A Collective Sigh of Relief After Coronation Case

Tax commentators have called the Constitutional Court judgment in the Coronation case “clear, smart and well-reasoned”. It brings an end to the protracted battle between Coronation and the South African Revenue Service (Sars). 

The court upheld the appeal by Coronation Investment Management SA (Cimsa) against the Supreme Court of Appeal (SCA) judgment in favour of Sars, calling that judgment “legally and factually unsustainable” and not making “commercial sense at all”.

The Constitutional Court ordered Sars to pay Coronation’s costs, including the costs of two counsels – and it is not getting the R800 million it said Coronation owed it. 

Read: Coronation wins protracted tax battle against Sars

The highest court in the country found that Sars and the SCA “misconceived” the distinction between fund management and investment trading. They basically did not understand Coronation’s business model when it set up operations in Ireland. 

The Constitutional Court held that Dublin-based Coronation Global Fund Managers (CGFM) conducted the business of a fund manager. Its “primary business operations” were those of a fund manager operating in terms of the business model used by most fund managers in Ireland, says ENSafrica in its note on the latest judgment. 

The court says it was “fallacious” of the SCA and Sars to hold that CGFM was not conducting its core business in Ireland because it “outsourced” certain of its functions. 

The court unanimously found that the SCA, instead of looking at what CGFM “actually” did, adopted a “notional business” approach.

“The court [SCA] failed to draw the important distinction between investment management in its wide sense and investment management trading, the narrower concept,” the Constitutional Court held.

What it’s All About

South Africa introduced controlled foreign company rules to prevent South African multinationals from avoiding tax in SA. However, if the foreign entity qualifies as a foreign business establishment (FBE), the net income attributable to the qualifying FBE is excluded from the taxable income of its SA holding company.

To qualify, the FBE must have a fixed place of business located outside South Africa that is used for conducting the “primary operations” of the controlled foreign company’s business for a period of at least one year. 

Read: Important tax case for SA companies with international operations

In 2012, Sars included the entire net income of the Dublin-based CGFM into the taxable income of its holding company, Cimsa, arguing that CGFM did not qualify for the exemption. This created a tax liability of close to R800 million. 

Cimsa took the matter to the Western Cape Tax Court, which found in its favour. However, Sars successfully appealed to the SCA, which agreed with Sars.

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Peter Dachs, head of tax at ENSafrica, says most commentators felt that the SCA judgment was incorrect in law. “It is great to see the Constitutional Court remedy a bad decision.” 

The Constitutional Court criticised the SCA, saying it has misapplied itself. The SCA got the law and even the facts wrong. This is quite a damning indictment of the SCA judgment, says Dachs.

Criticism Against SCA Judgment

Joon Chong, a tax partner at law firm Webber Wentzel, says South African multinationals will be “most relieved” by the Constitutional Court’s unanimous judgment. 

“I am especially heartened by the court’s observation that the SCA’s approach did not make any commercial sense and that the approach meant that there was only one single, ideal notional concept of what a business entails, and that there is no scope at all for a controlled foreign company [CFC] to delegate.”

There was a clear recognition by the Constitutional Court that the FBE definition is not anti-outsourcing.

Its purpose is to ensure that an offshore business, regardless of its chosen business model, has economic substance in that foreign country and is not merely an “illusory or paper business”.

According to Dachs, the Constitutional Court judgment, in essence, says the SCA’s interpretation of the FBE exemption is unworkable. It worked off “notional concepts” of what the business could have been and not what it actually was.

“That interpretation would have been very anti-competitive for SA and bad for the economy.”

Dachs says companies with business models similar to Coronation’s or those with subcontracts for some of their services were nervous that they could somehow be swept up in the SCA judgment. 

They can now breathe a sigh of relief since the Constitutional Court found that outsourcing or subcontracting is irrelevant. All that is relevant is whether the controlled foreign company’s actual operations are conducted in the right jurisdictions. 

Future Amendments

National Treasury wanted to codify the SCA decision in a legislative amendment. The proposal was withdrawn pending the outcome of the Constitutional Court judgment. 

Chong says it is unlikely that the same proposed amendment to the FBE exemption would be resurrected by Treasury in the 2024 legislative cycle. Other wording may be chosen, but it is unlikely to be the same as the 2023 draft bill. There may also not be enough time to amend the FBE exemption in the draft bill this year.

She says the Section 9D anti-avoidance provision is world-class and rivals the controlled foreign company regimes of developed nations such as the US. It is a highly complicated provision and unduly overburdensome on SA multinationals. 

Read: New global tax rules may see African countries losing out, again

The carve-out – the FBE exemption – is to ensure that the offshore company remains competitive against its foreign rivals. “One hopes that Treasury and Sars will heed this call when proposing amendments to section 9D,” Chong adds.

Dachs agrees. It would be very hard to go ahead with any changes given the Constitutional Court’s comments about how the SCA interpreted the law – basically saying it was unworkable.

“For Treasury to implement something that the Constitutional Court says is unworkable will be tricky. They would have to word it very precisely and carefully if they are going to make amendments.”

Click here to read the full judgment.

Source: Moneyweb

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