Curbing the Use of Foreign Trusts to Bypass Controlled Foreign Company Rules: A Critical View of Recent Taxation Amendments

JurisdictionSouth Africa
Published date26 January 2021
Pages505-
Date26 January 2021
Citation(2020) 31 Stell LR 505
AuthorRudd, R.
505
CURBING THE USE OF FOREIGN TRUSTS TO
BYPASS CONTROLLED FOREIGN COMPANY
RULES: A CRITICAL VIEW OF RECENT
TAXATION AMENDMENTS
Reinhard Rudd
B Com (Hons) M Com CA (SA)
Senior Lecturer, School of Accountancy, University of the Witwatersrand
Abstract
The legislature set out to close the gap in the tax treatment of schemes
where a foreign trust is interposed between a South African resident and a
foreign company. With regards to South Afr ican resident companies, this was
done by ame nding the denition of a Controlled Foreign Company (“CFC”)
to include any company of which the nanc ial result s would be included in the
consolidated nancial statements of the resident company in term s of IFRS 10.
As far as resident natural persons are concerned, after failing to include
such companies in the denit ion of a CFC, a mendments were made to the
provisions relating to the ta xation of trusts. In thi s regard, section 7(8)(aA)
and section 25B(2B) of the Income Tax Act were introduced, both of which
require the foreign dividend e xemption in terms of section 10B(2)(a) to be
ignored when determining whe ther an amount would have constitute d income
had the relevant person bee n a resident.
In this article, a number of concerns regarding these amendments are
discussed. First, consideration is given a s to whether the amendments to
section 7(8) were needed at all considering cour t decisions regarding the
interpretation of the provi sions of section 7. Next, consideration is g iven to
whether the deemed net income inclusion which would result from determining
the income of the foreign tru st as if it were a resident could tr igger the
attribution r ule in terms of section 7(8). The question is also raised why
the legislature only require d section 10B(2)(a) to be ignored in determining
whether an amount would ha ve constituted income had the person been a
resident and not also section 10B(2)(c). Lastly, consideration is given to
whether the amount included in the income of a beneciar y of a foreig n trust
in terms of section 25B(2A) retains its nature as income or wheth er it becomes
capital in nature, which would re sult in excessively harsh t reatment of the
amount in the hands of the re sident beneciary.
Keyword s: controlled foreign company, trust, income ta x
(2020) 31 Stell LR 505
© Juta and Company (Pty) Ltd
1 Introduction
Governments across t he world increasingly face the th reat of tax base
erosion through prot shifting as a result of taxpayers’ attempts to eliminate
taxes by exploiting gaps in the inter action of domestic tax systems.1 This
is due, in part, to t he fact that intern ational tax rules , many of which were
designed more than a cent ury ago, have not kept pace with the high levels of
integration of national econom ie s and markets in the modern world.2
One of the methods used by govern ments to curb t he shifting of prots
to avoid tax is the implementation of Controlled Foreign Company (“CFC”)
rules.3 Ma ny jurisdictions apply CFC rules i n order to prevent a taxpayer
who holds a controlling interest i n a foreign company from eroding t he local
tax base by shift ing income to that company.4 In South Africa, the CFC rules
are contained in se ction 9D of the I ncome Tax Act 58 of 1962 (the “Act”).
In 2017, National Treasur y expressed concern over the use of foreign trust s
by taxpayers to circumvent the CFC r ules, as foreign companies ow ned by
foreign trusts fell outside of the scope of the r ules at the time. Str uctures
that utilised foreign tr usts therefore allowed taxpayers to shift prots to other
jurisdictions and e scape the South African tax net.5
In response to thi s concern, amendme nts were made to section 9D in 2017
to bring foreign subsidiar ies of South African resident compa nies which are
owned through foreign t rusts within the scope of the CFC rules.6
Additional amendments to t he CFC provisions, which were aimed at
natural per sons who make use of similar str uctures, were s uggested in 2017
but were ultimately scrapped af ter concerns were r aised by stakeholders that
the provisions were punitive and cast thei r nets too wide.7 The amendments
made in 2017, the refore, s olved the p roble m relating to South African resident
companies, but left the mat ter of natural persons who make use of similar t ax
structu res unresolved.
In the 2018 legislative cycle, an entirely different approach was followed for
bringing the t reatment of natural persons in l ine with that of companies.8 This
time, the amendment s were made to the provisions relating to the t axation
of trusts, rat her than to those relating t o CFCs.9 In this way, Treasury has
now, through targeted measu res outside of section 9D, addressed schemes
it had for years wanted to att ack under the CFC rules. Even though t he 2018
1 OECD Addressin g Base Erosion and Prof it Shifting (2013) 13
2 OECD Designing E ffective Contro lled Foreign Company Ru les, Action 3 – 2015 Final Report (2 015) 3
3 11
4 11
5 National Treasu ry “Explana tory Memora ndum on the Taxation L aws Amendment Bi ll 2017” (15-12-2017)
SARS 75 sars gov za/AllDocs/ LegalDoclib/ExplMemo/LA PD-LPrep-EM-2017-01%20
-%20Explanatory%20Memorandum%20on%20t he%202017%20Ta xation%20Laws%20
Amendment%20Bill%2015%20December%202017pd f> (accessed 18-11-2020)
6 75
7 National Treasu ry “Explanat ory Memorand um on the Taxation Laws A mendment Bill 2 018” (17- 01-2019)
SARS 38 rs gov za/AllDocs/LegalDo clib/ExplMemo/LAPD-LPrep -EM-2018-02%20
-%20Explanatory%20Memorandum%20on%20t he%202018%20TLAB%20-%2017%20Ja nuary%20
2019pdf > (accessed 18-11-2020)
8 38
9 38
506 STELL LR 2020 3
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