A controlled foreign company (CFC) is any foreign company of which more than 50% of the total participation rights are directly or indirectly held, or of which more than 50% of the voting rights are directly or indirectly exercisable, by one or more South African residents.
Section 9D of the Income Tax Act is the anti-avoidance provision aimed at preventing South African residents from excluding tainted forms of taxable income from the South African tax net through investment into CFCs. Prior to 2011, one of the primary targets of section 9D was diversionary foreign business income (from the import of goods, the export of goods and/or the import of services) generated through convoluted structures designed to circumvent South African tax. The complex diversionary transaction rules sought to deter South African taxpayers from entering into transactions which effectively shifted income from the South African tax base to a jurisdiction with a more favourable, lower tax regime. Unfortunately due to the highly mechanised operation of the diversionary rules, legitimate commercial activities, conducted at arm's length, were on occasion caught within the anti-avoidance provisions, resulting in the generation of tainted income.
To redress the above, in 2012 the diversionary rules were simplified and limited in their application. National Treasury was of the view that suspect transactions between CFCs and connected persons could be satisfactorily addressed by applying the transfer pricing arm's length principle embodied in the provisions of s31 of the Income Tax Act.
It appears that the section 31 transfer pricing provisions have not performed adequately, hence the proposed reinstatement of the diversionary rules to the sale of goods by a CFC to a connected person (hopefully in a simpler incarnation).
In addition, consideration is to be given to extending the ambit of s9D to allow for the taxation of CFCs held by interposed trusts.