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Extending the application of CFC Legislation to foreign companies held by foreign trusts and foundations

Extending the application of CFC Legislation to foreign companies held by foreign trusts and foundations

27 Mar 2018

South African legislation has for many years contained anti-avoidance provisions in the form of controlled foreign company (CFC) rules which effectively taxes South African residents on their percentage of income of a CFC. A CFC is defined as any foreign company where more than 50% of the participation rights (equity and voting rights) are held by one or more South African residents.

However prior to the change detailed below, foreign companies which are held by foreign discretionary trusts or foundations did not fall into these CFC provisions resulting in the income of such foreign companies remaining outside of the SA tax net but still be included in consolidated financial statements for accounting reporting purposes in terms of International Financial Reporting Standards (IFRS) 10.

In terms of the G20/OECD base erosion and profit shifting (BEPS) report, Action 3 it was recommended that the scope of CFC rules be extended to include foreign companies that are consolidated into the accounts of a resident company in terms of IFRS.

In order to affect this change, the definition of CFC has been extended to include any foreign company that is consolidated in the financial statements of a South African resident company in terms of IFRS 10 and an additional proviso was inserted to allow for an inclusion of net income equal to the proportion of profits of the foreign company that is included for the purposes of the consolidated financial statements.

This will result in the net profit of that foreign company being included in the South African resident company’s taxable income in proportion with the percentage of participation rights held in that company.

This change is demonstrated in these 2 examples as contained in the Explanatory Memorandum to the Amendment Act.

Example 1:

SA Parent Co A owns all the shares in Foreign Co C via a foreign trust B. SA Parent Co A includes in its consolidated financial statements the assets, liabilities, income, expenses and cash flows of foreign trust B and Foreign Co C effectively presenting the 3 entities as a single economic entity.

Example 2:

SA Parent Co D owns 40 per cent of the shares in Foreign Co F via a foreign trust E. Although, SA Parent Co D has an indirect interest of 40 per cent in Foreign Co F, it controls Foreign Co F. In terms of IFRS 10, a company that controls another is required to present consolidated financial statements. Therefore, SA Parent Co D includes in its consolidated financial statements a net percentage of 40 per cent of the financial results of Foreign Co F determined after subtracting the non-controlling interest that is equal to 60 per cent.

This change is effective for years of assessment commencing 1 January 2018.

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