eBusiness Weekly
SOUTH African companies with international operations will have to take a closer look at their business models following a significant and far-reaching tax judgment by the Supreme Court of Appeal.
One of that country’s most successful investment companies, Coronation, has been given a bloody nose by the court and is now facing a massive tax bill after losing a case that dates back to the 2012 tax year.
The main issue before the court was whether the net income of its Dublin-based Coronation Global Fund Managers (CGFM) should have been included in the taxable income of its South African holding company, Coronation Investment Management SA (Cimsa).
CGFM was a controlled foreign company in terms of the Income Tax Act and the question was whether the tax exemption relating to foreign business establishments was applicable to it.
The Western Cape Tax Court found it did apply, but the Supreme Court found it did not.
Primary operations
Some of the criteria that must be met to qualify include having a fixed place of business in the foreign country, and that the business be “suitably staffed” and “suitably equipped” for conducting the “primary operations” of the business.
Charles de Wet, executive consultant at ENSafrica, says many fund managers in South Africa have similar structures to Coronation and should scrutinise their business models to make sure they meet the requirements to qualify for the tax exemption.
The implications of the judgment extend beyond the fund management industry.
De Wet gives an example where a company is registered in a foreign tax jurisdiction, produces goods in South Africa, and delivers them in Zambia.
The company must be able to show that there is a commercial rationale for its business model.
Section 9D of the Income Tax Act allows certain foreign business entities to operate free from tax “to the extent that an objective rationale exists for maintaining operations abroad” and if the operations do not pose a threat to the South African tax base.
The Supreme Court notes in its judgment that the exemption was introduced as a “balancing mechanism” between two competing interests, namely tax avoidance and competitiveness.
CGFM was incorporated in Ireland to provide opportunities for its clients to invest in both South African and Irish collective investment funds.
It received a licence for fund management, which includes investment management, administration and marketing.
However, the investment management services and trading functions were outsourced to Coronation Asset Managers in South Africa and Coronation International in the United Kingdom, neither of which were tax-resident in Ireland.
Although CGFM ticked all the boxes to qualify for the exemption as a foreign business establishment, it failed on the issue of “economic substance”.
The court found that since its primary business in terms of its licence is that of investment and none of it was done in Ireland, the exemption did not apply and CGFM’s net income must be included in the taxable income of Cimsa.
Drilling down to the crux
De Wet says companies with foreign business establishments should take careful note of the amount of scrutiny the court applied in drilling down to establish what is meant by primary operations.
He believes the Western Cape Tax Court’s judgment in favour of the taxpayer was a well-reasoned and practical approach.
It found that CGFM did have offices, staff and facilities in Dublin and that the business did not only exist on paper.
“However, the Supreme Court of Appeal took it a step further to say that you must have a proper look at the ‘primary operations’ of the foreign business.
“The court therefore looked at the lifeblood of the business in Ireland to determine whether it qualified for the foreign business establishment exemption,” says De Wet.
The court found that GCFM’s primary source of income was from investment, indicating that CGFM’s core function is investment management. However, since this was outsourced to companies outside of Ireland it meant its primary operations could not have been conducted in Ireland.
Tick all the boxes
CGFM did not dispute that it did not have sufficient staff to conduct investment trading services but said its staff complement was sufficient to maintain the licence requirements.
The Supreme Court was not swayed by the argument.
Hanneke Farrand, MD of Farrand Global, says it is important for companies to ensure that the correct functions are performed in the correct jurisdiction. This also applies to transfer pricing policies and several other considerations that are not limited to tax matters, such as regulatory and economic substance requirements.
“Companies should carefully consider the functions of all [their] international employees to ensure that they comply with the requirements.”
Her advice is to document all the functions in all the agreements and tax returns that are submitted to regulators and tax authorities. -moneyweb
