The recent judgment of the Supreme Court of Appeal (SCA) in Coronation Investment Management (Pty) Ltd [Coronation] v SARS has truly created a consternation among many South African taxpayers who hold shares in offshore companies.

Put simply, in terms of section 9D of the Income Tax Act, in certain circumstances the income of an offshore company that is (i) located in a low-tax jurisdiction, and (ii) is a so-called “controlled foreign company” (CFC), may be imputed to a South African tax resident for income tax purposes. Section 9D is an anti-avoidance provision: it seeks to prevent South African taxpayers from creating offshore companies that earn passive income and never repatriate the income to South Africa so that it can be subject to tax here.

Section 9D contains some exceptions. Notably, income is not imputed in the case where the CFC has a “foreign business establishment” (FBE) in the relevant jurisdiction. Put simply, a CFC has an FBE if it has a fixed place of business in the jurisdiction which is used for the carrying on of the business of the CFC, with the necessary premises, equipment, staff, management and facilities.

The Coronation case concerned Coronation, one of the largest asset managers in South Africa, with shares listed on the JSE, and one of its Irish subsidiaries, Coronation Global Fund Managers (Ireland) Limited (CGFM). Ireland imposes a low corporate tax rate on trading income. The question that arose was whether CGFM had an FBE in Ireland and therefore escaped the operation of section 9D. If CGFM did have an FBE in Ireland, the income of CGFM would not have been attributed to Coronation.

The facts of the case and the judgment are complex. Suffice to say that the SCA found that Coronation did not have an FBE in Ireland and, accordingly, imposed tax, penalties, and interest on Coronation in respect of the income of CGFM that was attributed to Coronation under section 9D. The amount of tax was so large that Coronation was obliged to issue a cautionary announcement.
Instead of discussing the facts and the findings at length, we summarise below the take-aways from the case:

• Before setting up an offshore subsidiary, a taxpayer should ask itself two questions, namely, first, what precisely the business is that the subsidiary will be carrying on in the relevant jurisdiction and, second, whether it will have sufficient premises, equipment, and operational and managerial staff to carry on that business. For example, it would be difficult for a taxpayer to argue that a CFC with a large turnover has an FBE in a country if the CFC has one or two employees with laptops, sitting in a shared workspace.
• While a CFC may outsource certain functions, it should take great care to ensure that it retains its primary operations, and that it maintains such resources as may be necessary to ensure that the company has an FBE in the relevant jurisdiction. An extract from the following statement in Silke on South African Income Tax (at paragraph 5.44) was quoted by the SCA in its judgment:
  Which functions may be outsourced to other parties must always depend on the particular facts and, to some extent, may vary according [sic] the nature of the industry. Where outsourcing does occur, a manager should possess experience, knowledge and skills in relation to the primary business operations and must also have the authority to dismiss an underperforming outsourcing service provider. Clearly, the personnel, equipment and facilities for the critical ‘primary operations’ of a business, cannot be outsourced; but secondary operations, which are presumably determined in accordance with reference to turnover, profitability or assets employed, need not necessarily require dedicated personnel, equipment and facilities. For example, a car rental business must of course have an office with at least a manager and staff to attend to customers. But the accounting function of the business and tasks such as printing and janitorial services could easily be outsourced and may even leverage the economies of scale that the core business can offer.
• Taxpayers should ensure that the terms of their constitutional documents (for example, their objects as stated in their memoranda of incorporation) and the terms of their trading licences are directly relevant to the business operations that they are carrying on in the jurisdiction.
• It is apparent that SARS is focusing its attention on CFCs. Taxpayers should review their offshore operations to ensure that they are not falling foul of section 9D.
• Taxpayers should obtain detailed advice from tax professionals before they establish offshore companies, and continuously assess the nature and extent of their offshore operations to ensure that they maintain an FBE.

We understand that Coronation is appealing to the Constitutional Court.
Ben Strauss & Margot Basson