Abstract
M.Comm.
In the Introduction to this study, two potential measures of effectiveness of controlled foreign company (hereinafter “CFC”) rules (as anti-avoidance legislation) are identified, namely the extent to which tax avoidance or deferral is prevented, and the extent to which those business undertakings and investments for which tax avoidance or deferral is not the sole or main purpose or effect are complicated or subjected to disincentives, with the focus of the study being on the latter.
Section 9D of the Income Tax Act 58 of 1962 (South Africa: 2012a), (hereinafter “the Act”, to which all otherwise un-referenced section references also refer) operates within the context of the worldwide basis of taxation adopted by South Africa and its related provisions. The study of the fundamentals of section 9D demonstrates that residents who, alone or together with one or more “connected persons”, invest in “foreign companies” which meet the definition of a “controlled foreign company” in section 9D(1), and who meet the minimum holding requirement of at least 10% of either participation rights or voting rights (proviso (A) to section 9D(2)), are subjected to the inclusion in their income for tax purposes of a notional amount equal to their proportion of participation rights in the CFC applied to the CFC’s net income (section 9D(2)), unless any exemption or exclusion from the provisions of section 9D of the Act applies.
A foreign company meets the CFC definition (subject to provisos) if residents “directly or indirectly” hold over 50% of participation rights or voting rights. The legislature is understood to have intended this section as both an anti-deferral and anti-avoidance measure regarding income tax, within the context of the intention of the legislature to tax South African residents on a worldwide basis. Relief is provided where limitations in the jurisdiction of residence of a CFC would inhibit the funding of a resident’s tax liability by way of CFC dividends (section 9A), however not when such dividends are not forthcoming for other reasons.
The study highlights in a number of areas that when section 9D of the Act is measured against the extent to which business is complicated or subjected to disincentives, it may fall short in that the section is found to both introduce considerable complexity, and to contain a number of uncertainties and potential pitfalls which may introduce risk and compliance cost for resident investors in CFCs. The section appears however to be effective in its prevention of avoidance or deferral of tax, which is its main purpose, although it is submitted that the section does have wider implications for resident taxpayers. Further legislative focus appears to be warranted with a view to alleviating those impacts which may be undesirable from a policy point of view.
Negative impacts may include potential reduced after-tax investment returns; increased taxation uncertainty; increased administrative costs; and increased requirements for scarce business resources.