In terms of section 9D of the Income Tax Act 58 of 1962 (“ITA”), income tax is imposed on South African shareholders of ‘controlled foreign companies’ (“CFC”) on the income earned by the CFC in certain circumstances. However, where a CFC has a FBE in the jurisdiction from where it operates, the income of that CFC may fall outside of section 9D.
Section 9D(1) defines a FBE as a fixed place of business which is conducted through one or more physical structures (e.g. office), which is suitably staffed and equipped and has suitable facilities— all to such a degree that it allows the CFC to conduct the primary operations of its business.
The supreme court of appeal (“SCA”) recently considered the definition of FBE in Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd [2023] 2 All SA 44 (SCA). The somewhat controversial judgement caused significant uncertainty and concern amongst South African multinational enterprises which operate via subsidiaries in foreign countries.
The case dealt with the question of whether the operations of an Irish subsidiary (“the CFC”) of the respondent constitutes a FBE as defined. In applying this definition, the SCA was required to identify the primary business operations of the CFC. The CFC held a licence issued by the Central Bank of Ireland authorising it to conduct collective investment management (including investment management, administration and marketing). The CFC opted to outsource the management of collective investment schemes to service providers outside of Ireland and therefore had no staff in Ireland to perform the outsourced functions. The respondent argued that the primary business operations of the CFC were that of fund manager (as distinct from investment manager) and maintaining its business licence in Ireland.
The SCA noted that the CFC’s Memorandum of Association and its business licence entitled it to conduct the wider business of fund management and investment management and the fact that it decided to outsource its investment management functions implied that it did not conduct its primary business via the office in Ireland. The SCA rejected the notion that the primary business is determined with reference to how the CFC chooses to operate. The SCA acknowledged that there are many functions which a company may choose to legitimately outsource, but it cannot outsource its primary business. The court found that the FBE exemption did not apply to the income of the CFC.
While the Tax Court and the SCA reached different factual conclusions, the judgments both shine a sharp light on the requirement for a FBE not only to involve having substance abroad but also that the relevant CFC's primary operations need to be exercised through that infrastructure, especially where the CFC outsources to a third party that is not based in the same jurisdiction.
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