How Foreign is Your Business Establishment?

How Foreign is Your Business Establishment?

Author: David Clegg

ISSN: 2219-1585
Affiliations: Tax Consultant, Cape Town
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 2, 2023, p. 1 – 7

Abstract

The introduction of full residence-based taxation in 2001 brought with it the concept of a ‘Controlled Foreign Company’ (CFC), whose profits (calculated on SA income tax principles) would be attributed to qualifying South African shareholders (‘participants’) as taxable income. Exempted from attribution were those profits of a CFC which arose from a ‘business establishment’, a term which was tightly defined and relied in part upon the establishment displaying the hallmarks of a real operating business in the foreign country and not having been set up for the purpose of tax avoidance. Since those early days, the definition of what is now a ‘foreign business establishment’ (FBE) has undergone detail change. Today, and central to the definition, is the requirement that in order to qualify there must be a ‘fixed place of business’ located in the foreign country and ‘used for the carrying on of the business of the CFC , … where that fixed place of business is (inter alia) … suitably staffed with on-site managerial and operational employees … who conduct the primary operations of that business …’. Over the years there has been much comment in the tax specialist press dealing with the extent to which the operations of an FBE can be outsourced, before it is no longer ‘suitably staffed’ for conducting its primary operations. Silke and Income Tax South Africa took slightly different positions on this issue and now the SCA has handed down judgement in Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd 2023 JDR 0295 (SCA), which sets out that court’s view on the point. In Volume 14, Issue 1 of this journal Wally Horak criticised elements of this judgment and in this edition David Clegg raises some additional concerns. These are whether the court was correct in its identification of the ‘primary operations’, and in finding that a ‘primary operation’ cannot, in principle, be outsourced. Clegg also addresses what he sees as a fundamental mistake made by the taxpayer, in setting up his foreign business.

Can Directors in a Private Company have Weighted Voting Rights at Board Meetings?

Can Directors in a Private Company have Weighted Voting Rights at Board Meetings?

Author: Matthew Blumberg SC

ISSN: 2219-1585
Affiliations: N/A
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 2, 2023, p. 8 – 12

Abstract

The Companies Act implicitly permits the memorandum of incorporation of a company to depart from the default or general position of ‘one director, one vote’. But, as I have endeavoured to set out, the freedom to do so is not unlimited. A regime for directors’ voting rights that weights votes in proportion to the shareholding of the shareholder that appointed the director in question should in my view withstand court scrutiny. It is simply another means by which to confer majority control over the board (in the sense explained below) — which is in line with the company law principle of majoritarianism, and in my view unobjectionable. That the weighting of directors’ voting rights results in a situation in which individual directors have equal responsibilities, but unequal ‘rights’, is in my view not in itself problematic. Duties are imposed on individual directors in order to ensure the effective governance of companies (not because those duties are commensurate with the director’s ‘rights’). Thus, the diminution of a director’s ‘rights’ need not bring about a commensurate reduction in his or her responsibilities.

Unlocking the Beneficial Interest and Beneficial Ownership Quagmire

Unlocking the Beneficial Interest and Beneficial Ownership Quagmire

Author: Julie Oppenheim

ISSN: 2219-1585
Affiliations: Partner, M&A, Bowmans
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 2, 2023, p. 13 – 18

Abstract

The General Laws (Anti-Money Laundering and Combating Terrorism Financing) Amendment Act 22 of 2022 (GLAA) was introduced in 2022 and amends the Companies Act 71 of 2008 (Companies Act) by (i) providing for a comprehensive mechanism through which the Companies and Intellectual Property Commission can keep accurate and up-to-date beneficial ownership information; (ii) requiring a company, which is not an ‘affected company’ for purposes of the Companies Act, to keep, and fi le with CIPC, a record of the ’beneficial owners’ of a company, and by providing for specified timelines within which a company must record any changes in this information; (iii) requiring a company, which is an ‘affected company’ for purposes of the Companies Act, to establish and maintain a register of the persons who hold beneficial interests equal to or in excess of 5% of the total number of securities of that class issued by the company, together with the extent of those beneficial interests; and (iv) specifying that persons who are convicted of offences relating to money laundering, terrorist financing, or proliferation financing activities or are subject to a resolution of the UN Security Council are prohibited from registering as company directors. Key to the amendments is the distinction between a company which falls within the definition of an ’affected company‘ for purposes of the Companies Act, on the one hand, and a company which does not fall within the definition of an ;affected company; for purposes of the Companies Act, on the other hand. Also key is the definition of ‘beneficial owner’ and the manner in which it will be interpreted — which remains to be seen. Time will tell as to how beneficial these provisions are and whether they can assist in having South Africa removed as a grey list country. Enforcement may be more effective if the sanction for non-compliance is a criminal sanction (in addition to a financial sanction) — as is the case in Mauritius, which managed to convince the Financial Action Task Force to remove it from the grey list.

The Misuse and Abuse of Section 80J of the Income Tax Act: Time to get back to the basics

The Misuse and Abuse of Section 80J of the Income Tax Act: Time to get back to the basics

Author: Ed Liptak

ISSN: 2219-1585
Affiliations: Independent Tax Person Extraordinaire
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 1, 2023, p. 1 – 12

Abstract

Section 80J of the Income Tax Act was introduced in 2006 as part of the then new General Anti-Avoidance Rule (GAAR). This section requires the Commissioner to notify a taxpayer at the point in an audit when he/she first comes to believe that the GAAR may be applicable to an arrangement entered into or carried out by the taxpayer. It was enacted in response to concerns that the new GAAR might be automatically relied upon by SARS as a ‘catch-all’ section of last resort without due and proper consideration. Commentators also expressed concerns about conduct of audits under former s 103, particularly with respect to delays they encountered and the time and expensed they incurred. Section 80J attempted to address these concerns by providing a logical framework for the timeous conduct of audits under the new GAAR. Subsection (1) requires the Commissioner to notify the taxpayer if he/she believes the GAAR may be applicable to an arrangement and state his/her reasons therefor; sub-s (2) gives the taxpayer an opportunity to respond to that notice; sub-s (3) requires the Commissioner to take further action within a specific statutory time frame; and sub-s (4) permits the Commissioner to revise or modify his reasons for applying the GAAR in light of any additional information that may come to his knowledge. Two recent judgments have raised concerns about the current approach being taken to s 80J by taxpayers and, to a certain extent, SARS itself. In particular, taxpayers appear to be taking the position that section 80J(1), read together with the statutory definition of ‘arrangement’, have imposed a burden upon the Commissioner to identify and describe a transaction, operation or scheme with an exacting degree of precision never before required under the former s 103 or its predecessors. This approach cannot be support by a textual, contextual and purposive interpretation of the provisions involved, and, in fact, would severely frustrate both the overriding purpose of the current GAAR and the specific purposes of s 80J itself.

Outsourcing and the Foreign Business Establishment Rule for CFC Purposes: Why The SCA Got it Wrong in CSARS v Coronation Investment Management SA (Pty) Ltd

Outsourcing and the Foreign Business Establishment Rule for CFC Purposes: Why The SCA Got it Wrong in CSARS v Coronation Investment Management SA (Pty) Ltd

Authors: Wally Horak and James Mckinnell

ISSN: 2219-1585
Affiliations: Head of Tax, Cape Town, Bowmans; Head of Litigation, Cape Town, Bowmans
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 1, 2023, p. 13 – 23

Abstract

The judgment recently delivered by the Supreme Court of Appeal in the case of CSARS v Coronation Investment Management SA (Pty) Ltd, has caused significant uncertainty and concern amongst South African multinational enterprises which operate via subsidiaries in foreign countries. The judgment had to consider the requirements under section 9D of the Income Tax Act 58 of 1962 to qualify for the foreign business establishment (FBE) exemption from the controlled foreign company (CFC) rules, which may result in the imposition of South African normal tax on the South African parent company (‘Coronation SA’) of an amount equal to the net income of the CFC. In particular, the question was whether the CFC (‘Coronation Ireland’) may determine the scope of its primary business conducted in the foreign country or whether objective factors determine the potential scope of such business. The SCA considered the question with reference to the CFC’s Memorandum of Association and its business licence and concluded that the CFC was entitled to conduct the wider business of fund management and investment management and the fact that it decided to outsource its investment management functions implied that it did not conduct its primary business via the FBE in Ireland. Therefore, the SCA rejected the notion that the primary business is determined with reference to how the CFC chooses to operate, i e the choice of a business model cannot alter the primary operations of the CFC. The SCA thus held that the CFC did not qualify for the FBE exemption. With respect to the imposition of an understatement penalty and under-estimation of provisional tax penalty, the SCA found that the taxpayer relied on a legal opinion that it was entitled to the FBE exemption and there is nothing to suggest that the taxpayer’s tax returns were not submitted in the bona fide belief that it may be eligible for the FBE exemption. Therefore, the Court ruled that the claim for understatement penalties and under-estimation penalties must fail.

The Modified Section 23M: Interest deduction limitations

The Modified Section 23M: Interest deduction limitations

Author: Michael Rudnicki

ISSN: 2219-1585
Affiliations: Executive, Bowmans
Source: Business Tax & Company Law Quarterly, Volume 14 Issue 1, 2023, p. 24 – 31

Abstract

Section 23M of the Income Tax Act 58 of 1962 seeks to limit the deduction of interest on debt arising between parties related to one another and in respect of which the interest is not subject to tax in the hands of the recipient of the interest.

Section 23M was amended in 2021 by the Tax Laws Amendment Act 20 of 2021 and is effective from years of assessment ending on or after 31 March 2023. The key amendments to the section deal with:

  • Interest partially subject to tax.
  • The amendment to the definition of ‘interest’, being the subject matter of the limitation rules in the section.

In respect of interest partially subject to tax, i e a tax rate say of 5% in terms of a double taxation agreement, the limitation rules will apply to that part which is not subject to tax, i e 10% in the example given (being the 15% withholding tax rate — 5% withholding tax limitation under the applicable double taxation agreement).

The definition of ‘interest’ is expanded. The relevance of the definition’s expansion is that all ‘interest’ payable to a related party (a ‘controlling relationship’ as defined) which is not subject to tax, could be limited in terms of its deductibility.

The amended interest defi nition includes:

  • Interest as contemplated in s 24J of the Act: which includes common law interest and other charges of a similar nature;
  • Amounts incurred or accrued in respect of ‘interest rate agreements as contemplated in section 24K of the Act;
  • Any fi nance cost element recognised for purposes of IFRS in respect of any lease agreement that constitutes a finance lease as defined in IFRS16;
  • Foreign exchange gains and losses; and
  • Amounts deemed to be interest in terms of Sharia compliant financing arrangements.

Accordingly, finance arrangements between related parties where the ‘interest’, as defined, is not subject to tax or is partially subject to tax may be limited in terms of its deductibility.