A CRITICAL EXAMINATION OF THE INCOME TAX PROVISIONS RELATING TO THE TAXATION OF FOREIGN INCOME OF
A CRITICAL EXAMINATION OF THE INCOME TAX PROVISIONS RELATING TO THE TAXATION OF FOREIGN INCOME OF
RESIDENTS AS DEFINED
Submitted in partial fulfillment of the
Magister Commercii (Taxation)
in the
Faculty of Economic & Building Sciences
By
William Nevel Smith
Supervisor
Professor A.J.N. Brettenny
University of Port Elizabeth
December 2004
Declaration
This project is an original piece of work which is made available for photocopying, and inter-library loan.
Signed: ……….. WN SMITH
ACKNOWLEDGEMENTS
I hereby wish to express my gratitude to all those who have assisted me with the preparation of this project.
To the Professors for their part in installing within me, the ability to analyse, interpret and apply Income Tax Legislation and relevant Case Law.
In particular I wish to thank:
• Professor Alex Brettenny, my supervisor for the guidance and advice.
• Professor George Devenish, Professors Lindsay and Kevin Mitchell and
Mr Clive Sharwood, for the benefit I derived from their tuition.
• My family for their support, understanding and encouragement.
SUMMARY
The Budget speech of 23 February 2000 by the Minister of Finance marked the introduction of significant changes to the income tax system of the Republic of South Africa (Republic). A residence-based system of taxation (RBT) was adopted for years of assessment commencing on or after 1 January 2001 and Capital Gains Tax (CGT) was introduced with effect from 1 October 2001. According to the 2000 Budget Review a move to a residence-based system would significantly broaden the tax base, limit opportunities for tax arbitrage and bring the tax system in line with generally accepted international practice.
The relaxation of exchange controls for South African residents with effect from 1 July 1997 made it possible for residents to invest limited funds offshore. The Fifth Interim Report of the Katz Commission suggested that if exchange controls were relaxed, the taxation of active income should remain on a source basis, but that passive income should be taxed on a residence basis. As a result deemed source rules in the form of section 9C and 9D were introduced into the Act with effect from 1 July 1997 and applied to “investment income” as defined.
Section 9C taxed investment income of both residents and non-residents (from activities carried on by a permanent establishment in the Republic). Section 9D taxed investment income of controlled foreign entities and investment income arising from donations, settlements or other dispositions in the hands of residents.
The taxation of foreign dividends with effect from 23 February 2000 as a first phase in the move to a residence based system, lead to the introduction of s 9E. Foreign Dividends were taxed in the hands of residents subject to certain exemptions. The basic interest exemption was extended to foreign dividends. Section 6quat was revised to extend the rebate to foreign dividends and profits of a company from which dividends were declared. Section 9D was amended to cater for foreign dividends received by or accrued to controlled foreign entities.
The implementation of a full residence-based system of taxation with effect from years of assessment commencing on or after 1 January 2001 required amendments to various sections of the Income Tax Act as well as the introduction of new sections. A residence minus system was adopted which means that residents as defined are now taxed on their world- wide income with certain exemptions. Non-residents are taxed on their income from sources within or deemed to be within the Republic.
The provisions relating to the taxation of foreign income of residents is complex; adding to the complexity is the fact that several changes have already been made to these provisions since the inception of the world-wide basis of taxation. The provisions must also be interpreted against the background of any double taxation agreement (DTA) between the Republic and the relevant foreign country as the applicable DTA may override the Republic domestic legislation. For purposes of this treatise the amending Acts enacted up to the end of December 2003 are taken into account.
Hardly five years after the Katz commission of inquiry into the tax structure concluded that RBT and CGT were too complicated to be administered by SARS, the implementation of RBT and CGT were announced in the 2000 Budget.
A detailed examination of the provisions relating to foreign income of residents as defined was undertaken. Interpretational issues to be clarified by legislation and certain planning issues are highlighted. It is essential to understand and carefully consider the Republic tax laws and the relevant double taxation agreements, for the successful application of the provisions. Careful planning before concluding transactions is of vital importance in order to avoid or minimize any unwanted tax consequences resulting from the RBT and CGT provisions.
Key Words:
• Residence Based System of taxation
• Resident
• Controlled foreign company • Foreign dividend
• Foreign tax relief • Estimated assessment
• Currency conversion
• Double Taxation Agreement (DTA)
TABLE OF CONTENTS
Table of Cases (v)
Chapter 1: Introduction 1
Chapter 2: Definition of a Resident 9
Chapter 3: Natural Persons 21
Chapter 4: Trusts 30
Chapter 5: Controlled Foreign Companies 40
Chapter 6: Foreign Dividends 63
Chapter 7: Capital Gains Tax 76
Chapter 8: Foreign Tax Relief 86
Chapter 9: Reporting, Blocked foreign funds,
Estimated Assessments and Currency Conversions 93
Chapter 10: Conclusion and Recommendations 105
TABLE OF CASES
CIR v Berold 1962 (3) SA 748 (A), 24 SATC 729
CIR v Cohen 1946 AD 174, 13 SATC 362
CIR v Kuttel 1992 (3) SA 242 (A), 54 SATC 298
CIR v Simpson 1949 (4) SA 678 (A), 16 SATC 268
CIR v Widan 1955 (1) SA 226(A), 19 SATC 341
H v COT 1960 (2) SA 695 (SR), 23 SATC 292
Joss v SIR 1980 (1) SA 674 (T), 41 SATC 206
Kohler v CIR 1949 (4) SA 1022 (T), 16 SATC 312
Levene v Inland Revenue Commissioner 1928 AC 217, 13 TC 486
Ovenstone v SIR 1980 (2) SA 721 (A), 42 SATC 55
CHAPTER 1
INTRODUCTION
The Budget speech of 23 February 2000 by the Minister of Finance marked the introduction of significant changes to the income tax system of the Republic of South Africa (Republic). A residence-based system of taxation (RBT) was adopted for years of assessment commencing on or after 1 January 2001 for persons other than natural persons and from 1 March 2001 for natural persons and Capital Gains Tax (CGT) was introduced with effect from 1 October 2001. The 2000 Budget Review1
states that the source basis of taxation provides opportunities for tax planning and avoidance, as taxpayers seeks to reclassify as untaxed foreign source income, income that would normally be taxed in South Africa. This is facilitated by the increasing globalisation of the economy and the relaxation of exchange controls, which provide considerable opportunities for taxpayers to avoid South African tax and that a move to a residence-based system would significantly broaden the tax base, limit opportunities for tax arbitrage and bring the tax system in line with generally accepted international practice.
The relaxation of exchange controls for residents of the Republic with effect from
1 July 1997 made it possible for residents to invest limited funds offshore. The Katz Commission2 concluded that if exchange controls were relaxed, the taxation of active income should remain on a source basis, but that passive income should be taxed on a residence basis. As a result deemed source provisions in the form of s 9C3 and 9D4 were introduced into the Income Tax Act No. 58 of 1962, as amended (the Act) with effect from 1 July 1997 and applied to “investment income”5 as defined.
Section 9C deemed investment income of both residents and non-residents (from activities carried on by a permanent establishment in the Republic) to be from a source in the Republic. Section 9D taxed investment income of controlled foreign entities and investment income arising from donations, settlements or other dispositions in the hands of residents.
The taxation of foreign dividends with effect from 23 February 2000 as a first phase in the move to a residence based system, led to the introduction of s 9E6. Foreign dividends were taxed in the hands of residents subject to certain exemptions. The basic interest exemption was extended to foreign dividends. Section 6quat7 has been revised to extend the rebate to foreign dividends and profits of a company from which
2The Fifth Interim Report of the Commission of Inquiry into certain aspects of the Tax Structure of South Africa (1997).
3
Section 9C was repealed with effect from years if assessment commencing on or after 1 January 2001, Act No. 59 of 2000.
4 Section 9D was substituted by Act No. 74 of 2002. 5
Annuities, interest, rental income, royalties or income of a similar nature.
6
See Chapter 6.
dividends were declared. Section 9D8 was amended to cater for foreign dividends received by or accrued to controlled foreign entities.
The implementation of a full residence-based system of taxation with effect from the years of assessment commencing on or after 1 January 2001 required amendments to various sections of the Act as well as the introduction of new sections. A residence minus system was adopted which means that residents9 as defined are now taxed on their world- wide income with certain exemptions. Non-residents are taxed on their income from sources within or deemed to be within the Republic.
There is consensus amongst various authors10 on tax matters that the provisions are complex and this view is accurately summed up by Kolitz as follows: “The quantum of the foreign income that is included in the resident’s South African taxable income, the timing of the inclusion, whether or not the income qualifies for any exemptions and the quantum of the tax payable to the South African fiscus depend on several complex provisions in the Income Tax Act.”11 Adding to the complexity is the fact that several changes have already been made to these provisions since the inception of the world-wide basis of taxation. The provisions must also be interpreted against the background of any double taxation agreement (DTA) between the Republic and
8 Act No. 30 of 2000. 9 See Chapter 2. 10
See for example Olivier LO ‘Resident Based Taxation’ at 39; Kolitz M ‘Tax on foreign income Influential factors’ at 92.
the relevant foreign country as the applicable DTA may override the domestic legislation. Any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the Republic and another country for the avoidance of double taxation is not regarded as a resident under the Republic law.
It is therefore essential for both the South African Revenue Service (SARS) and tax practitioners to develop the required skills and stay abreast with these changes for the successful operation of the new basis of taxation in the Republic. For purposes of this treatise the amending Acts enacted up to the end of December 2003 are taken into account.
This treatise is divided into ten chapters of which chapter 1 gives an introduction to the issues to be considered.
Chapter two examines the definition of a resident in terms of the Act. Residents as defined are taxed on their world- wide receipts and accruals. The term “resident” is therefore critical to a residence-based system of taxation. A natural person is a resident if that person is ordinarily resident in the Republic or will be regarded as a resident if the person was not ordinarily resident in the Republic but meets certain criteria concerning his physical presence in the Republic. A person (other than a
natural person) will be regarded as a resident if incorporated, established or formed or have its place of effective management in the Republic.
Chapter three examines the provisions applicable to natural persons earning employment income, pensions and trade income. An exemption exists if the resident has been outside the Republic rendering services for a period exceeding 183 full days during any 12 month period commencing or ending during that year of assessment of which more than 60 full days have been continuous. The importance to work forwards and backwards when calculating the most suitable 12 month period is highlighted.
Chapter four examines the provisions applicable to trusts and income that accrues to a non-resident from donations, settlements and other dispositions. The world-wide receipts and accruals of trusts and beneficiaries are taxed in terms of s 25B subject to the provisions of s 7. Section 7(8) includes in the income of a resident income that accrues to a non-resident which is derived by reason of or in consequence of any donation, settlement or other disposition made by that resident. In terms of the gross income definition non-residents are taxed on their receipts and accruals from sources within or deemed to be within the Republic. The taxability of foreign source (non-Republic) income which accrues to a non-resident where that income is attributed to a donation by a resident is explored.
Chapter five examines the provisions applicable to controlled foreign companies (previously controlled foreign entities). Section 9D is an anti-avoidance provision of which the overall effect is to tax the Republic owners of foreign companies on the income derived by the companies by imputing the foreign income to the Republic residents. In the absence of anti-avoidance provisions residents could easily avoid tax by shifting their income to foreign companies often delaying repatriation for years or never repatriating funds at all.
Chapter six examines the provisions applicable to foreign dividends. The taxation of foreign dividends originally under the regime of s 9E, was the first phase in the move to a residence based tax system. Section 9E has been substantially amended since its introduction and eventually fell out of favour and was repealed with effect from years of assessment commencing on or after 1 June 2004. The taxation of foreign dividends is now contained in various sections in the Act.
Chapter seven examines the provisions applicable to capital gains tax (CGT). CGT is regarded as a tax on income and although it is the person’s taxable capital gain which is included in the person’s taxable income for the year of assessment, it is important to consider the CGT provisions applicable to capital gains from non Republic sources as it impacts directly on the resident’s tax liability. CGT applies to the world-wide assets of a resident disposed of on or after 1 October 2001. A person’s capital gain
(or part thereof) may be deemed to be that of another person in terms of paragraphs 68 to 73.
Chapter eight examines the provisions applicable to foreign tax relief. The rebate is deductible from normal tax payable by a resident whose taxable income includes foreign income. Relief from double tax is achieved either by the treaty alone or a combination of treaty law and the domestic laws of the countries which are party to the treaty. The Republic uses a combination of rebates and exemptions. Foreign tax actually paid is allowed as a credit in determining provisional tax payments of a resident.
Chapter nine examines the provisions applicable to reporting, blocked foreign funds, estimated assessments and currency conversions. The Act contains various administrative provisions to regulate the reporting and the consequences of non-compliance with the relevant reporting provisions of foreign income and assets of residents. A DTA may also contain provisions to facilitate the exchange of information between contracting states, with a view to ensuring that taxpayers make proper disclosure of their tax affairs. The resident’s failure to properly account for assets that are invested abroad regardless of when those assets were originally acquired may result in an estimated assessment being raised on a deemed taxable income.
The general rule is that the amount of any taxable income that is not in the currency of the Republic must be converted to the Republic currency by applying the average exchange rate for the year of assessment.
Chapter ten gives a conclusion and recommendations. Interpretational differences to be clarified by legislation and certain planning issues are highlighted. Careful planning before concluding transactions is of vital importance in order to avoid or minimize any unwanted tax consequences resulting from the RBT and CGT provisions.
CHAPTER 2
DEFINITION OF A RESIDENT
Introduction
Under a residence based system tax is levied on the residents of a country on their world-wide income. The gross income definition lays the foundation for the implementation of the residence based system of taxation and distinguishes between residents and non-residents. The gross income definition in s 1 of the Act reads as follows:
‘ “gross income”, in relation to any year or period of assessment, means-
(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident; or
(ii) in the case of any person other than a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such person from a source within or deemed to be within the Republic,…’
Residents as defined are therefore taxed on their world- wide receipts and accruals and non-residents on their receipts and accruals from sources within or deemed to be within the Republic. The term “resident” is therefore central to a residence-based system of taxation and is defined in s 1as:
‘ “resident” means any- (a) natural person who is—
(ii) not at any time during the year of assessment ordinarily resident in the Republic, if such person was physically present in the Republic—
(aa) for a period or periods exceeding 91 days in aggregate during the relevant year of assessment, as well as for a period or periods exceeding 91 days in aggregate during each of the three years of assessment preceding such year of assessment; and
(bb) for a period or periods exceeding 549 days in aggregate during such three preceding years of assessment,
in which case that person will be resident with effect from the first day of the relevant year of assessment:
Provided that—
(A) a day shall include a part of a day, but shall not include any day that a person is in transit through the Republic between two places outside the Republic and that person does not formally enter the Republic through a “port of entry” as contemplated in section 9(1) of the Immigration Act, 2002 (Act No. 13 of 2002) or at any other place in the case of a person authorised by the Minister of Home Affairs in terms of section 31(2) (c) of that Act; and
(B) where a person who is a resident in terms of this subparagraph is physically outside the Republic for a continuous period of at least 330 full days immediately after the day on which such person ceases to be physically present in the Republic, such person shall be deemed not to
have been a resident from the day on which such person so ceased to be physically present in the Republic; or
(b) person (other than a natural person) which is incorporated, established or formed in the Republic or which has its place of effective management in the Republic (but excluding any international headquarter company)
but does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation;’
The definition distinguishes between natural persons and non-natural persons.
Natural persons
Two alternative tests apply to determine whether a natural person is a resident. Under the first test a person is a resident if that person is ordinarily resident in the Republic and under the second test a person is regarded as a resident if a person who was not ordinarily resident in the Republic during the year of assessment but meets certain criteria concerning his physical presence in the Republic.
Ordinarily resident
The Act does not define the concept “ordinarily resident”. Interpretation Note No. 312 points out that the question whether a person is ordinarily resident in a country is one of fact and that each case must be decided on its own merit having
12
SARS: Interpretation Note No.3 - 4 February 2002 ‘Resident: Definition in relation to a natural person – Ordinarily Resident’ at 4.
regard to principles already established by case law, meanings expressed in the text books, etc., as it is not possible to lay down hard and fast rules. The court in CIR v Kuttel13 said
‘That a person may have more than one residence at any time is clear [but] [i]n the present case we are concerned with the words “ordinary resident”. That is something different and, in my opinion, narrower than just “resident”.’
In CIR v Cohen14the court said
“If though a man may be ‘resident’ in more than one country at a time he can only be ‘ordinary resident’ in one, it would be natural to interpret ‘ordinary’ by reference to the country of his most fixed or settled residence.”
The court went on to interpret the concept “ordinary residence” to mean
“the country to which a person would naturally and as a matter of course return from his wanderings; as contrasted with other lands it might be called his usual or principal residence and it would be described more aptly than other countries as his real home. If this suggested meaning were given to “ordinary ” it would not, I think, be logically permissible to hold that a person could be “ordinarily resident” in more than one country at the same time.”
This interpretation was confirmed in CIR v Kuttel that
“a person is ‘ordinarily resident’ where he has his usual or principal residence, i.e. what may be described as his real home.”
13
1992 (3) SA 242 (A), 54 SATC 298.
The Interpretation Note15gives a summary of what the courts have held in ascribing a meaning to the concept “ordinary resident” namely:
• “living in a place with some degree of continuity, apart from accidental or temporary absence. If it is part of a person’s ordinary regular course of life to live in a particular place with a degree of permanence, he must be regarded as ordinary resident. (Levene v Inland Revenue Commissioner [1928] ALL ER Rep. 746 (HL))
• the place where his permanent place of abode was, where his belongings were stored, which he left for temporary absences and to which he regularly returned after such absences. (H v COT 24 SATC 738)
• the residence must be settled and certain and not temporary and casual. (Soldier v COT 1943 SR)
• ordinary resident is narrower than resident. A person is ordinary resident where he/she normally resides, apart from temporary/ occasional absences. ( CIR v Kuttel (supra))”
Date a person ceases to be resident
When a person who is ordinarily resident emigrates, he ceases to be a resident from the day after the date of emigration.16
The ‘peregrinus’17
Clegg considered the question of whether foreign nationals who have permanent establishments in the Republic and who spend substantial time here, claiming,
15
At 3.
16
See page 15. Emigrants may become residents again in the year after emigration.
however to be ‘non-resident’ are not in fact ordinarily resident in the Republic. He is of the view that the courts will in future not pay too much attention to the centre of financial affairs of an individual in determining his ‘ordinary’ residence. He concludes that there are two major and significant factors upon which ordinary residence will in future be seen to rest, namely:
• The apparent permanence of the residences in the countries concerned, and
• The actual period of time spent in these countries.
In this regard Silke18 submits that a person’s visits year after year that becomes in effect a part of his habit of life and the annual visits of a substantial period of time, would be difficult to resist a challenge that the person is ordinarily resident in the Republic.
Physical presence test
The test is only applicable to persons who were not at any time during the year of assessment ordinarily resident in the Republic. The test is based on the number of days during which a person is physically present in the Republic and consists of three requirements. A day includes a part of a day but excludes any day that a person is in transit through the Republic between two places outside the Republic and that person does not formally enter the Republic through a “port of entry” as defined in the Immigration Act, 2002 (Act No. 13 of 2002) or at any other place in the case of a person authorised by the Minister of Home Affairs in terms of that Act. All three
requirements must be met in order for a person to become a resident by virtue of his physical presence, namely he must be physical present for a period or periods exceeding:
(i) 91 days in aggregate during the current year of assessment,
(ii) 91 days in aggregate during each of the three years of assessment preceding the current year of assessment; and
(iii) 549 days in aggregate during such three preceding years of assessment:
A person will only become resident in the fourth year of assessment in which he has a physical presence in the Republic.19 It is suggested20 that a person can avoid becoming a resident at all by arranging not to be physical present for more than 91 days in any of the three preceding years or the current year of assessment or every fourth year of assessment.
A person who was ordinary resident and emigrated may however become a resident again in the year after immigration. As noted21 emigrants should be careful not to be caught by the physical presence test in the year after emigration by being present in the Republic for more than ninety-one days in that year, as he may have been present for 549 days in aggregate in the previous three years. The physical presence test
19 SARS: Interpretation Note No. 4 – 4 February 2002 ‘Resident: Definition in relation to a natural
person - Physical Present Test’ at 3; Silke at 5.2B; Meyerowitz on Income Tax at 5.18.
20
Meyerowitz at 5.18; Silke at 5.2B.
cannot apply in the year of assessment in which the person emigrates because the person was ordinary resident in that year.22
Interpretation Note No. 423states that where a person is resident both in the Republic and in a foreign country, any agreement for the avoidance of double taxation between the two countries must be considered when determining the taxability of income in the Republic and the other country and that the tie-breaker rules must be applied to determine the country of residence. “Expressly not included (rather than expressly excluded) as a resident is ‘any person who is deemed to be exclusively a resident of another country for purposes of the application of any agreement entered into between the governments of the Republic and that other country for the avoidance of double taxation.’ It should be noted that this exclusion applies only if the person is deemed to be exclusively a resident of the other country that is a party to the agreement.”24 Therefore a person may qualify as a resident in terms of the domestic Act yet in terms the DTA the person is deemed to be a resident of the other country.
Date a person becomes a resident
Before the amendments25 to the definition the Act did not state when a person would become a resident under the test. One interpretation26 was that a person would
22 Paragraph (a)(ii) of the definition of ‘resident’. 23 At 1.
24
Silke at 5.2B.
25
Revenue Laws Amendment Act, 2003 (Act 45 of 2003).
become a resident from the first day of the year of assessment during which he meets all the requirements. The other interpretation27 submitted that a person would become resident from day ninety-two when he qualifies as a resident in terms of the test and further submitted that in each subsequent year of assessment for which he meets the requirements of the physical presence test, he will be resident from day ninety-two of his physical presence. This uncertainty has been resolved by legislation28 which now confirms that a “person will be a resident with effect from the first day of the relevant year of assessment” in which the person qualifies as a resident.
Date a person ceases to be resident
A person ceases to be a resident the day after the day he leaves the Republic for a continuous period of at least 330 full days. According to Stein29 a person need not wait 330 days but can simply leave the country within ninety-one days of the beginning of the year of assessment and ensure that he is not present for more than ninety-one days during the entire year. In this case the person ceases to be a resident from the first day of the year of assessment.
Persons other than natural persons
A person (other than a natural person) will be regarded as a resident if
• incorporated, established or formed in the Republic or
27
Silke at 5.2B; ‘Taxing the South African Sunshine’ at 70.
28 Section 12(1)(j) of Act 45 of 2003. 29 Stein M ‘The importance residence’ at 79.
• its place of effective management is in the Republic except if an international
headquarter company30.
Once a person is incorporated, established or formed in the Republic it will forever be regarded as a resident but if incorporated, established or formed (incorporated) outside the Republic it will still be regarded as a resident if effectively managed in the Republic. It is therefore possible for persons not incorporated in the Republic to change its residence by changing the place of effective management. The place of effective management is therefore critical if the person is not incorporated, established or formed in the Republic.31
The concept ‘place of effective management’ is not defined in the Act and there is no specific case law in the Republic. The Interpretation Note32 states that the ordinary meaning of words, taking into account international precedent and interpretation, all the relevant facts and circumstances will assist in ascribing a meaning to the concept and that no definitive rule can be laid down. The closest concept is that of place of ‘management and control’ but as pointed out by Silke,33 the use of different terminology by the legislature must surely indicate a desire to indicate a concept different from a place of effective management.
30 International headquarter company was defined in s 1 but repealed with effect from 1 June 2004. 31 ‘The importance of ‘residence”. And how it ends’ at 80.
32
SARS: Interpretation Note No. 6 – 26 March 2002 ‘Resident: Place of Effective Management (Persons other than Natural Persons)’ at 2.
Meyerowtz34 considers that the place of effective management is normally the place where in the case of the company the directors meet on the business of the company, which may differ from the place where the company carries on business or is managed by staff or directors individually and not as a board.
The correct position may well be that effective management of a company is located where the executive directors and management conduct the daily activities of the business. 35
SARS’s view is based on whether the management functions are executed at a single location, and if not via distance communication the place where the business operations/activities are actually carried out or conducted or if the business activities are conducted from various locations the place with the strongest economic nexus. The concept is commonly used in double taxation agreements (DTA) based on the model treaty of the Organisation for Economic Co-operation and Development (OECD). Based on the fact that the Republic DTAs are replete with references to the ‘place of effective management’, Silke36 “accordingly concludes that the concept bears the same meaning in the Act as it does in these agreements, which are in any event deemed for certain purposes to be part of the Act itself by s 108(2).”
34
At 5.19.
35
‘The importance of ‘residence”. And how it ends’at 80; Silke at 5.2G and 14.45.
Resident in terms of a DTA
The definition of a resident differs from country to country. Resident in terms of a DTA may not be the same as the definition of a resident in the Income Tax Act37 in which case the relevant DTA must be considered to determine the country of residence. A resident as defined in the Act does not include any person who is deemed to be exclusively a resident of another country in terms of the relevant DTA.
Article 4 of the OECD Model Treaty defines a “Resident of a contracting state” as a person who is subject to world-wide taxation in the state on the basis of certain criteria. A person may therefore be regarded as a resident in both countries in which event the so called ‘tie-breaker rules’ are applied to determine the residence status of a person. A natural person will be regarded as a resident of the country in which he has a permanent home. If he has a permanent home in both countries then determine on the facts in which country his personal and economic relations (centre of vital interest) are closer. If the centre of vital interest cannot be determined he will be a resident of the country in which he has an habitual abode. If this test fails he will be a resident of the country of which he is a national and if a national of both states the competent authorities of both countries shall decide by mutual agreement.
When a person other than a natural person is a resident of both countries residence is where the place of effective management is situated.
CHAPTER 3
NATURAL PERSONS
Introduction
The receipts and accruals of residents are included in gross income in terms of part (i) of the gross income definition.38 For non- residents the receipts and accruals from a Republic or deemed Republic source are included in terms of part (ii) of the gross income definition.
Remuneration for Foreign Employment
Section 10(1)(o)(ii) exempts from tax any receipts and accruals of a resident in respect of services rendered outside the Republic. The exemption is only available where services are rendered outside the Republic for or on behalf of any employer.39 In order to qualify for the exemption the resident must have been outside the Republic rendering services for a period exceeding 183 full days during any 12 month period commencing or ending during that year of assessment of which more than 60 full days have been continuous. The period of 183 days need not be continuous but the sixty days must be continuous and the days must fall within the same 12 months.
38 See Chapter 2 for definition.
39 Excluding the national or provincial or local government of the Republic as employer, any national
or provincial public entity or the holding of a public office appointed in terms of an Act of Parliament.
Interpretation Note No.1640 points out that each month in the 12 month period, is a month as defined in the Interpretation Act, 1957 i.e. a calendar month and that the period must therefore commence on the first day of a particular month, and end thereafter on the last day of the twelfth month thereafter. The Interpretation Note41
emphasises the importance to work forwards and backwards when calculating the 12 month period. In identifying the possible 12 month periods the note suggests the following approach for determining the most suitable 12 month period by way of the following example:
The resident is employed by a Republic multi-national company and was seconded to the New Zealand subsidiary on 1 June 2001 where he worked until 31 December 2001 and often returned to the Republic. The number of days during which remuneration was derived from services rendered in New Zealand in the 2002 year of assessment is as follows:
Jun Jul Aug Sep Oct Nov Dec TOTAL
1 June 01 to 26 July 01 30 26 56 1 Aug 01 to 4 Sept 01 31 4 35 10 Sept 01 to 10 Nov 01 21 31 10 62 16 Nov 01 to 20 Dec 01 15 20 35 188 40
SARS: Interpretation Note No. 16 – 27 March 2003 ‘Exemption from Income Tax: Foreign Employment Income’ at 4.
It is clear from the above table that the period during which services were rendered outside the Republic includes an aggregate of 183 days and a continuous period of 60 days which fall into the 12 month period commencing in the 2002 year of assessment, i.e. 1 June 2001 to
31 May 2002 and another 12 month period ending in the 2002 year of assessment, i.e. 1 January 2001 to 31 December 2001.
The same resident was seconded to England from 1 March 2002 to 30 April 2002 where the number of days for remuneration for services was derived from outside the Republic as follows:
Mar Apr TOTAL
1 March 02 to 28 March 02 28 28
2 April 02 30 April 02 29 29
57
Two qualifying 12 month periods commencing and ending in the 2003 year of assessment can be identified, namely:
• 1 March 2002 to 28 February 2003; and
• 1 May 2001 to 30 April 2002.
The resident was not outside the Republic for an aggregate of 183 days during the 12 month period 1 March 2002 to 28 February 2003 and can therefore not be used. It is necessary to consider the 12 month period ending in the year of assessment, i.e. 1 May 2001 to 30 April 2002.
May Jun Jul Aug Sept Oct Nov
Dec Jan Feb Mar Apr TOTAL
1 Jun 01 to 26 Jul 01 30 26 56 1 Aug 01 to 4 Sept 01 31 4 35 10 Sept 01 to 10 Nov 01 21 31 10 62 16 Nov 01 to 20 Dec 01 15 20 35 1 Mar 02 to 28 Mar 02 28 28 2 Apr 02 30 Apr 02 29 29 Total 245
The importance to work forwards and backwards when calculating the 12 month period is highlighted as it is clear that the initial 12 month period could not exempt the income from England in the 2003 year of assessment, the alternative period could exempt the same income.
According to Mitchell42 it is the absence for more than sixty consecutive days that is the unattractive aspect or disadvantage of this tax concession. The Republic tax consequences that arise in relation to different periods of absence from the Republic is analysed by Mitchell:43 It is assumed for purposes of the analysis that the resident commenced working outside the Republic on 1 August 2001 for a twelve month period ending 31 July 2002. The twelve-month period therefore commenced during the 2002 year of assessment and ended during the 2003 year of assessment.
42
Mitchell L ‘Working Abroad’ at 60.
• Period of 183 days and less
The resident does not render services outside the Republic for or on behalf of his employer for a period exceeding 183 full days during a twelve-month period and therefore does not qualify for the exemption.
• Period of more than 183 days
Section 10(1)(o)(ii)(bb) requires that during the twelve- month period the resident must be continuously outside the Republic rendering services for or on behalf of his employer for more than sixty days. If the resident is outside the Republic for the whole of August and September 2001
rendering services for or on behalf of his employer he will be outside the Republic for a continuous period of sixty-one days during this twelve- month period. Mitchell44 submits that the phrase ‘commencing or ending
during such period of 12 months’ permit a single period of rendering more than sixty days services for or on behalf of his employer outside the Republic, to qualify for the exemption in both years of assessment in which the twelve-month period falls.
• Period of more than a year
If the resident is outside the Republic for more than a year a second twelve-month period commences. To qualify for the exemption again, another period of more than sixty continuous days of rendering services outside the Republic is required. With careful planning a common period could be selected that will secure the exemption for contracts of up to twenty-two months. This can be achieved by coinciding the last two months of the
first month period with first two months of the second twelve-month period. Within the twenty-two twelve-month period the first twelve-twelve-month period would commence on 1 August 2001 (2002 year of assessment) and end on 31 July 2002 (2003 year of assessment). A second twelve-month period would end on 31 May 2003 (2004 year of assessment) having commenced on 1 June 2002 (2003 year of assessment). A common period 1 June 2002 to 31 July 2002 of more than sixty continuous days of rendering services outside the Republic for or on behalf of an employer would cause the salary earned for the twenty-two months by the resident to be exempt.
• Period of more than twenty-two months
For periods exceeding twenty-two months a second continuous period of more than sixty days outside the Republic is required to secure the exemption. The analysis shows that a salary earned for maximum of thirty-four months could qualify for the exemption by serving two periods of more than sixty continuous days of rendering services outside the Republic for or on behalf of an employer. The first twelve-month would be the first period of twelve-months and the second period the twenty-two month period commencing in month ‘thirteen’ and end in month ‘thirty-four’. The two periods of more than sixty continuous days of rendering services outside the Republic for or on behalf of an employer would have to be a period somewhere during the first twelve-months and months ‘twenty-three’ and ‘twenty-four’ in the second period.
It is important to note that the days that a resident is in transit between two places outside the Republic count as days outside. The days of departure from or arrival in the Republic will therefore not count as days outside the Republic.
In the case of an officer or a crew member of a ship the following criteria must be met:
• the person must be outside the Republic for more that 183 full days, and
• the ship must be engaged in international transport business, or
• prospecting for or mining of minerals from the seabed outside the continental
shelf of the Republic. (Section 10(1)(o)(i).)
Internationally it is accepted practice to exempt foreign employment income if the resident was rendering services outside his country for a period exceeding 183 days. In terms of Article 15 of the OECD model treaty45 the other contracting state is excluded from taxing the income if certain criteria are met. The Republic will tax the income if a resident is not more than 183 days outside the country rendering the services. If more than 183 days both the Republic and the other contracting state can tax the income. Where the same income is taxed in both countries the country of residence must give a credit or an exemption from tax. The Republic allows an exemption in terms of s 10(1)(o), which is in line with Article 15.
Foreign Pensions
Section 10(1)(gC) exempts from tax any—
• amount received by or accrued to any resident under the social security system of
any other country; or
• pension received by or accrued to any resident from a source outside the
Republic, which is not deemed to be from a source in the Republic in terms of s 9(1)(g)46, in consideration of past employment outside the Republic.
The Explanatory Memorandum47 points out that the exemption is merely an interim measure and will be revisited over the next three years. There is however no indication of any changes to date.
Trade Income
The taxable income derived from trade carried on outside the Republic is determined on the same basis as for income derived from trade within the Republic. The provisions of s 11 have been extended to trade outside the Republic and there is no longer a distinction between expenses and losses incurred in or outside the Republic. In determining the amount of allowances and deductions in terms of s 11(e), 11(o), 12B, 12C, 12D, 13, 13bis and 13ter, on assets previously used for trade carried on
46 any pension or annuity granted by the Government, any provincial administration, or by any local
authority in the Republic; or by any person, if the services within the Republic for at least two years during the ten years immediately preceding the date the pension or annuity first became due.
outside the Republic, a proportional amount of the allowance may be written off, if the income was not previously subjected to taxation in the Republic, but became taxable under the residence based system.48
Similarly as above s 8(4) amounts recovered or recouped on the sale of assets are not subject to taxation, if the amount recovered or recouped relates to the years when no allowance was available.49
Assessed losses are determined world-wide, but assessed losses from foreign trade may not be set off against Republic trade income.50 Assessed losses from foreign trade may however be set off against trade income from another foreign country. The Republic assessed loss may be set off against foreign trade income.
Interest
Interest, which accrues to a resident who is a natural person from a foreign country, is exempt in terms of s 10(1)(i)(xv)(aa), limited to R 1000 but is first applied in respect of foreign dividends and thereafter in respect of interest.51 The interest may also be taxed in terms of Article 11 of a DTA in the foreign country limited to a maximum of 10% with certain exceptions.
48 Individuals from 1 March 2001 and other entities from 1 January 2001. 49
Individuals from 1 March 2001 and other entities from 1 January 2001.
50 Section 20(1)Proviso (b). 51 See also page 73.
CHAPTER 4
TRUSTS
Introduction
A trust is a person for income tax purposes and is defined in section 1 of the Act. A trust is a resident if it is incorporated, established or formed in the Republic or has its place of effective management in the Republic.52 A non-resident trust can no longer be a Controlled foreign company (CFC) as a result of amendments53 to s 9D. The anti-avoidance provisions which may prevent the avoidance or deferral of tax on foreign source income through the use of off-shore trusts are contained in s 7, 25B and 31 of the Act.
The world-wide receipts and accruals of resident trusts and resident beneficiaries are taxed in terms of s 25B subject to the provisions of s 7. The income is taxed in the hands of the beneficiaries to the extent that the income vests in the beneficiaries including the income that vests in a beneficiary in consequence of the exercise of a discretion in the case of a discretionary trust. Any trust income that does not vest in the beneficiaries is taxed in the trust.
Deductions and allowances are available proportionate to the income derived by the beneficiary or the trust. Certain exclusions in respect of deductions and allowances
52
See Chapter 2.
apply to beneficiaries who are not subject to tax in the Republic on the income that is deemed to have accrued to them. Such deductions and allowances of a beneficiary are limited to the income derived as beneficiary and any excess may be written off by the trust limited to the taxable income of the trust. If the trust is not able to utilize the excess such excess is carried forward to the beneficiary in the succeeding year of assessment and deducted from his income derived as a beneficiary. Where the trust is not subject to tax in the Republic the excess is carried forward to the beneficiary in the succeeding year of assessment and deducted from his income derived as a beneficiary. (Section 25B(3) – (7).)
Non Republic source income by Non Resident Trusts
A resident is required to include in his income in the year he acquires a vested right to the capital (accumulated income) of a foreign trust if that resident had a contingent right to that income54 when it accrued to the trust and the income was not subject to tax in the Republic. (Section 25B(2A).) In order for the section to operate the resident beneficiary must have had a contingent right to that income when it accrued to the trust and it is irrelevant whether it’s a discretionary trust or not. It must be noted55 that the section overrides any argument that the income is of a capital nature and therefore not taxable. According to Meyerowitz56 it is immaterial whether the
54
See Chapter 7 for discussion of para 80(3) where a vested right to a capital gain is acquired.
55
Jooste RJ ‘Shifting Foreign Income’ at 55.
person was always a resident or not. The crucial determinant of the person’s liability arises from the fact that he is a resident in the year the capital accrued to him.
Therefore non-residents57 and immigrants to the Republic need to be particularly careful because once a resident beneficiary, he is caught by the provision whether he had the contingent right before he became a resident.
The Explanatory Memorandum58 states that “if ‘income’ of a non-resident trust was not received or did not accrue from a source in the Republic, it would not constitute income as defined in the hands of the trust.” Hence subsec (2A) of s 25B was amended to also refer to “amounts which would have constituted income had the trust been a resident”. Therefore the world-wide accumulated income of the non-resident trust is subject to the provisions of s 25B(2A).
Donation, settlement or other disposition
Section 7(8) includes in the income of a resident income that accrues to a non-resident which is derived by reason of or in consequence of any donation, settlement or other disposition made by that resident. This section does not apply to a CFC. Where the income is in the form of foreign dividends the amount is determined in accordance with s 9E59 and the non-resident is deemed to be a resident shareholder. (Proviso to s 7(8).)60 Although the provision is discussed under trusts, it must be
57 See physical presence test in Chapter 2. 58
Explanatory Memorandum on the Revenue Laws Amendment Bill, 2001 [W.P. 2 – 2001] at 18.
59
See chapter 6.
emphasised that it is not limited to trusts but applies to any person who made a donation, settlement or other disposition resulting in income accruing to a non-resident.61
Jooste62 points out that a problem may exist with the application of s 7(8) and s 7(5) if ‘income’ as used in these sections is given its defined meaning as neither provision will be applicable to non Republic source income. Income as defined for non-residents includes only income from sources within or deemed to be within the Republic therefore foreign source income is excluded. As seen above in relation to s 25B(2A), “income” meant income as defined hence the amendment there to include “amounts which would have constituted income had the trust been a resident”.
This defect in s 7(8) was addressed by legislation during 2004. The word “income” was deleted to include “any amount which would have constituted income had that person been a resident”, however no changes were made to s 7(5), therefore one can conclude that income in this subsection means income as defined.
Clegg63 contends that s 7(8) does not apply to foreign source (non-Republic) income derived by a non-resident trust which accrues to a non-resident since non-residents cannot be taxed in the Republic on non-Republic source income. This conclusion is
61
Huxman K & Haupt P at 582.
62
‘Shifting Foreign Income’ at 57.
based on his interpretation of Simpson’s64 case that s 7 as a whole must be interpreted on the basis that ‘income’ means profits determined using the method of a taxable income calculation. Clegg65 further finds support for his contention in the fact that the provisions of s 3166 will catch the resident in any event if the foreign trust is funded by a low interest loan and by the donations tax provisions if funded by a donation. The foreign source accumulated income (capital) will be taxed in terms of s 25B(2A) when it actually accrues to the resident if that resident was a contingent beneficiary when the income accrued to the trust.
Malcolm’s67 interpretation of the Simpson case in ascribing a meaning to the word ‘income’ is that the chances are good that the court could give s 7(8) the legislature’s intended meaning being that all profits accruing to a non-resident by virtue of a resident’s gratuitous disposition to be deemed income of the resident.
The income is deemed to be the resident’s income and is therefore taxable subject to the relevant DTA with that country.
Huxham K & Haupt P68 contend that s 7(8) applies to all income accruing to any non-resident. 64 1949(4) SA 678 (A), 16 SATC 268. 65 At 15. 66 See Chapter 5. 67
‘Effective or ineffective. The new s 7(8) and s 25B(2A)’ at 42.
Based on the same interpretation of the word ‘income’ Clegg concludes that s 7(5) could also not apply since the amounts actually accrued to a non-resident and are from sources outside the Republic.69
Huxham K & Haupt P70 submit that s 7(5) should not apply to foreign trusts if they receive only income from a non Republic source but do not provide reasons for their view.
Assets sold at less than market value
The reference to ‘assets sold at less than market value’ in s 7(9) is according to Huxham K & Haupt P71 superfluous as the sale of less than market value is a “similar disposition” in any event. The Appellate Division of the Supreme Court (now the Supreme Court of Appeal) had already held that72
“the words ‘donation, settlement or other disposition’ all have this feature in common: they each denote the disposal of property to another otherwise than for due consideration, i.e. otherwise than commercially or in the course of business. ‘Donation’ and ‘settlement’ all have this further feature in common: the disposal of property is made gratuitously or (occasionally in the case of a settlement) gratuitously to an appreciable extent. Since ‘disposition’, the general word that rounds off the critical phrase, was not intended to have its wide, unrestricted meaning, I think that this is an appropriate situation in which to
69 At 15. 70 At 588. 71
At 582.
72Ovenstone v SIR 1980 (2) SA 721 (A), 42 SATC 55 at 74; Joss v SIR 1980 (1) SA 674 (T),
circumscribe its scope by extending that common element of gratuitousness to it too by the
ejusdem generis or noscitur a sociis rule. The critical phrase should in other words, be read as ‘any donation, settlement or other similar disposition’. So construed, ‘disposition’ means any disposal of property made wholly or to an appreciable extent gratuitously out of liberality or generosity of the disposer. It need not flow from a unilateral contract for it is not
necessarily a common element of a ‘donation’ and ‘settlement’.”
Jooste73 however points out that s 7(9) only extends to the meaning of ‘donation’ and that the courts inclusion of interest-free and low-interest loans within the meaning of ‘other disposition’ appears not to be affected by s 7(9) because if the section was extending on the meaning of ‘other disposition’ it may be arguable that by including only a ‘disposition for a consideration less than market value’, whether interest-free and low-interest loans are by implication excluded to render s 7(8) (and also s 7(2) to s 7(7)) ineffective. In CIR v Berold74 it was held that an interest –free loan is a continuing donation for purposes of s 7 because
“the taxpayer sold and transferred a large number of valuable assets to Luzen, he did so on credit without charging interest on the purchase price. In fact he lent a substantial sum of money to Luzen and as long as he refrained from compelling Luzan to repay that sum, there was a continuing donation by him to Luzen of the interest on that loan.”
73
‘Shifting Foreign Income’ at 56.
Coetzee J in Joss v SIR75 referring to Berold’s case (supra) said
“one must be careful to distinguish between the disposition of the shares at a proper value and thereafter the loan to the company which is interest-free. Thus there are two dispositions and it is only the latter which is a disposition within the meaning of s 7(3) of the Act. It is also logically imperative to separate the interest-free loan from the transfer of the shares, to determine the causal connection between the receipt of the income and the disposition. This flows from the words ‘by reason of’ in the section.”
Income derived ‘by reason of or in consequence of’
Section 7(8) will come into operation if the income is derived ‘by reason of or in consequence of’ the ‘donation, settlement or other disposition’ made by that resident. The income does not have to accrue to the person to whom the interest free loan or donation is made because the crucial factor is whether the income accruing to the non-resident is ‘by reason of or in consequence of’ the interest-free loan or donation. In deciding whether income was received by reason of a donation the court in
Kohler v CIR76 found that
“Once income has (actually or by deeming) accrued to or been received by the minor, and has been capitalised, its subsequent earning or product is attributed not to the source from which the original income was derived but to the advantageous employment of the minor’s new capital. In this respect the ‘income upon income’ now in issue stands, as I see it, on the same footing as income derived by the minor from employment of other capital of his, borrowed, earned or bequeathed. I therefore consider that though the original donation may have been a
75
1980 (1) SA 674(T), 41 SATC 206 at 216.
causa sine qua non it was not the causa by reason of which the amounts now in issue came to the minors.”
In CIR v Widan77 Centlivres who delivered the judgement referred to Kohler’s case (supra) said
“ As I understand the learned Judge’s reasoning he came to the conclusion on the ground that the words ‘by reason of’ in section 9(3) should be interpreted as referring to the proximate and not the remote cause. He seems to have approved of the contention advanced on behalf of the taxpayer in that case that ‘ this causal connection between the donation and the accrual (or receipt) of this “income upon income” was interrupted by the introduction of a novus actus, viz, the reinvestment of the original income, and it was by reason of this reinvestment that such accrual (or receipt) occurred’…. There must be some causal relationship between the donation and the income in question. Difficult cases may conceivably arise. Where, for instance, a father donates a sum of money to a minor child and the child buys a business to which he contributes his skill and labour and from which he earns an income that income may be regarded as being attributable to two causes, viz, the donation and the skill and labour of the child. In such case it may be impossible to say which part of his income was the result of the donation and which part the result of his skill; and labour and it may be that the Commissioner would not be able to apply section 9(3).”
Referring to Widan’s case the judge in Berold’s78 case said
“…as in that case, so also in the present case the taxpayer’s donation was intended to have the result which was ultimately achieved, even though every step taken may not have been worked out beforehand; and the conclusion cannot be avoided that his donation was the
77CIR v Widan, 1955(1) SA 226(A), 19 SATC 341 at 350. 78 At 738.
efficient cause of the accumulation of income for the benefit of his children and that the dividend paid by Zenlu was therefore income accumulated by reason of that donation.”
Therefore if the donor makes an interest-free loan to a foreign trust that in turn makes an interest-free loan to a foreign company, whether the income accrues to the company and not the trust will not matter. If the income accrues ‘by reason of or in consequence of’ the interest-free loan it will be included in the resident’s income.
Disclosure
Residents are required to disclose in writing the fact that they made any donation, settlement or other disposition as contemplated in s 7 during any year of assessment when submitting their returns. (Section 7(10).)
CHAPTER 5
CONTROLLED FOREIGN COMPANIES
Introduction
An effective RBT system should draw into the tax net any income earned by resident owned foreign companies. Section 9D is an anti-avoidance provision of which the overall effect is to tax the Republic owners of foreign companies on the income derived by the companies by imputing the foreign income to the Republic residents. In the absence of anti-avoidance provisions residents could easily avoid tax by shifting their income to foreign companies often delaying repatriation for years or never repatriating funds at all.79
Foreign company is defined80 as:
‘ “foreign company” means any association, corporation, company, arrangement or scheme contemplated in paragraph (a), (b) or (e) of the definition of “company” in section 1, which is not a resident, or which is a resident but where that association, corporation, company, arrangement or scheme is as a result of the application of the provisions of any agreement entered into by the Republic for the avoidance of double taxation treated as not being a resident’
79
Jooste R ‘The Imputation of Income of Controlled Foreign Entities’ at 474.
The definition has been amended81 and now reads:
‘ “foreign company” means any association, corporation, company, arrangement or scheme contemplated in paragraph (a), (b) or (e) of the definition of “company” in section 1, which is not a resident;’
It is important to note that the foreign company must be a controlled foreign company (CFC) for the income to be imputed to the resident. Controlled foreign company is defined82 as:
‘ “controlled foreign company” means any foreign company where more than 50 per cent of the total participation rights in that foreign company are held by one or more residents whether directly or indirectly: Provided that a person who holds less than five per cent of the participation rights of a foreign company which is either a listed company or a scheme or arrangement contemplated in paragraph (e) (ii) of the definition of “company” in section 1, shall be deemed not to be a resident in determining whether residents directly or indirectly hold more than 50 per cent of the participation rights in—
(a) that foreign company; or
(b) any other foreign company in which that person indirectly holds any participation rights as a result of the interest in that listed company or scheme or arrangement,
81
Act 45 of 2003, to fall in line with the definition of a resident in the Exchange Control Amnesty and Amendment of Taxation Laws Act, 2003.
unless more than 50 per cent of the participation rights of that foreign company or other foreign company are held by persons who are connected persons83 in relation to
each other ’
For purposes of determining whether residents hold more than 50 per cent of the participation rights in a listed foreign company the residents holding less than 5 per cent are not taken into account, they are deemed not to be residents. However the proviso does not apply if they are connected persons.
Participation rights are defined84 as:
‘“participation rights” in relation to a foreign company means the right to participate directly or indirectly in the share capital, share premium, current or accumulated profits or services of that foreign company, whether or not of a capital nature.’
Amount of net income to be imputed
Section 9D(2) contains the rules for the attribution of the income of a CFC to a resident. A proportional amount of the net income85 of the CFC is included in the income of a qualifying resident that holds any participation rights in a CFC. The proportional amount is an amount that is in the same ratio as the percentage participation rights of the resident bears to the total participation rights.
83
Connected person is defined in s 1 of the Act.
84
Section 9D(1).
The resident is relieved from including any amount of the income of the CFC in his income if.
• the resident (together with any connected person) in aggregate holds less than 10
per cent of the participation rights on the dates specified below. (s 9D(2)(Proviso A)) This resident is required to include in his income any
foreign dividend86 accrued to him from the CFC. or
• the resident held participation rights indirectly through a company which is a
resident.(s 9D(2)(Proviso B)) Indirect holdings are ignored because the net income is imputed to the resident company that holds direct participation rights.
The determination of the proportional amount depends on when the participation rights are held during the foreign tax year.87
There are two situations when a resident qualifies for the income to be imputed, namely if the participation rights are held:
• On the last day of the foreign tax year of the CFC which ends during the
resident’s year of assessment and
(i) The foreign company was a CFC for the entire foreign tax year
An amount that is in the same ratio as the percentage participation rights
86 See Chapter 6. 87
Defined in s 9D as ‘in relation to a controlled foreign company means the year or period of reporting for foreign income tax purposes or, if that company is not subject to foreign income tax, the annual period of financial reporting by that company’
of the resident which bears to the total participation right on the last day of the foreign tax year. The following formula88 illustrates the determination of the proportional amount:
A = B/C x D where: A = the proportional amount
B = the resident’s percentage participation C = 100%
D = the net income of the CFC for the foreign tax year.
or
(ii) The foreign company became CFC during the foreign tax year The resident has an option to include
(aa) A = B x D x number of days that the company was a CFC C total number of days in the foreign tax year
or
(bb) A = B x D where: D= net income from the day the company became a CFC C
• Immediately before the foreign company ceased to be a CFC before the last day
of the foreign tax year during the resident’s year of assessment. The resident has an option to calculate the proportional amount as follows:
(i) A = B x D x number of days that the company was a CFC C total number of days in the foreign tax year
or
88
