Two new changes have been proposed in the draft Taxation Laws Amendment Bill, 2012 (Bill) in relation to the definition of the term ‘resident’ in section 1 of the Income Tax Act, No 58 of 1962 (‘the Act’). The changes are aimed at, amongst others, facilitating the Government’s initiative to establish South Africa as the gateway into Africa by eliminating the potential triggering of a dual residence status for a foreign operating subsidiary and thus, triggering potential double taxation of that entity and allowing South African based fund managers of foreign investment funds to operate competitively in the international investment business.

The first change is directed at excluding from the definition of the term “resident”, active controlled foreign companies (‘CFCs’) in high-tax jurisdictions that are effectively managed in South Africa. The second change is directed at providing relief to foreign investment funds which are effectively managed in South Africa. In both cases, certain caveats are proposed in relation to the “place of effective management” test in the definition of the term “resident”.

relief for CFCs in high tax jurisdictions

A foreign incorporated company may find itself having a dual residence status in cases where it is effectively managed from South Africa but incorporated in a foreign jurisdiction. The foreign company may be subject to double taxation and in some cases the corporate tax payable in the foreign jurisdiction may be higher than in South Africa resulting in little or no additional revenue for the South African fiscus when foreign tax rebates are applied. To eliminate the potential double residency risk, the Bill proposes eliminating the “place of effective management” test in the definition of “resident” where a company -

  • is incorporated, established or formed in a foreign country;
  • has a “foreign business establishment” as defined in section 9D(1);
  • has its place of effective management in South Africa;
  • would, but for the company having its place of effective management in South Africa, be a controlled foreign company; and
  • the aggregate of all tax payable by the company to a government of any foreign country, in respect of any tax year is at least 75% of the amount of normal tax that would have been payable by that company, if it had been a resident of South Africa.

The effect of this proposed change is that foreign companies which meet the abovementioned requirements need not concern themselves with questions as to whether the South African management activities will trigger a basis for taxation in South Africa based on residency. The proposed effective date for this change is 1 January 2013 and it will apply in respect of years of assessment commencing on or after that date.

South African fund manager of foreign investment funds

Foreign investors are attracted by South Africa’s sophisticated financial services industry and therefore sometimes utilise South African based fund managers to manage their Africa region investment funds. The downside of having an active South African based fund manager actively managing foreign investments into Africa is that the activities of the fund manager could potentially result in the foreign fund being regarded as a tax resident of South Africa on the basis of the “place of effective management” test. This risk generally results in South African fund managers being given limited mandates in relation to making decisions on portfolio investments.

The second proposed change to the definition of the term “resident” is aimed at removing the potential risk of foreign investment funds falling within the South African tax net when they engage a South African based fund manager.

In order to qualify under the carve-out from the place of effective management test, the foreign investment fund must be an entity other than an individual -

  • that is not incorporated, established or formed in South Africa;
  • that carries on the business of an investment scheme similar to that of a portfolio of a collective investment scheme;
  • the business of which is carried on outside South Africa;
  • the assets of which consist of solely one of more of, inter alia, amounts in cash or that constitute cash equivalents; financial instruments issued by a listed company or by the Government of South Africa; and financial instruments the value of which are determined with reference to financial instruments issued by a listed company;
  • where no more than 10% of the shares or other form of participatory interest in that entity are directly or indirectly held by South African residents; and
  • that has no employees and no directors or trustees that are engaged in the management of that company or trust on a full-time basis.

To the extent that these requirements are met, the place of effective management test will not take into account services provided by a foreign investment fund that qualifies as a licensed “financial services provider” under the Financial Advisory and Intermediary Services Act, 2002 (‘FAIS’). Activities that will be disregarded include the provision of financial product advice, intermediary services and incidental activities thereto in terms of FAIS.

This is a welcome amendment which will allow South African fund managers to actively and competitively take part in the international investment fund business and this accords with the Government’s initiative to strategically place South Africa as the gateway into Africa.

The proposed effective date for this change is 1 January 2013 and it will apply in respect of years of assessment commencing on or after that date.