In the Draft Taxation Laws Amendment Bill published on 2 June 2011, one of the amendments relates to the taxation of offshore cell companies in terms of section 9D of the Income Tax Act 36 of 1996. It is indicated in the Explanatory Memorandum that offshore captive insurers are generally subject to indirect tax under the controlled foreign companies (CFC) regime contained in section 9D as the excess build up of reserves is passive income. It is further indicated that no reason exists to allow offshore cell companies to be treated differently and that as a matter of parity offshore cell companies should fall within the South African CFC regime.
In order to achieve this identified need for parity between captive insurers and offshore cell companies, it is proposed that the CFC rules be adjusted such that each cell of a foreign statutory cell company be treated as a separate stand-alone foreign company for purposes of section 9D.
The proposed amendment will come into operation on 1 January 2012 in respect of foreign tax years of a CFC ending during years of assessment commencing on or after 1 January 2012.
A new definition of "protected cell company" is to be inserted and is widely defined to include any entity incorporated, established or formed, whether by way of conversion or otherwise, in terms of any law of any country other than South Africa where the law makes provision for:
- the segregation of the assets of that entity into structurally independent cells or segregated accounts;
- the linking or attribution of specified assets and liabilities to those cells or segregated accounts; or
- separate participation rights in respect of each such cell or segregated account, irrespective of whether or not that law provides that the establishment or formation of a cell or segregated account creates a legal person distinct from that entity.
The provisions of section 9D are further to be amended by the insertion of a definition of "foreign company" which in turn refers to the defined "protected cell company".
The implication of the proposed amendments is that if more than 50% of the total participation rights in any foreign company is held by a South African resident, the offshore cell will be deemed to be a CFC notwithstanding the ownership of any of the other cells. The following example is included in the Explanatory Memorandum:
Facts: A protected cell company (PCC) located in Foreign Country X with the core managed and controlled by Country X's residents. The PCC has 100 cells; one cell (Cell 1) is owned by South African Company. The PCC is engaged in the business of insurance with each cell offering a different insurance package to each cell participant. Cell 1 provides insurance solely to South African Company (and some of its group members).
Result: The CFC status of Cell 1 will be tested separately. Because South African Company completely owns the cell, the cell qualifies as a CFC. The proportionate tainted amount of the net income of the cell will be attributed to the South African Company. All passive income will be tainted because the cell standing alone qualifies as a foreign financial instrument holding company (due to the connected person nature of the insurer parties). However Cell 1 may be entitled to deductions for short-term as a short-term insurer (ie section 28)".
In considering whether the provisions of section 9D are applicable, it will therefore in future be necessary that the status of each offshore cell be considered separately and to the extent that the participation rights threshold is crossed, there will be need to account for any net income of the cell which is attributed to South Africa.
Natalie Napier, Director, Tax