In terms of the South African controlled foreign company ("CFC") legislation contained in section 9D of the Income Tax Act, 58 of 1962 (the "Act"), where South African residents directly or indirectly hold more than 50% of the total participation rights (essentially, the right to participate in the benefits of the rights attaching to a share) in a foreign company, a proportional amount of the “net income” of that foreign company (as a CFC) will be included in the income of those residents.
In determining the “net income” of the CFC, section 9D(9)(b) of the Act exempts, inter alia, any amount which is attributable to any foreign business establishment (“FBE”) of that CFC.
In this context, it is relevant to note that the presence of an FBE is only the first requirement in a two-step test, which must be met in order for a CFC to rely on the FBE exemption. Secondly, it must be determined whether the specific amount is attributable to the FBE of that CFC.
An FBE is defined in section 9D(1) of the Act, inter alia, as:
“a fixed place of business located in a country other than the Republic [of South Africa] that is used or will continue to be used for the carrying on of the business of that controlled foreign company for a period of not less than one year, where-
(i) that business is conducted through one or more offices, shops, factories, warehouses or other structures;
(ii) that fixed place of business is suitably staffed with on-site managerial and operational employees of that controlled foreign company who conduct the primary operations of that business;
(iii) that fixed place of business is suitably equipped for conducting the primary operations of that business;
(iv) that fixed place of business has suitable facilities for conducting the primary operations of that business; and
(v) that fixed place of business is located outside the Republic solely or mainly for a purpose other than the postponement or reduction of any tax imposed by any sphere of government in the Republic…”
In the modern globalised economy, many multi-national enterprises conduct more than one business from a single fixed place of business, or conduct various businesses from different locations, but these businesses are housed in one legal entity. The question that arises is: Can a CFC have more than one FBE, or can this exemption only be relied upon for one of the businesses that is conducted through the legal entity which constitutes a CFC?
It is common business practice (and has been recognised in a number of South African cases) that different businesses may be housed in one legal entity, for example, where one legal entity conducts business through separate divisions.
As set out above, an FBE is defined as a fixed place of business of that CFC, which is used for the carrying on of the business of that CFC, subject to certain further requirements pertaining to the employees, structures, equipment and facilities. Relevant in this regard, is how these further requirements are worded, referring to “that business” and the “primary operations of that business”.
By making use of the phrase “a fixed place of business”, which is then followed by the further requirements having reference to “that [fixed place of] business” and not the CFC, in our view, the legislature did not preclude the application of the FBE exemption to a CFC which has more than one fixed place of business and/or different businesses are carried on at a particular fixed place. The fact that the exemption may be relied upon in respect of more than one FBE is, in our view, further supported by the wording in section 9D(9), which provides that there must not be taken into account any amount that is attributable to any FBE of that CFC (and specifically not the FBE of that CFC).
Furthermore, it is clear that what needs to be considered in determining whether the FBE exemption applies to an amount received by a CFC is firstly, whether the business (as opposed to CFC) in respect of which a particular amount was received, complies with the requirements of an FBE.
Therefore, in establishing whether a CFC has an FBE, the relevant requirements should be considered in relation to each of the CFC’s businesses separately.
In our view, it is therefore possible for one of the CFC’s businesses to not meet the requirements for an FBE without “tainting” the other businesses of that CFC, which may still meet all the requirements of an FBE. Similarly, it may be possible for certain amounts received by a CFC to be attributable to its FBE and therefore qualify for the FBE exemption, while other amounts that are not attributable to the FBE does not qualify for the exemption and must thus be included in the “net income” of the CFC.