A few changes relating to controlled foreign companies

A controlled foreign company (CFC) is essentially a foreign company where 50% or more of its shares or voting rights are collectively held by South African residents.

21 Feb 2024 3 min read Special Edition Budget Speech Alert 2024 Article

A special tax regime, as set out in section 9D of the ITA, applies to CFCs and specifically the residents who hold the relevant shares or voting rights.

In terms of section 9D(2) of the ITA, the “net income” (or portion thereof) of a CFC is included in the income of the residents for South African income tax purposes (unless any exceptions or exemptions otherwise apply), in accordance with the resident’s proportional interest.

The net income of a CFC is calculated in terms of the ITA as if that CFC were a resident.

Proposal relating to translation for hyperinflationary currencies

The net income must first be calculated in the “functional currency” of the CFC (usually a foreign currency) and is then translated into rand at an average exchange rate for the foreign tax year (section 9D(6)).

“Functional currency” in relation to a person is:

“[T]he currency of the primary economic environment in which the business operations of that person are conducted” and in relation to a permanent establishment of any person “the currency of the primary economic environment in which the business operations of that permanent establishment are conducted.”

Section 24I of the ITA and Paragraph 43 of the Eighth Schedule to the ITA applies to CFCs and must in principle be used to calculate the net income of the CFC by including gains or losses on exchange items.

In this regard section 9D(2A)(k) is relevant, which provides that:

“[F]or the purposes of section 24I and paragraph 43 of the Eighth Schedule, ‘local currency’ of a controlled foreign company otherwise than in relation to a permanent establishment of that controlled foreign company, means the functional currency of that company”.

While the analysis is somewhat technical, the upshot is that where a CFC holds an exchange item that is neither attributable to a permanent establishment inside or outside of South Africa, the local currency is the functional currency, and it effectively means that no gain or loss is determined in relation to items denominated in the functional currency (there is no exchange item). If it is denominated in a currency other than the functional currency, exchange differences may arise.

In terms of the proviso to section 9D(6) of the ITA, any exchange item denominated in a currency other than the functional currency is deemed not to be attributable to any permanent establishment of that CFC if the functional currency is a currency of a country with an inflation rate of 100% or more for the year. In other words, a hyperinflationary currency must not be used for purposes of translation (section 9D(6)).

According to the proposals in the Budget, this principle is not currently reflected in the provisions of section 9D(2A)(k) of the ITA. It is accordingly proposed that an amendment be introduced so as to not allow the use of hyperinflationary functional currencies for translation purposes.

Translation of foreign taxes payable

Another proposal in respect of CFCs relates to the translation of foreign taxes payable by a CFC for purposes of ultimately determining the tax liability of the resident holder of shares or voting rights. The foreign taxes payable must be translated to rand at an average exchange rate for the year of assessment.

However, the net income of the CFC is translated to rand using the average rate for the foreign tax year of the CFC.

It has been proposed that amendments be introduced to align the years and curtail any mismatches that may result.

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