Proposed simplification of foreign business establishment exemption for controlled foreign companies

In terms of s9D of the Income Tax Act, No 58 of 1962 (Act), a South African tax resident can be taxed on the ‘net income’ of its controlled foreign companies (CFC). However, various exemptions exist in this regard.

For example, in terms of the second proviso to the definition of ‘net income’ in s9D(2A) of the Act, the net income of a CFC will be deemed to be nil if the taxes payable by that CFC in foreign jurisdictions are at least equal to 75% of the tax that the CFC would have paid had it been a South African tax resident. This is often referred to as the high-tax exemption. In performing the calculation regard must be had to any international treaties for the avoidance of double taxation, and tax credits or rebates.

Further exemptions are contained in s9D(9) of the Act, which effectively excludes certain amounts from being taken into account when determining a CFC’s net income. The most notable exemption is the so-called foreign business establishment exemption, which excludes amounts attributable to any foreign business establishment that a CFC has from the net income calculation.

When performing the calculation for the net income of a CFC, it should first be determined whether the high-tax exemption applies and deems the net income of the CFC to be zero, before potentially proceeding with disregarding the relevant amounts excluded in terms of s9D(9) of the Act from net income. Testing for whether the high-tax exemption applies can however be quite onerous, especially when a resident has multiple CFCs and the income in respect of those CFCs are in any event attributable to foreign business establishments.

In terms of the draft Taxation Laws Amendment Bill 2014 (Bill) that was released earlier this year, it is proposed to simplify the process where the foreign business establishment exemption applies to all the income of the relevant CFC. The Bill proposes that, similar to the high-tax exemption, the net income of a CFC also be deemed to be zero where ‘all the receipts and accruals’ of the CFC is attributable to a foreign business establishment.

The effect of the proposal is that it becomes unnecessary for a resident to first determine the hypothetical tax position of each of its CFCs and to only thereafter apply the foreign business establishment exemption if the high-tax exemption does not apply. Where all of a CFC’s receipts and accruals are attributable to a foreign business establishment, the net income of the CFC will automatically be deemed to be zero and it would not be necessary to do any calculations in respect of the high-tax exemption.

This is a welcomed amendment to s9D of the Act.