Ex­emp­tion of for­eign busi­ness from CFC

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW -

IN TERMS of the sec­tion 9D(1) of the In­come Tax Act, a con­trolled for­eign com­pany (CFC) is de­fined as: “any for­eign com­pany where more than 50% of the to­tal par­tic­i­pa­tion rights in that for­eign com­pany are di­rectly or in­di­rectly held, or more than 50% of the vot­ing rights in that for­eign com­pany are di­rectly or in­di­rectly ex­er­cis­able, by one or more per­sons that are res­i­dents other than per­sons that are head­quar­ter com­pa­nies…”

A for­eign com­pany will there­fore con­sti­tute a CFC if more than 50% of the to­tal par­tic­i­pa­tion rights (shares) or more than 50% of the vot­ing rights in that com­pany are di­rectly or in­di­rectly held by one or more South African res­i­dents (other than head­quar­ter com­pa­nies).

Ab­sent an ap­pli­ca­ble ex­emp­tion, an al­lo­ca­tion is made for tax pur­poses to all South African res­i­dents who hold 10% or more of the shares in the for­eign en­tity.

The ap­pli­ca­tion of the CFC rules is ex­cluded in a num­ber of sit­u­a­tions, in­clud­ing where an amount is at­trib­ut­able to any “for­eign busi­ness es­tab­lish­ment” of that CFC. A “for­eign busi­ness es­tab­lish­ment” refers to a place of busi­ness of the CFC which is lo­cated in a ju­ris­dic­tion other than SA which is, among other things, con­ducted through an of­fice and suit­ably staffed with em­ploy­ees.

How­ever, in terms of amend­ments made in the Tax­a­tion Laws Amend­ment Act 2011, the for­eign busi­ness es­tab­lish­ment ex­emp­tion will not ap­ply in re­spect of amounts aris­ing from fi­nan­cial in­stru­ments un­less those fi­nan­cial in­stru­ments are at­trib­ut­able to the prin­ci­pal trad­ing ac­tiv­i­ties of the for­eign busi­ness es­tab­lish­ment and those prin­ci­pal trad­ing ac­tiv­i­ties:

Con­sti­tute the ac­tiv­i­ties of a bank, fi­nan­cial ser­vice provider or in­surer; and

Do not con­sti­tute the ac­tiv­i­ties of a trea­sury op­er­a­tion or cap­tive in­surer.

It is there­fore nec­es­sary to an­a­lyse the con­cept of a “fi­nan­cial ser­vice provider”.

In this re­gard the law pre­vi­ously re­quired that the CFC carry out a fi­nan­cial ser­vices busi­ness. The is­sue there­fore arises whether the in­tro­duc­tion of the word “provider” lim­its the wider con­cept of a fi­nan­cial ser­vices busi­ness.

Sec­tion 1(1) of the Fi­nan­cial Ad­vi­sory and In­ter­me­di­ary Ser­vice, 2002, de­fines a fi­nan­cial ser­vice provider for pur­poses of such leg­is­la­tion as any per­son, other than a rep­re­sen­ta­tive, who as a reg­u­lar fea­ture of the busi­ness of such per­son fur­nishes ad­vice and/or ren­ders an in­ter­me­di­ary ser­vice. The term “provider” is de­fined in a busi­ness dic­tionary as “a per­son, or­gan­i­sa­tion or busi­ness that of­fers a good or a ser­vice”.

The is­sue there­fore arises whether a “fi­nan­cial ser­vice provider” is an in­ter­me­di­ary as op­posed to a prin­ci­pal in re­spect of fi­nan­cial ser­vice trans­ac­tions.

The eius­dem-generis rule of in­ter­pre­ta­tion ap­plies to the in­ter­pre­ta­tion of pro­vi­sions made up of a phrase of gen­eral ap­pli­ca­tion pre­ceded by a class of words of a limited or par­tic­u­lar mean­ing. The gen­eral phrase is then re­stricted to the nar­rower, generic mean­ing of the pre­ced­ing words.

In terms of the eius­dem-generis rule the words “bank” and “in­surer” in­clude en­ti­ties that raise cap­i­tal in the form of bor­row­ings or is­suance of poli­cies and in­vest such cap­i­tal with the aim of pro­vid­ing a re­turn to the fun­ders/pol­i­cy­hold­ers. Ar­guably the term “fi­nan­cial ser­vice provider” should there­fore have the same com­mon fea­tures.

In ad­di­tion, in or­der for the for­eign busi­ness es­tab­lish­ment ex­emp­tion to ap­ply, the bank, fi­nan­cial ser­vice provider or in­surer must also not con­sti­tute the ac­tiv­i­ties of a “trea­sury op­er­a­tion” or “cap­tive in­surer”. It must there­fore be pos­si­ble for a fi­nan­cial ser­vice provider to con­sti­tute a “trea­sury op­er­a­tion”. As set out be­low a “trea­sury op­er­a­tion” is an en­tity that bor­rows and on-lends funds.

There­fore, it is ar­guable that the term “fi­nan­cial ser­vice provider” in­cludes an en­tity which acts as a prin­ci­pal, that is, raises cap­i­tal and re-in­vests such cap­i­tal.

A fur­ther re­quire­ment in or­der for the for­eign busi­ness es­tab­lish­ment ex­emp­tion to ap­ply in re­spect of amounts aris­ing from fi­nan­cial in­stru­ments is that the rel­e­vant prin­ci­pal trad­ing ac­tiv­i­ties of the CFC do not con­sti­tute the ac­tiv­i­ties of a trea­sury op­er­a­tion.

The is­sue arises what is en­vis­aged by a “trea­sury op­er­a­tion”. In this re­gard var­i­ous deem­ing pro­vi­sions set out cir­cum­stances where a trea­sury op­er­a­tion is deemed to ex­ist. In essence a trea­sury op­er­a­tion is deemed to ex­ist where a com­pany pro­vides fi­nance to other group en­ti­ties.

On the ba­sis that a CFC’S op­er­a­tions are not deemed to be a “trea­sury op­er­a­tion” it is then nec­es­sary to de­ter­mine whether these con­sti­tute a trea­sury op­er­a­tion in terms of the or­di­nary mean­ing of that term.

The deem­ing pro­vi­sions are use­ful in this re­gard since they pro­vide in­sight and con­text to the con­cept of a “trea­sury op­er­a­tion”. As men­tioned above, the deem­ing pro­vi­sions re­fer to the pro­vi­sion of credit to re­lated par­ties.

There­fore, it is ar­guable that the con­cept of a “trea­sury op­er­a­tion” refers to an en­tity within a group of com­pa­nies con­duct­ing trea­sury op­er­a­tions for the group and does not ap­ply to an en­tity which con­ducts busi­ness with or ex­tends credit to third par­ties.

Amend­ments ap­ply­ing to CFCS are con­tained in the Tax­a­tion Laws Amend­ment Act 2011.

When de­ter­min­ing whether the for­eign busi­ness es­tab­lish­ment ex­emp­tion will ap­ply to CFCS in re­spect of amounts aris­ing from fi­nan­cial in­stru­ments it is now nec­es­sary to con­sider whether the CFC car­ries out prin­ci­pal trad­ing ac­tiv­i­ties which con­sti­tute, amongst other things, the ac­tiv­i­ties of a fi­nan­cial ser­vice provider and also do not con­sti­tute the ac­tiv­i­ties of a trea­sury op­er­a­tion.

Peter Dachs and Bernard du Plessis are tax di­rec­tors in the tax di­vi­sion at ENS.

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