Extending the application of controlled foreign company rules to foreign trusts and foreign foundations

Section 9D of the Income Tax Act, No 58 of 1962 (Act) provides for the rules applicable to controlled foreign company (CFC). Section 9D of the Act provides for the imputation of the net income of a CFC to its resident shareholder in proportion to that resident’s participation rights or voting rights in the CFC. A CFC is defined as a foreign company where more than 50% of the participation rights in that foreign company are directly or indirectly held or more than 50% of the voting rights in that foreign company are directly or indirectly exercisable by one or more South African residents.

22 Feb 2018 3 min read Article

The Government was concerned that the CFC Rules did not capture foreign companies held by interposed foreign trusts or foreign foundations. In the 2015 Budget it was announced that the Government would consider allowing CFCs held by interposed trusts or foundations to be subject to tax in South Africa. The Government was particularly concerned about the use of foreign discretionary trusts or foreign foundations used to escape the application of the CFC rules even if the participation or voting rights requirements were met. This was achieved by interposing a foreign trust or foreign foundation between South African tax residents and a foreign company, despite the fact that the foreign trust and foreign company formed part of the same group and consolidated by the South African tax resident group for financial reporting purposes under International Financial Reporting Standards 10 (IFRS 10).

The proposal was to capture foreign companies to whom the CFC Rules would have applied had no foreign trust or foreign foundation been interposed. The following proposals were made: 

  • the definition of a CFC in s9D would be adjusted so that a foreign company held through a foreign trust or foreign foundation whose financial results formed part of the consolidated financial statements (contemplated in IFRS 10) of a group of which the parent company is resident in south Africa, is regarded as a CFC for purposes of the Act; and
  • a new proviso regarding the inclusion of net income of a CFC in terms of s9D(2) of the Act be inserted to clarify that the percentage of participation rights in respect of the CFC will be equal to the net percentage of the proportion of profits of a foreign company that are included in the consolidated financial statements (contemplated in IFRS 10) for the year of assessment of any resident company, and that it is a holding company as defined in the Companies Act, 2008.

The Taxation Laws Amendment Act, 2017 accordingly extended the application of CFC Rules to foreign companies held through foreign trusts and foreign foundations. The aforementioned amendments became effective on 1 January 2018.

In the Budget it was announced that the draft Taxation Laws Amendment Bill, 2017 developed related rules to classify distributions of discretionary foreign trusts or foreign foundations that holds shares in a foreign company to South African resident beneficiaries to be income in the hands of the South African resident beneficiaries and subject to normal tax in South Africa, based on applicable rates. This was done to discourage the use of trusts to defer tax or recharacterise the nature of income. These provisions would apply to any person other than a company, in other words to a natural person, trust, estate or a deceased person and insolvent estate. 

Due to the complexity and broadness of the last-mentioned proposal, the specific rules were withdrawn and postponed to 2018. According to the Budget, these rules will now be considered.

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