Author: Jan-Paul Berry
INTRODUCTION
The recent Constitutional Court (CC) judgment in the case of Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd has delivered a significant victory for South African multinational companies. The ruling overturned a previous judgment by the Supreme Court of Appeal (SCA) that had sided with the South African Revenue Service (SARS) in a dispute over the tax treatment of Coronation's foreign subsidiary.
This article delves into section 9D of the South African Income Tax Act 58 of 1962 (ITA) and the CC’s interpretation of this intricate section in coming to its findings.
SECTION 9D OF THE ITA
Section 9D of the ITA deals with the taxation of "controlled foreign companies" (CFCs). Under this provision, the net income of a CFC is included in the taxable income of its South African resident shareholders, subject to certain exemptions. One such exemption is the "foreign business establishment" (FBE) exemption, which excludes the net income of a CFC from being taxed in South Africa if the CFC's "business" is carried on through a FBE. The FBE exemption is defined in section 9D(9)(b) of the ITA and requires that the CFC's "business" be carried on through a "foreign business establishment" that has adequate staff, plant, and equipment to conduct the primary operations of that business. The purpose of the FBE exemption is to avoid the double taxation of income that has already been subject to tax in the foreign jurisdiction where the CFC operates.
THE FACTS OF THE CASE
Coronation Investment Management SA (Pty) Ltd (CIMSA) is the holding company of the Coronation Group, one of South Africa's leading investment management firms. During the 2012 tax year, CIMSA was the 100% owner of various subsidiaries, including Coronation Global Fund Managers (Ireland) Limited (CGFM), which provided fund management services to several Coronation-branded investment funds. CGFM operated as a fund management company that outsourced, amongst others, its investment management trading function. SARS sought to tax CIMSA on the net income of CGFM, arguing that CGFM did not constitute a FBE and thus its income should be included in CIMSA's taxable income under section 9D. This contention was based on SARS’ averment that CGFM outsourced its entire core activities and all that remained in Ireland were ancillary, non-core activities. CIMSA disputed this assessment, contending that CGFM's operations qualified as a FBE and were therefore exempt from taxation in South Africa.
THE LEGAL QUESTION
The key legal question to be determined by the CC was whether CGFM's fund management activities constituted a "business" that was carried on through a "foreign business establishment" as defined in section 9D of the Income Tax Act. If so, CIMSA would be entitled to the FBE exemption and the income of CGFM would not be taxable in South Africa.
THE JUDGMENT
The CC held that two elements of the definition of a FBE are central to the determination of the legal question:
In coming to its decision, the CC emphasized that the concepts of "business" and "primary operations" in the FBE definition should be interpreted broadly, in line with the purpose of the exemption to avoid double taxation.
The CC made an important distinction between fund management and investment management in its analysis. Fund management involves the governance of and ultimate responsibility for all regulatory, legal and other investor-related aspects. This includes the administration of funds, trusteeship or custodianship, management of investments, distributions and marketing. In contrast, investment trading activities (which were outsourced by CGFM) refer to the expert allocation of funds invested in collective investment funds.
The CC held that CGFM’s business was that of a fund manager and not an investment manager. CGFM adopted a delegated business model, where it conducted specific management functions while delegating the investment trading activities to other entities. This model was elected by CGFM for commercial reasons and was in line with its legal obligations and prevailing industry practice. Furthermore, CGFM’s fixed place of business in Ireland was suitably staffed and equipped to conduct the primary operations of its fund management business.
The CC therefore agreed with the Tax Court's finding that CGFM's day-to-day operations met the economic substance requirements of the FBE exemption. Accordingly, it held that SARS should exclude the amount of CGFM's foreign income from Coronation's South African taxable income, as the FBE exemption applied.
The CC criticized the “notional business” approach adopted by the SCA in coming to its findings. The CC endeavoured to establish the true business of CGFM, and whether it is suitably staffed and equipped to conduct that business. In contrast, the SCA looked at everything that CGFM was theoretically and notionally capable of doing in pursuing a commercial endeavour, even if that was not what it did in reality. The CC held that this approach would lead to insensible and unbusinesslike results that do not achieve section 9D’s objectives.
CONCLUSION
The CC’s judgment is a significant relief for South African multinationals, as it provides clarity on the application of the FBE exemption and allows them to set up and operate foreign subsidiaries more flexibly, promoting global competitiveness. The ruling rejects SARS' narrow interpretation and affirms that outsourcing certain functions is a legitimate business practice that should not solely disqualify a company from the FBE exemption.
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The contents of any article published by Pieterse Sellner Erasmus should not be construed as professional legal advice.