SA Budget 2023 – Does your controlled foreign company have real substance?

An offshore company which meets the definition of a controlled foreign company (CFC) will have substance if it has a foreign business establishment (FBE) as contemplated.

Usually, if the income of your CFC is attributable to an FBE, such income will not be taxed in the South African shareholders hands. Conversely if there is no FBE such income may be taxed in the SA shareholders hands.

Earlier this month the Supreme Court of Appeal delivered its judgement in CSARS v Coronation Investment Management on whether the CFC in question had an FBE. The court ruled in favour of SARS.

What concerned the court was that certain functions of the CFC, which was established in Ireland, had been outsourced to another company which was situated in a different country.

The court had to consider what the primary operations of the CFC entailed, and whether those primary operations were conducted in Ireland. The full bench held that its primary operations were that of investment management and that it was not conducted in Ireland, but were rather outsourced elsewhere.

The outcome of the case in our view is certainly debatable despite the fact that there were no dissenting judgments.

Presumably as a result of this case and similar scenarios, it is proposed in the 2023 Budget Review that the FBE exemption be clarified. Treasury is concerned that important functions of CFCs are often outsourced while arguing compliance with the FBE exemption.

It is proposed that for the CFC to have a FBE, all important functions for which a CFC is compensated by its clients need to be performed by the CFC itself.

While we do not have an issue with such proposal which is in line with the legislation one hopes that Treasury will also take into account the modern business world and somewhat relax certain FBE requirements.

In our view the current definition of an FBE assumes a business must be conducted using set traditional and often archaic business structures. Following the COVID pandemic many businesses have found that they can, and had to, work remotely. One hopes that Treasury will take such modern working arrangements into account which have often become the norm!