4.7.1 The distribution exemption
The United Kingdom is the only country to have adopted the distribution exemption.126 Under the distribution exemption, all income of a controlled foreign company is exempt
Brincker, Honiball and OlivierInternational Tax: A South African Comparison (2003) 187.
124 This amendment was effective from I October 200 I and applies to the disposal of any interest or dividend received or accrued on or after that date.
National Treasury'sDetailed Explanation to Section 9D ofthe Tax Act (June 2002) 24. Also see Brincker, Honiball and OlivierInternational Tax: A South African Perspective (2003) 187.
SandlerControlled Foreign Company Legislation (1996) (OECD) 68. The United States did have a distribution exemption until 1975 when it was repealed due to its complexity and susceptibility to manipulation (see Arnold The Taxation of Controlled Foreign Corporations: An International Comparison (1986) 484). Indonesia provides a similar exemption in that it requires no attribution where a CFC has distributed its after-tax profits in the form of dividends to domestic shareholders within four months after the end of its tax year, where the company is obligated to file a tax return, or within seven months after the end of its tax year, where the company is not obligated to file a tax return. (Sandler Tax Treaties and Controlled Foreign Company Legislation 2nd ed (1998) 241). It may be argued that the above does not in essence constitute a distribution exemption, but is actually a relief for double taxation that would otherwise result.
from attribution provided that the company pursues an acceptable distribution policy.127 The theory underlying the distribution exemption is that it encourages repatriation of foreign-earned profits to domestic shareholders, as domestic-earned profits would be. A company is able to shelter a certain percentage of its profits, rather than having all foreign earned profits attributable. In the case of the United Kingdom, 10 percent deferral is allowed, merely by the fact that 90 percent of profits must be distributed within 18 months.128
The exemption also ensures that CFC rules do not apply where domestic tax is not being avoided through the use of tax haven companies.129 The Katz Commission13o recommended against the adoption of the distribution exemption in South Africa on the grounds that dividends were (at the time the commission considered the matter) exempt from tax in South Africa anyway. Since 23 February 2000 foreign dividends are taxable in terms of section 9E of the Income Tax ACt.131
There were two major reasons why the distribution exemption was not adopted in South Africa:
a) fustly, the exemption is more compatible with entity-based countries where the requisite distribution percentage is determined by taking into account the dividends of a CFC, whether declared out of active income or passive income. On the contrary, South Africa's CFC legislation (at the time considered by the Katz Commission) was essentially transaction-based and only targeted passive income of a CFE for attribution.132Therefore, the exemption of all income on the basis of distribution of a certain minimum percentage of that income would permit the entity to shelter a portion of its attributable investment income,133 and
127
128
129
130 131
132
133
A certain percentage of the company's income must be distributed to domestic shareholders by way of dividends within a prescribed period of time. Under the United Kingdom's legislation, the CFE rules do not apply if a controlled foreign company distributes at least 90 percent of its taxable profits (determined according to UK tax rules) as dividends within 18 months after the end of its tax year. (Section 748(1 )(a) read with Part I, Schedule 25, of the Income and Corporations Taxes Act 1988 (UK)).
SandlerControlled Foreign Company Legislation (1996) (OECD) 68. Also see Macheli A Critical Legal Analysis o/the Regime/or the Taxation o/Controlled Foreign Entities in Terms o/Section 9D o/the Income Tax Act No. 58 0/1962 (Unpublished PhD dissertation, University of Natal, Pietermaritzburg) (2000) 302.
Hustler Tax Haven Use and Control: A Study 0/Tax Haven Use by Australian Public Companies And The Development o/Controlled Foreign Company Legislation in Australia (1994) 286.
Fifth Interim Report para 8.3.1.8.
Section 9E as amended by section 20 of the Taxation Laws Amendment Act 30 of2000 with effect from 23 February 2000.
Even though both active and passive income is currently targeted in South Africa, the second reason (b) provided above, of the exemption being open to manipulation, outweighs the first reason (a), and hence this exemption will still not be considered for adoption in South Africa.
AmoldThe Taxation0/Controlled Foreign Corporations: An International Comparison (1986) 484-488.
b) secondly, the exemption is open to manipulation. Itrequires complex legislation and anti- avoidance rules to make it effective.134 This provides for additional administrative burden on the South African Revenue Services (SARS), and accordingly was rejected by the Katz Commission.
4.7.2 de minimis exemption
A de minimis exemption is an exemption which exempts income earned from a CFC being taxed in the resident country, provided that such income does not exceed certain limitations.135 There are two approaches to the de minimis exemption, and a country can adopt either one.136 The two approaches are:
• a' cap'137 by way of a stipulated minimum amount designated in the local currency; and
• a 'percentagede minimis' approach being percentage foreign sourced income earned from a CFC in relation to total income of the resident shareholder.138
In South Africa, a percentage de minimis exemption was introduced with effect from 23 February 2000 in terms of section 9E(7)(a) which exempted foreign dividends from tax:
• which was declared or deemed to have been declared by a resident South African company
• that derived 75 percent or more of its total receipts or accruals
• during the shorter of the entire period of its existence or each of the three years of assessment preceding the year of assessment during which the dividend is declared or deemed to have been declared from a source within or deemed to be within the Republic, and
• where these receipts and accruals were taxed in the Republic.
The above exemption was deleted by Act 59 of 2000.139 The rationale for the deletion of this exemption was, at the time this legislation was enacted, that the definition of 'foreign
134
135 136 137
138
139
SandlerControlled Foreign Company Legislation(1996) (OECD) 68 and MacheliA Critical Legal Analysis ofthe Regime for the Taxation of Controlled Foreign Entities in Terms of Section 9D of the Income Tax Act No. 58of 1962 (Unpublished PhD dissertation, University of Natal, Pietermaritzburg) (2000) 304. This exemption was abolished in the United States of America in 1975 (Martin and Wilson 'Comparative Analysis of Systems of Domestic Taxation of Controlled Foreign Corporations' (1981) 14 Vanderbilt Journal of Transnational Law131), largely on account of its complexity and susceptibility to manipulation. Accordingly, none of the countries considered in this dissertation has followed the UK example and adopted the exemption.
SandlerTax Treaties and Controlled Foreign Company Legislation2nded (1998) 75.
Ibid.
A 'cap' or 'ceiling' in this case which income earned from a CFC is not allowed to exceed in order for this exemption to apply.
Australia, Germany and the United States use a percentage'de minimis'exemption. (Sandler Controlled Foreign Company Legislation (1996) (OECD) 75).
Deleted by s 11 (1 )(g) of Act No. 59 of 2000 with effect from years of assessment commencing on or after 1 January 2001.
dividend' included any dividend which was distributed by a company from a source outside the Republic which was not deemed to be from a source within the Republic, or which was deemed to be from a source within the Republic, which had not been subject to tax in the Republic. This effectively meant that it was possible for a South African company to declare a foreign dividend. 14o Subsequently141 the definition of foreign dividend was amended to only include dividends declared by non-resident companies, as dividends declared from profits which were already taxed in the Republic will be exempt. 142 The amended definition of foreign dividend, however, includes a dividend distributed by a resident company from profits derived by such company before it became a resident. 143
The exemptions that were contained in section 9E(7)(a) were therefore no longer necessary, as it was now not possible for resident companies to declare foreign dividends. According to Sandler, 144 the only justification for a de minimis exemption is one of administrative convenience and simplicity, although it does sanction the avoidance of domestic tax to the extent of the exempt amount.
140 fi h
141 Re er to t e Explanatory Memorandum on the Revenue Laws Amendment Bill of2000 17..
Section 11 (I) of the Revenue Laws Amendment Act 59 of 2000 with effect from years of assessment commencing on or after I January 200I.
142 Section 9E( 1)(a).
143 Section 9E(1 )(a).
144 Sandler Controlled Foreign Company Legislation (1996) (OECD) 76.
CHAPTERS
RELIEF PROVISIONS OF INCOME TO BE ATTRIBUTED TO A RESIDENT TAXPAYER IN TERMS OF SECTION 9D
5.1 INTRODUCTION 99
5.2 FOREIGN TAXES PAID 101