International Tax
1786. Controlled foreign companies
November 2009 - Issue 123



In general, South African residents are required to impute into their net income an amount equal to the net income derived by controlled foreign companies (CFCs), if South African residents collectively hold more than 50% of the participation rights in the CFC. The concept of participation rights is defined with reference to the right to participate directly or indirectly in the share capital, share premium, current or accumulated profits or reserves of the CFC. Where it is not possible to determine these rights, the question of whether the foreign company constitutes a CFC is determined with reference to the right to exercise voting rights in the foreign company.


A number of exemptions apply in circumstances where a resident does not need to impute the CFC’s income in its own income for tax purposes. The first of these is whether the CFC has a so-called foreign business establishment in the foreign country. This definition has been amended to ensure that the foreign business establishment relied upon is economically meaningful. Four components must be present before this foreign business establishment exists - three relating to the nature of the business and the fourth relating to purpose. These components are as follows:

·      the business must have structure and thus be conducted through means of an office, shop or similar structure;

·      the business location must be suitably staffed with managerial and operational employees who conduct the primary operations of the business;

·      the place of business must be suitably equipped with reference to equipment and facilities; and

·      the sole or main purpose of the business must be that a fixed place of business is located in the country concerned.


From a practical perspective, a fixed place of business exists to the extent that the management of various businesses within a specific country is centralised. In other words, structures and employees can be taken into account if: 50% of

·      the components are located in the same country and are associated with the business that is conducted;

·      the other CFCs must be incorporated in the same country as the fixed place of business; and

·      the other CFC must form part of the same group of companies (i.e., an effective 70% shareholding).


Significantly, a South African resident does not need to impute the net income of the CFC to the extent that the CFC is located in a so called high-tax jurisdiction. A similar exemption existed previously, but was repealed due to perceived abuse. In terms of the new amendments, the argument is that the net income of a CFC will be deemed to be zero to the extent that the following requirements are met:

·      the CFC must be subject to a tax rate of at least 75% of the normal tax that the CFC would have paid had it been a resident. At the current corporate rate of 28%, this is 21%;

·      the net income of the CFC must be subject to a global level of foreign tax of at least 75% of the amount of tax that would have been imposed had the CFC been taxable in South Africa; and

·      the CFC must be subject to tax by the relevant government in the country in which it is incorporated.


The introduction of the exemption relating to high-tax jurisdictions will not necessarily assist South African taxpayers in circumstances where the foreign tax rate exceeds the South African corporate tax rate of 28%. In other words, the fact that the net income of the CFC need not be taken into account may result in there being no entitlement to use tax credits in determining the CFC’s income. In addition, the way in which the CFC’s income is taxed is more often than not quite different from the position that currently exists in South Africa.


Cliffe Dekker Hofmeyr


IT Act:S 9D