Authors: Gary Vogelman and Alexa Muller – ENSafrica
In terms of the ordinary business practices of property companies, it is not uncommon for such companies to outsource property and asset management functions to third party property and asset managers.
In this regard, to the extent that a South African property investment or development company or group (“SA PropCo”) may hold property investments or developments in offshore jurisdictions, SA PropCo would usually establish a subsidiary in the offshore jurisdiction concerned or some other holding jurisdiction to hold such investment (“Foreign SubCo”). Foreign SubCo would accordingly constitute a controlled foreign company (“CFC”) in relation to SA PropCo in the case where the SA PropCo or other South African resident investors hold the majority of the participation rights (shares) in the Foreign SubCo.
Foreign SubCo will have a proper operating business in the foreign jurisdiction concerned and will receive and accrue rental income in respect of immovable property held in such foreign jurisdiction and may declare and pay dividends to SA PropCo. Foreign SubCo will also usually have directors resident in the foreign jurisdiction concerned who oversee the operation of the business of Foreign SubCo in such foreign jurisdiction.
In terms of section 9D(9) of the Income Tax Act No. 58 of 1962 (“the Act”), in determining the net income of SA PropCo, there should not be taken into account any amount which, broadly speaking, is attributable to a foreign business establishment of Foreign SubCo. On the basis of the current definition of “foreign business establishment” as contained in section 9D(1) of the Act, the rental income and other income such as advertising income, parking income, gas and electricity recoveries received by or accruing to Foreign SubCo will be attributed to SA PropCo, as Foreign SubCo will not qualify as having a foreign business establishment as defined despite such entity having a proper operating business in the jurisdiction concerned.
The reason for this is that despite the proper operations of the Foreign SubCo in relation to the property that it owns, Foreign SubCo may not have an office in the foreign jurisdiction concerned which will be “suitably staffed” or “suitably equipped” with “suitable facilities” as is contemplated in paragraph (a) to the definition of “foreign business establishment” in section 9D(1) of the Act.
Furthermore, notwithstanding that the service providers to which Foreign SubCo will sub-contract its property and asset management functions will normally be resident and subject to tax in the foreign jurisdiction concerned and will have employees, equipment and facilities in such foreign jurisdiction. However, it would not be possible for Foreign SubCo to take into account the utilisation of such employees, equipment and facilities as contemplated in the proviso to paragraph (a) of the definition of “foreign business establishment”. This is on the basis that such service providers will not form part of the same group of companies as the Foreign SubCo, being third party service providers who render services in relation to numerous property companies in the relevant jurisdiction.
In addition, Foreign SubCo will not constitute a “foreign business establishment” in terms of any of paragraphs (b) to (g) of the definition thereof in section 9D(1) of the Act.
Accordingly, on the basis that Foreign SubCo will sub-contract its property and asset management functions to third party service providers (which, as indicated above, is usual business practice in the property industry), it will not have a foreign business establishment as currently defined in section 9D(1) of the Act and accordingly, the rental income derived by Foreign SubCo will be attributed to SA PropCo (with a credit being available in relation to tax paid in the jurisdiction in which the property is situated).
The above anomaly is an issue that is negatively affecting a number of South African property developers and investors as they expand their reach into foreign jurisdictions as a result of the competitive space in South Africa, the high levels of vacancies in certain sectors and areas in South Africa as well as the opportunities in Africa and the rest of the world arising from the growth in Africa and the lack of capital for developments in the rest of the world.
In our view, as Foreign SubCo will have a proper operating business in the foreign jurisdiction concerned, it should not be excluded from the definition of “foreign business establishment” in section 9D(1) of the Act merely on the basis of the business practice of sub-contracting its functions to third party property and asset managers in the foreign jurisdiction concerned.
We hope the above issue is considered by National Treasury with a view to addressing this anomaly forthwith so as to avoid prejudice to the foreign expansion of local property developers and investors whose world class investing and development skills should be an increasing export of this country.