Branch vs. Subsidiary: Key tax considerations

taxation 6Author: Wendy Lumsden

Foreign investors frequently face the decision of whether to conduct operations in South Africa as a branch or whether to setup a subsidiary for undertaking South African activities.

This article highlights the key South African tax consequences of a Branch as opposed to those of a Subsidiary and considers some of the other key considerations, such as legal liability.

Background

For the purpose of this article a subsidiary is a separately registered South African company in which a Foreign Company holds shares.  A branch, on the other hand, is not a separate legal entity and could be considered a South African ‘office’ or ‘division’ within the Foreign Company.

Although a branch is not legally a separate entity, it must register with SARS for tax purposes. In order to register with SARS, the “external company” i.e. the company seeking to extend or setup operations to South Africa, needs to first register with CIPC, which in turn provides the details and formalities required to register with SARS for tax.

Tax Consequences

The differences between the South African tax consequences of a branch and a subsidiary are illustrated in the table below by way of a practical example, assuming all income or profits are distributed each year to the Foreign Investor company:

  Subsidiary Branch
Taxable Income received from SA operations R1000 R1000
Income Tax Rate 28% 28%
Income Tax -R280 -R280
Retained Income/Profit attributable to branch R720 R720
Dividends Tax %

(may be reduced in terms of a Double Tax Agreement)

15% Not Applicable
Dividends Tax(may be reduced in terms of a Double Tax Agreement -R108 Not Applicable
Total Tax R388 R280

It is important to note that the Dividends Tax may be reduced in terms of a Double Tax Agreements, if the shareholder is a non-resident company.

Additional Considerations 

Whilst there is a South African income tax advantage of registering as a branch rather than as a subsidiary in South Africa, there are a number of other important considerations to take into account, such as:

a)  Structuring ownership: Sharing ownership of the South African operations is not achievable in the instance of a branch.  For example, a subsidiary would be necessary if BEE ownership or an employee share incentive scheme was required.

b)  Consolidation: losses may be allowed as a set-off on consolidation in the foreign country for tax purposes.  This benefit may only be the case for losses incurred by a branch in certain jurisdictions.

c)   Legal Liability:  In the case of a branch, the foreign company will be liable for acts carried out by the branch through its employees, agents and directors in South Africa, i.e. the branch creates risk exposure for the foreign company in South Africa.  In addition, in the case of a branch, the directors of the foreign company assume legal responsibility of directors under SA Law, whilst a separate legal directorship can be established in the case of a subsidiary.

d)   Reporting:  a branch is required to maintain at least one registered office in the Republic and inform SARS of any change in such registered address, appointments or resignation of the local representative and of any changes to their residential addresses.  A branch is not required to be audited or independently reviewed. In the case of a subsidiary, the subsidiary’s financials and changes to subsidiary’s directors, memorandum etc.  needs to be reported to CIPC.

e)   Winding Up:  a branch is not required to follow any deregistration, dissolution or winding-up  in terms of the Companies Act, although there are likely to be tax consequences thereof.

We make mention that the previous Companies Act was applicable in its entirety to branches, whilst in the current Companies Act, only the sections that specifically refer to “external companies” will apply to branches.

The administrative consequences of establishing, maintaining and operating as a branch or as a subsidiary are largely similar, with the Companies Act being less onerous for a branch. Therefore, the primary considerations to weigh up are the additional risk liability against the difference in tax rates.

Tax Implications of switching from a Subsidiary to a Branch 

If a Foreign Company is considering changing operations from a Subsidiary to a Branch, the South African business could be sold to the new local branch or distributed to the Foreign Holding Company, which for tax purposes, would need to be undertaken at market value.  This would trigger a disposal for capital gains tax purposes, with consequent crystallization of any contingent CGT liabilities.

If the business were sold as a “going concern” to the newly formed entity which met all the applicable requirements of the VAT Act, the transaction(s) could be zero rated for VAT purposes.

 

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