Controlled foreign companies: look before you leap

Controlled foreign companies: look before you leap

• 27 May 2021
• Corporate Tax
• Carmen Gers and Simone Krupanandham

Monday, 18 June 2018

Important:

This article is based on tax law for the tax year ending 28 February 2019.

Authors: Carmen Gers and Simone Krupanandham (ENSafrica)

Section 9D of the Income Tax Act, 1962 (the “Act”) is aimed at South African residents who directly or indirectly hold more than 50% of the total participation (broadly speaking shares) or voting rights in a foreign company. A foreign company in this context is classified as a controlled foreign company (“CFC”).

In terms of section 9D, the “net income” of the CFC is included in the relevant resident’s income in proportion to the resident’s effective participation rights in that CFC, thus resulting in the resident being subject to tax on such notional income “imputed” to it.

The calculation of the “net income” of a CFC is prepared by treating the CFC:

1. as a resident for certain specified sections of the Act, which include the Eighth Schedule to the Act, containing the capital gains tax (“CGT”) provisions; and
2. as a taxpayer for provisions that do not refer to the resident status of a taxpayer. 

There are various CFC-specific exemptions and exclusions, over and above those applicable by virtue of the other provisions of the Act. 

Aspects often overlooked in performing the “net income” calculation

Residents that hold investments in offshore subsidiaries (qualifying as CFCs) often overlook the South African tax implications that may result from such a foreign investment. We consider below a few of these aspects that often arise and which are preferable to consider prior to any transactions being entered into. 

Offshore mergers/reorganisations

One of the aspects often encountered resulting in unforeseen South African tax consequences, is where a reorganisation takes place in relation to offshore companies qualifying as CFCs. Specifically, many foreign jurisdictions have rules permitting the tax-free merger of companies. However, as this merger necessarily has the effect of terminating the existence of at least one of the companies, a number of South African tax implications may arise for such companies in their capacity as CFCs. This includes that the CFC disposes of all its assets and ceases to be a CFC and the disposal of shares by the CFC holding the shares in the CFC ceases to exist, with the resultant CGT implications potentially arising on more than one level.

This article first appeared on ensafrica.com.

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