Quick Recap
The journey to the Constitutional Court was initiated when Coronation disputed an assessment raised by SARS, which imputed the net profits of its Irish subsidiary, Coronation Global Fund Managers (Ireland) Limited (CGFM), to Coronation. The adverse finding was as a result of CGFM being considered a controlled foreign company (CFC) of Coronation. Effectively, as a CFC, CGFM’s profits would be included in Coronation’s taxable income.
Coronation’s dispute of SARS’ assessment was based on the contention that CGFM meets the foreign business establishment (FBE) exemption. This relief mechanism is specifically included in section 9D of the Income Tax Act (the Act), to exempt the income of a CFC where it can substantiate that the CFC amounts to an FBE as defined.
SARS maintains that CGFM does not meet the requirements of an FBE, and its income should thus be imputed to Coronation. While the Tax Court sided with Coronation, the SCA ruled in favour of SARS and determined that CGFM’s profits should be included in Coronation’s taxable income.
The SCA judgment considered the requirements which a taxpayer must fulfil in order to successfully rely on the FBE exemption. A core aspect of this enquiry was whether CGFM’s primary operations included investment management functions.
After hearing testimony from key representatives of the Coronation Group, the SCA held that that CGFM outsourced its investment management functions, and which formed part of its primary functions. The outsourcing of these primary functions meant that CGFM did not meet the “economic substance” requirements under section 9D of the Act, and did not qualify as an FBE.
Constitutional Court’s Analysis
In the unanimous judgment of Majiedt J, the Constitutional Court disagreed with SARS and the decision of the SCA.
The court considered the business of CGFM, and found that it consisted of fund management activities, and not of investment management activities. This means that the investment management activities which CGFM outsourced were not its primary functions.
The evidence before the court, including the licence conditions under which CGFM could operate, the prudential considerations, coupled with the fact that the evidence went uncontested, conclusively proved that CGFM’s core business did not extend to investment management.
In finding that the primary operations of CGFM were not outsourced, the court held that CGFM’s day-to-day operations in Ireland met the “economic substance” requirements of the FBE exemption. The net income of CGFM could therefore not be imputed to Coronation, and should accordingly not be included in its taxable income.
Lessons to Learn
This groundbreaking ruling underscores the importance of a substantial business presence abroad to qualify for the FBE exemption and reminds us of the enormous tax consequences that may follow when this exemption is not correctly applied.
The clear disconnect between the judgments of the SCA and Constitutional Court, notwithstanding that the same evidence and tax principles were considered, reveals that there remains a large degree of varying interpretation of the law concerning the taxability of CFCs. Taxpayers with offshore entities are cautioned to obtain robust tax advice, in light of the contradicting judgments handed down.
