One of the important messages from the recent Coronation tax battle is that outsourcing is not a “bad” word, and the carve-out to make South African multinationals competitive globally is not “anti-outsourcing”.
The Constitutional Court’s judgment in the case brought great relief for fund managers who follow a similar business plan as Coronation Investment Management SA (CIMSA) with its subsidiary Coronation Global Fund Managers (CGFM) in Ireland.
Read: Constitutional Court’s ruling in tax dispute a relief for SA multinationals
The court upheld CIMSA’s appeal against a previous judgment by the Supreme Court of Appeal (SCA) that would have resulted in it having to pay a tax debt of close to R800 million.
The judgment is significant for South African corporates with offshore operations that rely on the foreign business establishment (FBE) tax exemption in section 9D of the Income Tax Act.
Several companies could have been forced to change their business models if the SCA’s judgment had prevailed, simply because of the massive tax implications their chosen models would have caused.
The FBE exemption
The dispute between Coronation and the South African Revenue Service (SARS) dates to 2012. SARS determined that CGFM’s net income should have been included in Coronation’s taxable income because its operations in Ireland did not qualify for the FBE exemption.
Coronation insisted that CGFM qualified as an FBE and took the matter to the Tax Court, which found in its favour. SARS appealed to the SCA, which reversed the Tax Court’s decision. In its appeal to the Constitutional Court, Coronation submitted that the SCA erred in its interpretation of the FBE definition.
A controlled foreign company (CFC) must have a fixed place of business located outside South Africa that is used for conducting the “primary operations” of the CFC’s business for a at least one year to qualify for the FBE exemption.
The Constitutional Court unanimously found that the SCA did not look at what Dublin-based CGFM “actually” did but rather adopted a “notional business” approach.
The court held that SARS fundamentally misconceived the central issue in the case, which was the distinction between fund management and investment management. The court found that the SCA committed the same error, leading to its fallacious conclusions.
It is all about what you do
Dario Milo, partner at Webber Wentzel who has acted in similar matters against SARS, says the Constitutional Court’s judgment clarifies that in determining what a company’s “primary operations” are for the purposes of determining whether they qualify as an FBE, SARS cannot take a theoretical approach.
The departure point is what that company actually does. Once that factual determination has been made, the test is whether the fixed place of business in the foreign country is suitably staffed and equipped for conducting those actual primary operations of the company.
“The contrary approach leads to unbusinesslike results. If the actual operations of the business have economic substance, there is a wide discretion for companies to structure their offshore affairs to define for itself what its business is,” Milo adds.
Joon Chong, tax partner at Webber Wentzel, says as with most things in life, it is what you do that counts (your actions), not what you say you can do (hot air).
Chong says tongue-in-cheek, a foreign office staffed with only a goldfish and a post-box is just that – a goldfish and a post-box. It is unlikely to pass the objective test of economic substance.
“Be clear about your primary operations. What your competitors do in your industry is important, as they give insights into what are the norms. But sometimes, your competitive edge is to deviate from the norm. In that case, be super sure why you deviate and have the paperwork to back it up,” says Chong.
And when in doubt, call your friend the tax lawyer, she adds.
The FBE definition
Chong also revisited the proposed amendment to the FBE definition in the 2023 legislative cycle. The proposal was withdrawn pending the outcome of the case before the Constitutional Court.
The wording was changed to read that a CFC should be suitably staffed with employees and have suitable facilities to perform all the “important functions of that business for which the CFC is compensated” to qualify as an FBE. The current wording of the FBE exemption refers to the “primary operations of that business”.
Chong says it is unlikely that the same proposed amendment to the FBE exemption would be resurrected by National Treasury and SARS in the 2024 legislative cycle.
The section 9D safeguards are highly complicated and unduly overburdensome on South African multinationals.
“The complexity of section 9D creates commercial risks which are not conducive for South African multinationals competing globally against other businesses from developed and developing nations which may be better resourced, and which have more investor friendly rules.”
The objectives of the FBE carve-out are to ensure that the offshore company remains competitive with its foreign rivals. One hopes that Treasury and SARS will heed this call if they again propose amendments to the section, Chong adds.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal or tax advice that is appropriate to every individual’s needs and circumstances.
