International Tax
1730. Residence of a company for tax purposes?
May 2009 – Issue 117

In a state (such as South Africa) whose tax system is residence-based, in other words, which imposes tax on all persons "resident" in that state, the question of where a particular taxpayer "resides" is of fundamental importance in determining tax liability.

This principle also applies where the taxpayer is a company, for the law has long taken the view that a company, no less than an individual, can have a place of residence, despite the fact that a company has no physical existence and is a mere legal abstraction.

English law used to regard a company as being resident in the country where its "central management and control" is exercised, which meant, where its board of directors meets and takes top-level decisions regarding the affairs of the company.

According to this criterion, where the company carries on its day-to-day trading activities, or where lower-level managerial decisions are taken, is irrelevant in determining its country of residence.

The problem with this criterion, as a determinant of residence for tax purposes, was that it was an easy matter for the board of directors of a company to arrange to hold their meetings in some congenial and low-taxed country. The criterion of "central management and control" was therefore wide open to manipulation – at least once international air travel became quick and easy in the middle of the 20th century.

The country where a company’s "effective management" is located

For this and other reasons, many countries jettisoned "central management and control" as the criterion that determined a company’s country of residence for tax purposes, and instead adopted the rule that a company resides in the country where its "effective management" is exercised.

Thus, South Africa’s Income Tax Act provides that, if a company is "incorporated, established or formed in the Republic", then it is permanently and immutably resident in (and all its income is therefore taxable in) this country, even if it thereafter severs all links with the Republic.

The Act goes on to say that if a company is not incorporated, established or formed in the Republic, then it will be resident in the Republic if its "place of effective management" is in the Republic.

But what is meant by "effective management" in this context?

It is clear that "effective management" is not synonymous with the control exercised by shareholders vis-à-vis the affairs of the company via resolutions taken at a general meeting of shareholders.

In Interpretation Note No. 6, SARS has given its view on the interpretation of the concept of "place of effective management".

The interpretation note draws a distinction between "the place where central management and control is carried out by a board of directors" and "the place where executive directors or senior managers execute and implement day-to-day/regular/operational management and business activities".

The interpretation note then goes on to say that (emphasis added) – ‘The place of effective management is the place where the company is managed on a regular or day-to-day basis by the directors or senior managers of the company, irrespective of where the overriding control is exercised or where the board of directors meets. Management by these directors or senior managers refers to the execution and implementation of policy and strategic decisions made by the board of directors. It can also be referred to as the place of implementation of the entity’s overall group vision and objectives.’

Taken as a whole, what the Interpretation Note seems to say, albeit in an unnecessarily long-winded way, is that a company’s "effective management" is located, not where managerial decisions are "taken", but where they are "actually implemented".

A different interpretation of "effective management" in the United Kingdom

The interpretation of "effective management" by SARS deviates from the interpretation adopted in the United Kingdom and the European Union. In the case of Trevor Smallwood and Mary Caroline Smallwood, Trustees of The Trevor Smallwood Trust v HM Revenue and Customs [2008] UKSPC 669, there was argument in court as to the difference, in the context of a company, between "central management and control" (CMC) and "place of effective management" (POEM).

The Special Commissioners leaned toward the view that, although these two criteria are used in different contexts, there is no essential difference between them.

The Commissioners then referred to the OECD Commentary, and observed that –

"Currently the Commentary, in an amendment made in 2000, says:

‘The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity’s business are in substance made. The place of effective management will ordinarily be the place where the most senior person or group of persons (for example a board of directors) makes its decisions, the place where the actions to be taken by the entity as a whole are determined ...’

We see no reason why this approach should not be adopted ...."

Conflict between these two interpretations

Therefore, the UK courts and the OECD Commentary take the view that a company’s "effective management" is located in the country where key management decisions are taken, whereas SARS takes the view that "effective management" is located where the decisions are implemented.

This is of course a fundamental divergence of view, which considerably complicates tax planning for companies whose business crosses international borders.


IT Act:S 1 definition of "resident"

IT Act:S 9D

Interpretation Note No. 6