Controlled Foreign Company

• Published date: 01 December 2021
• DOI: 10.10520/ejc-btclq_v12_n4_a3
• Author: Des Kruger Kruger,Nola Brown
• Pages: 9-17
• Date: 01 December 2021

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Controlled Foreign Company:

PARTICIPATION RIGHTS

DES KRUGER* • Nola BrowN†

ABSTRACT

A foreign company will constitute a controlled foreign company (CFC) if

more than 50% of the total ‘participation rights’ in that foreign company are

directly or indirectly held by a South African tax resident, or more than 50% of

the voting rights in that foreign company are directly or indirectly exercisable

by one or more persons that are South African tax residents. The CFC regime

is complex, and central to that complexity is the question of whether or not

a South African tax resident holds participation rights in a foreign company.

While the def‌inition of ‘participation rights’ may at f‌irst blush appear straight

forward, its interpretation is not that clear and is untested.

At present ‘participation rights’ are def‌ined as

‘(a) the right to participate in all or part of the benef‌its of the rights (other

than voting rights) attaching to a share, or any interest of a similar nature,

in that company; or

(b) in the case where no person has any right in that foreign company, or no

such rights can be determined for any person, the right to exercise any

voting rights in that company’.

This article considers the test one needs to apply to determine the value of

the participation rights that a resident may hold in a foreign company under

paragraph (a) of the def‌inition of ‘participation rights’, and does not address

paragraph (b) of the def‌inition that relates to voting rights.

The authors note that the right to participate in all or part of the benef‌its of

the rights (other than voting rights) attaching to a share includes both the right

to the capital of the company (capital participation rights) as well as the right

to the income of the company (income participation rights), and both those

rights must be taken into account in the determination of the resident’s partici-

pation rights relative to the total participation rights in the foreign company.

The article submits that there are two ways in which to make the neces-

sary participation rights determination. Firstly. the so-called net percentage

approach, which aggregates the resident’s percentage income participation

rights and the percentage capital participation rights, and then divides it by

2. This approach, however, gives equal weight to the two participation rights,

while the relative value of those rights may in fact provide a very different

result. Thus, for example, a resident’s income participation rights of 10% in

respect of accumulated and current earnings of R100, should not carry the

same weight as 40% capital participation rights in respect of the capital of

the company amounting to R500000. Should this percentage approach be

adopted, the resident’s participation rights would amount to 25%, that is 10%

income participation rights plus 40% capital participation rights divided be 2.

* Consultant, Webber Wentzel.

† Associate Director, Webber Wentzel.