Legislative changes expected, despite withdrawal of far-reaching amendment.
SA authorities ‘were ready to pounce’ on multinationals with outsourcing models even before Sars won the case before the SCA. Image: Moneyweb
National Treasury has withdrawn – for now – the far-reaching proposed amendment to the Income Tax Act pertaining to the rules governing offshore entities of South African multinationals.
The amendment would have given effect to the Supreme Court of Appeal (SCA) decision in the much-publicised Coronation case, negatively impacting several SA multinationals with similar structures as Coronation. It was withdrawn because the case is now heading to the Constitutional Court.
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However, tax experts say there are likely to be legislative changes, irrespective of the outcome of the Constitutional Court case, which are bound to impact Coronation and several multinationals with similar offshore structures.
Authorities have been ready to pounce
Lutando Mvovo, executive head of international tax at Vodacom, said the authorities have been looking at multinationals with outsourcing models and were ready to pounce on them even before the SCA win for the South African Revenue Service (Sars).
The timeline of events was the giveaway.
The SCA heard the case in November 2022. The judgment was handed down on 7 February this year. Two weeks later, the 2023 Budget Review contained an amendment codifying the SCA decision.
“If the outcome of the Constitutional Court case is in favour of the taxpayer, we are likely to see Treasury bringing back the proposed amendment,” Mvovo said at the annual Transfer Pricing Summit hosted by the South African Institute of Taxation in Sandton.
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Nirvani Govender, transfer pricing expert at Sars, said at the summit that outsourcing, in general, is “a no-no”. The test is very stringent. Sars will determine whether the outsourcing is being conducted by the controlled foreign company (CFC), whether it is performed by another CFC in the same jurisdiction, and whether the staff is able to perform the activities resulting in the income stream.
Mvovo suggested that Sars prepare a Practice Note to assist taxpayers with this complex area.
“Large companies do not simply set up offshore structures to avoid taxes. Some of these structures are motivated by commercial decisions,” he said.
Foreign business establishment
The CFC rules were introduced to prevent multinationals from avoiding tax in SA but have a carve-out in the form of an exemption for foreign business establishments (FBEs) to ensure controlled foreign companies remain competitive.
The carve-out means that amounts attributable to a qualifying FBE are excluded from the net income of the holding company in SA.
To qualify, the FBE must have a fixed place of business located outside South Africa that is used for conducting the primary operations of the CFC’s business for a period of at least one year.
The question before the SCA was whether the net income of Dublin-based Coronation Global Fund Managers (CGFM) should have been included in the taxable income of its South African holding company, Coronation Investment Management SA (Cimsa).
Coronation (Dublin) outsourced, among others, its investment management function. The SCA agreed with Sars that the business was not suitably staffed and equipped to perform its “primary operations” in Ireland.
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The proposed amendment, which was since withdrawn, then changed the wording of “primary operations” to “all important functions”.
Outsourcing ‘common practice’ in this space
BDO associate director in transfer pricing Patrick McLennan said CGFM outsourced its investment management even though it had regulatory approval from the Central Bank of Ireland to provide a portfolio of services such as investment management and distribution.
“I think the logic for Sars was that fund management encompassed everything, whereas Coronation said it was not necessary for fund managers to provide all of these services … It was common practice in Ireland and in this space to outsource these functions.”
In the Coronation case, there was no consideration given to the nature of asset management, McLennan added. CGFM was fighting a losing battle when considering its outsourcing model, he remarked.
McLennan said he believes the legislation is not fit for purpose in terms of this type of business.
“We all have capacity constraints, including Sars, but having industry experts that know this area is really important because the distinction between a fund manager and an investment manager, in particular, is very key in this area.”
Mvovo added that it is still not clear whether the Constitutional Court will hear the merits of the case. A number of tax cases have not made it to the Constitutional Court because there was no public interest or constitutional issue in the appeals from the SCA to the court.
If the court does hear the case and the decision goes in favour of the taxpayer, Mvovo expects the proposed amendment to land back on the table.
“It would be important for them to exercise some form of fairness by giving taxpayers more time to adjust their models.”
He proposes an effective date of January 2026.
April Nicholson, associate director at Graphene Economics, says it will be helpful if Sars can release additional guidance on how multinational companies involved in outsourcing will be impacted. “As we know, outsourcing is quite common practice within a multinational context.”