What is a Controlled Foreign Company (CFC)?
Under ITA88, a CFC is defined as a foreign company in which South African residents directly or indirectly hold more than 50% of the participation or voting rights. This threshold is crucial because it determines when South African tax authorities will look beyond the offshore entity and attribute its income to the resident shareholders. The definition excludes trusts and partnerships, focusing solely on foreign companies. Understanding whether a foreign entity qualifies as a CFC is the first step in complying with Section 9D and avoiding unexpected tax liabilities.
Attribution of Net Income to South African Residents
One of the cornerstone principles of Section 9D of ITA88 is the attribution of net income from a CFC to its South African resident shareholders. The net income of the CFC is effectively ‘deemed’ to be earned by the South African residents in proportion to their participation rights. For example, if a resident owns 20% of a CFC that generates a net income of R1 million, R200,000 will be included in that resident’s taxable income in South Africa. This mechanism prevents deferral of tax by holding income offshore and aligns with international efforts to combat Base Erosion and Profit Shifting (BEPS).
Exemptions from Attribution: Reliefs under ITA88
While the attribution rule is broad, Section 9D provides important exemptions designed to avoid double taxation and encourage genuine offshore business activities. The two main exemptions are the Foreign Business Establishment (FBE) and the High-Tax Exemption.
Foreign Business Establishment (FBE)
The FBE exemption applies when a CFC operates a foreign business through a permanent establishment abroad. To qualify, the CFC must maintain a fixed place of business that is staffed, equipped, and actively involved in the company’s core operations for at least one year. Recent clarifications and rulings, including the significant Coronation CC decision in June 2024, have provided clearer guidelines on what constitutes substantive operations. Outsourcing ancillary functions abroad may still allow for the FBE exemption if the main business activities and decision-making remain firmly situated in the foreign establishment. This exemption is vital as it recognises the genuine economic substance of offshore businesses and prevents double taxation on active trading profits.
High-Tax Exemption
South African tax legislation also allows for a high-tax exemption under ITA88, where if the CFC is subject to foreign tax at a rate of at least 75% of the South African corporate tax rate (which is 28%), income attribution may be avoided. Practically, if the foreign jurisdiction taxes the CFC at 21% or more, South African tax on that income is generally not applied. This exemption helps prevent double taxation and aligns with the government’s commitment to fostering cross-border investments without undue tax burdens.
Look-Through Rule for Passive Income
Section 9D distinguishes between active and passive income, with a particular focus on passive income such as interest, royalties, and rental income. Even where an FBE exists, passive income may still be attributed to South African residents unless it can be demonstrated that such income forms part of the active business operations. There is a de-minimis rule where passive income below 5% of total receipts may be disregarded, but otherwise, taxpayers must carefully document the nature of their income to avoid unnecessary tax exposure.
Currency Translation Rules and Tax Calculation
Because CFCs operate in foreign currencies, ITA88 requires all income to be translated into South African rand (ZAR) using specific exchange rate guidelines. Section 24I of ITA88 outlines how SARS expects taxpayers to handle currency conversions for tax reporting purposes. These rules are significant because fluctuations in exchange rates can impact the timing and amount of taxable income, potentially leading to unintended tax consequences.
Anti-Avoidance and Transfer Pricing Interactions
South African Revenue Service (SARS) closely monitors arrangements designed to artificially shift income to low-tax foreign jurisdictions through CFCs. Section 9D operates alongside transfer pricing legislation to counteract profit shifting and abusive tax planning. Post-Coronation CC ruling, SARS has increased scrutiny on outsourced functions and the substance of foreign operations to ensure taxpayers are not exploiting loopholes to claim FBE exemptions improperly. This emphasises the importance of maintaining genuine substance and robust documentation in foreign business activities.
Disclosure Obligations under ITA88
Transparency is a fundamental element of Section 9D compliance. Resident companies or individuals holding interests in CFCs with a minimum of 10% participation must file detailed disclosures using the IT10B form. This includes information about ownership structures, financials of the CFC, exemptions claimed, and foreign tax paid. Timely and accurate disclosure not only supports compliance but also reduces the risk of SARS audits or penalties.
Interaction with Double Tax Agreements (DTAs)
South Africa has entered into numerous DTAs that may limit the application of Section 9D in certain circumstances. For instance, if a CFC has a permanent establishment (PE) in a foreign country covered by a DTA, income earned through that PE may be taxed offshore, reducing or eliminating South African tax on that income. The interplay between Section 9D and DTAs requires careful planning to ensure proper application of reliefs and avoid double taxation or non-taxation.
Why Understanding ITA88 Section 9D Matters
The CFC rules under Section 9D of ITA88 are more than just tax technicalities—they are essential safeguards ensuring South African taxpayers meet their global tax obligations. As SARS intensifies enforcement and scrutiny, non-compliance or misunderstandings of this complex regime can result in significant penalties, interest charges, and reputational damage. For businesses and investors, mastering Section 9D not only mitigates tax risk but also optimises tax planning in line with global standards.
How DCM Corporate Can Help You Navigate Section 9D
Navigating the complexities of ITA88, particularly Section 9D, requires expert guidance. At DCM Corporate, we understand the intricacies of South Africa’s CFC rules and how to apply exemptions effectively while ensuring compliance. Whether you need assistance with identifying CFCs, applying the FBE exemption, managing currency translation issues, or preparing the necessary disclosures, our team is here to support you every step of the way. Reach out to us to safeguard your international tax position and maintain peace of mind in your cross-border operations.