.
This definition in essence states that a “resident” in relation to a company is “any person (other than a natural person) which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic, but does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation”.
Accordingly, a company will be a “resident” for South African income tax purposes if:
It is incorporated, established or formed in SA; or
It has its place of effective management in SA, unless such company is deemed to be exclusively a resident of another country for the purposes of the application of any double taxation agreement between SA and such other country.
Certain other exemptions apply to companies based in high tax jurisdictions and foreign investment entities.
The concept “place of effective management” is not defined in the Income Tax Act, and has not, to date, been analysed in detail by the South African courts.
An income tax interpretation note no 6 was issued in 2002 by the South African Revenue Service (SARS) relating to the concept of “effective management”. This Interpretation Note is not binding in terms of South African law. However, it sets out a general view of SARS’s interpretation of, in this case, the concept of effective management. In 2011 a discussion paper on the interpretation note was released.
The discussion paper states that in the determination of where a company is “effectively managed”:
“The primary emphasis is upon those ‘top’ personnel who ‘call the shots’ and exercise ‘realistic positive management’. In general, these individuals would be the senior officers or executives who are responsible for: (1) actually developing or formulating key operational or commercial strategies and policies for, or taking decisions on key operational or commercial actions by the company (regardless of whether those strategies, policies and decisions are subject to formal approval by a board or similar body) and (2) ensuring that those strategies and policies are carried out...
“...day-to-day operational decisionmaking by junior and middle management would also generally fall outside of the [relevant] level of management, as would the performance of routine administrative or support functions...”
Although, as stated above, the concept of the place of “effective management” has not, to date, been analysed in detail by the South African courts, the Western Cape High Court acknowledged in its judgment in The Oceanic Trust Co Ltd NO v The Commissioner for the South African Revenue Service 74 SATC 127, that the place of effective management of a person other than a natural person is the place where key management and commercial decisions that are necessary for the conduct of a person’s business are in substance made.
The Organisation for Economic Co-operation and Development (OECD) has set out a definition of “place of effective management”.
In terms of this definition, the place of effective management is:
“… the place where key management and commercial decisions that are necessary for the conduct of the entity’s business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management. An entity may have more than one place of management, but it can have only one place of effective management at any one time.”
In terms of the OECD guidelines, the Interpretation Note and Discussion Paper and the limited case law references, in determining where a company is effectively managed it is principally necessary to have reference to the place where:
The important management decisions for the company are actually taken (excluding shareholder decisions);
Any day-to-day decisions by senior management and directors are taken; and
Decisions are taken which relate to the development or formulation of key operational or commercial strategies and policies and where implementation of these strategies and policies takes place.
Peter Dachs and Bernard du Plessis are directors and joint heads of ENS’s tax department.