R'OOO R'OOO R'OOO R'OOO R' 000 R'OOO
CHAPTER 7 CONCLUSION
7.3 THE COMPLEXITY OF SECTION 9D
Section 9D was initially a complex section with numerous exemptions, resulting partly from the fact that when it was introduced in 1997, only passive income was attributable in
2 SandlerControlled Foreign Company Legislation(1996) (OECD) 97.
3 In the United States CFC legislation was introduced in 1962, in the United Kingdom in 1984 and in Australia in 1990 (Sandler op cit 21-25).
In a purely transactional-based approach, CFC legislation applies to a CFC wherever resident and as a result there is no definition of a target territory.
In a jurisdictional approach, the applicability ofCFC legislation is dependent on where the CFC is resident and carries on business as well as the type of income it derives.
6 In a purely transactional-based regime, all passive investment income and tainted base company income is attributed to the resident taxpayers, while active business income is excluded.
7 In an entity approach, also referred to as an 'all or nothing' approach, all of a CFC's income is attributed to resident
~ax~ayers,unless the CFC is exempt due to its jurisdiction of residence, or due to the amount of foreign tax paid on Its mcome, or due to certam exemptIons dependent on the nature of the CFC's predominant activities.
8 What constitutes successful legislation is a subjective issue, but issues such as the number of cases relating to CFC legislatIOn and whether the Courts were able to successfully defend the legislation in these cases, are factors that could assist in determining the success of the legislation.
tenns of section 9C9and not active income. With the introduction of a residence-based system of taxation effective from 1 January 2001, all income, passive and active, is now attributable to a resident. This has led to sections 9D (3), (4), (4A), (5), (7) and (8) being deleted by section 10 of Act No. 59 of 200010. This left only the sections necessary in order to administer effective controlled foreign company legislation in order to support such a residence-based taxation system.
However, section 9D still remains complex for numerous reasons. The enactment of CFC legislation in any country automatically poses two immediate problems: firstly, the issue of what constitutes a 'foreign company' and secondly, what defines the tenn 'control'. The latter issue results in severe complexities especially due to indirect holdings through multi- tier structured groups or holding just below the required minimum voting shares to effect control but nevertheless still maintaining control by such other means as, for example, a veto power against the majority vote, or being able to control the board of directors. This in turn poses a huge administrative burden on both taxpayers and administrative authorities in order to detennine if such 'control' really exists. Many major OECD1] countries have stringent and unnecessary complexities attached to their CFC legislation, summarised as follows:
a) having a minimum ownership requirement (i.e. only residents who hold greater than a certain percentage will be considered in determining control);12
b) concentrating control in a limited number of individuals; and
c) control can only be vested in a group of related individuals who are 'acting in concert'.
South Africa did not initially adopt any of the above requirements. However, the detennination of what constitutes a 'controlled foreign company' for the purposes of section 9D has been a point of debate since the introduction of the provision into the Act, particularly given that the wording as it stands appears to create a CFC in circumstances where South African residents jointly hold more than 50 percent of the participation rights, but are not acting in concert (for example, mere portfolio holders in foreign listed companies in which the shares happened to be more than 50 percent South African held).
~o Secti.on 9C was deleted by section 9 of the Act No. 59 of 2000 with effect from I January 200 I.
Section 10 of the Revenue Laws Amendment Act 59 of 2000 with effect from I January 200 I.
11 These include Australia, United Kingdom and Sweden.
12 South Africa does have a 5 percent minimum ownership requirement in order to determine control, but this is only applIcable to a lIsted company or a scheme or arrangement contemplated in paragraph (e)(ii) of the definition of 'company' in section I. Furthermore, a resident taxpayer needs to hold a minimum of 10 percent interest in a CFC in order for his portion of its income to be imputed to him in terms of section 9D (s 9D(2)(A)).
The first two requirements (a and b) are open to manipulation, in that these can be fairly easily avoided by concentrating ownership so as to not meet these requirements, but just narrowly avoid them.13
However, the third requirement (c) can be extremely difficult to enforce. It would be almost impossible for the revenue authorities to determine if a group of individuals are 'acting in concert'. As a result, and as discussed in detail in chapter 3 of this dissertation, the 'acting in concert' requirement appears not to be a requirement in terms of South African CFC legislation in order to determine control.
Section 9D as it stands in the Act is not free from uncertainties and ambiguity. As pointed out in this dissertation, there are areas which are fraught with uncertainty and ambiguity.
This is evident in the fact that the current definition of 'participation rights' in section 9D( I) no longer makes reference to the inclusion of 'voting rights'. It is therefore questionable whether 'participation rights' encompass all direct and indirect holdings in any form, thus preventing the system from being manipulated by holding fewer than the required number of shares or voting rights for control, but nevertheless maintaining control via some other indirect means, such as being able to control the majority of the board of directors. Italso appears from the definition of 'participation rights' that the legislation, in using the term 'indirectly' in section 9D(2), refers solely to the holding of shares through another company and not conditional holdings.
The other complexity with regard to section 9D and its requirements is the calculations involved in determining the amount to be imputed to a South African resident. The calculations raise concern when multi-tiered groups are involved and indirect holdings are brought into play. Other complexities include the holding of preference shares as opposed to ordinary shares and how this affects the amount of income to be distributed and the percentage proportion that this income needs to be distributed to the various residents.
13 For example, if the minimum ownership requirement is 10 percent, then control can be concentrated in individuals who individually hold a maximum of 9 percent thus avoiding this requirement. Similarly, if control must be
concentrated in a maximum offive individuals, then control can in tum be concentrated in six individuals once again
avoiding such a requirement. '
The legislation also appears to be open to manipulation as regards imputation in terms of the 10 percent minimum threshold rule.14 Imputation can thus be avoided by never holding more than 10 percent of the participation rights of a foreign company. More importantly, this 10 percent shareholding is determined at the end of the foreign company's tax year and is independent of any other holdings during the year. As a result this encourages disposals and re-acquisitions in the controlled foreign company around its year- end.
Another issue that surfaces with regard to calculations with respect to section 9D is that it is now no longer possible to dispose of any interest prior to the controlled foreign company's year-end and avoid tax in terms of section 9D. Inthis case imputation will still need to take place based either on the number of days that the CFC was a CFC for the year of assessment under consideration or the proportion of the income earned during that period that the CFC was a CFC to total income earned for the year of assessment under consideration.
This approach imposes tremendous difficulty on revenue authorities as well as taxpayers due to the fact that they do not have access to the books and records of the foreign company and the fact that the foreign company might not always be willing to disclose such information at various times during the year. This might prove especially true if the resident taxpayer wishes to calculate his tax liability in terms of section 9D based on the net income earned during the period the foreign company was a CFC and if monthly management accounts of the foreign company are not readily available to the resident or the Republic revenue authorities.
Such calculatio~s in terms of section 9D are also fraught with the various exemptions in terms of section 9D(9) and relief provisions in terms of section6quat.