Coronation loses critical tax case against SARS

SARS wins CFC Case against Coronation

In Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd (1269/2021) [2023] ZASCA 10 (07 February 2023) the Supreme Court of Appeal handed down judgement on income imputation of a Controlled Foreign Company (CFC) to its South African holding company.

Coronation Investment Management SA (Pty) Ltd (CIMSA) is the holding company for the Coronation Group and registered and tax resident in South Africa. CIMSA was the 100% holding company of CFM (Isle of Man) Ltd, tax resident in Isle of Man. CFM (Isle of Man) Ltd, in turn, was the 100% owner of Coronation Global Fund Managers (Ireland) Limited (CGFM) and Coronation International Ltd (CIL), which were registered and tax resident in Ireland and the United Kingdom, respectively.

The Court had to consider whether the net income of CGFM had to be included in the taxable income of its South African holding company, CIMSA, or whether a tax exemption in terms of section 9D of the Income Tax Act, 1962 (ITA) applied to the income earned by CGFM. This depended on the nature of the primary functions of CGFM in Ireland. If the primary operations were conducted in Ireland, then the section 9D exemption would apply. CGFM adopted an outsource business model. It had to be considered whether the primary business of CGFM was that of investment (not conducted in Ireland), or of maintaining its license and managing its service providers (conducted in Ireland).

The South African Revenue Service (SARS) assessed the tax liability of CIMSA for the 2012 tax year and included the net income of CGFM in its income. The Tax Court upheld CIMSA’s objection and found that CGFM was a “foreign business establishment” (FBE) as per section 9D(1) of the ITA which qualified for a tax exemption. SARS appealed the Tax Court decision.

The South African tax system was source-based prior to 2001 and was then changed to a resident-based or worldwide tax system. Section 9D was introduced to address how South African taxpayers should be taxed on their income earned abroad, especially income earned by South African owned foreign entities. A pure anti-deferral regime would immediately deem back all the South African owned foreign company income. As a result, no foreign income would receive any advantage over domestic income. However, international law only allows South Africa to tax foreign residents on their South African source income, not on their foreign source income, even if the entity is completely owned by South African residents. To address this, section 9D imposes tax on South African owners on the income earned by their foreign entities as if those entities immediately repatriated their foreign income when earned.

Section 9D(2) of the ITA imputes the net income of a CFC to a South African resident company holding participation rights in that controlled foreign company unless it falls into the FBE exemption. In the 2012 tax year of assessment CGFM was a CFC and its net income would be imputable to CIMSA, unless it fell into the FBE exemption. In terms of section 9D(1) of the ITA a FBE in relation to a CFC means a fixed place of business outside South Africa used or will continue to be used for the carrying on of the business of the CFC for a period of at least one year, where the business is conducted through one or more offices, shops, factories, warehouses or other structures; the fixed place of business is suitably staffed with on-site managerial and operational employees of that controlled foreign company who conduct primary operations of that business; the fixed place of business is suitably equipped for conducting the primary operations of that business; the fixed place of business has suitable facilities for conducting the primary operations of that business; and the fixed place of business is located outside South Africa solely or mainly for a purpose other than the postponement or reduction of tax imposed by South Africa.

CGFM was incorporated in Ireland in 1997 to provide opportunities for clients to invest in South African and Irish domiciled collective investment funds (CIS). SARS contended that CGFM did not meet the FBE requirements. Had the investment functions been outsourced to a company, subject to tax in Ireland where CGFM was located within the same group of companies and to the extent that the structures, employees and facilities were located in Ireland it would have qualified as a FBE. Since CGFM outsourced its investment management functions to CAM and CIL, and neither were subject to tax in Ireland, the requirements of the FBE exemption were not met.

CGFM did not dispute that it did not have sufficient staff to conduct investment trading but argued that its staff complement was sufficient to maintain the license which is a function of its primary business of fund management.

SARS argued that CGFM elected to apply for a license whereby its investment functions were outsourced but that it did not alter the nature of its business, which remained that of investment. The revenue generated by CGFM was percentage based and calculated on the market value of the assets of the Irish fund. Other service costs, such as those in respect of administration, custodial and distribution, were paid out of the fees earned by CGFM.

The Court found that collective portfolio management, which CGFM was authorised to conduct in terms of its license, included investment management, administration, and marketing. It also found that the regulations indicated that the purpose of delegation was to enhance the efficiency of the company’s business. It did not detract from the business of the company, nor did the delegation alter the business. It merely entailed supervision of the core business which was recognised as investment management. Regulatory the management company acted in the best interest of the investors. The liability of the management company was also not affected by the delegation of its core function.

Since CGFM’s license entailed investment management, it had to be determined whether the nature of CGFM’s business in Ireland was that of an investment company or a management company. It was common cause that the investment function was not located in Ireland. As a result, if its primary business was that of investment, its net income as a CFC would be imputable to CIMSA.

The definition of FBE refers to the “primary operations of that business,” which is a direct reference to the business of the CFC. Neither the ITA nor the Tax Administration Act, 2011 (TAA) defines the phrase “primary operations.” In terms of the dictionary definition the word “primary” is, amongst others, “first in importance, chief, leading, main…” “Operations” is defined to mean, amongst others, “working activity, the exertion of force or influence, the way in which a thing works.”

The notion that investment management was not CGFM’s core business was found in contrast with its memorandum of association. The stated objects of CGFM were to carry on the business of establishing specified collective investment undertakings; to promote, establish, manage, regulate, and carry on any investment, unit or other trust or fund; and to carry on the business of investment and financial management.

If the key operations of the business (investment management) have been outsourced, then the fixed place of business in Ireland lacked the staff and facilities to conduct those operations. If these operations were central to CGFM’s business, CGFM did not conduct its primary operations in Ireland. Without the investment management operations, CGFM did not conduct its primary operations in Ireland.

The essential operations of the business must be conducted in the jurisdiction in respect of which the FBE exemption is sought. A company cannot outsource its primary business and its primary operations must take place in the same foreign jurisdiction. The court concluded that the primary operations of CGFM’s business (as a CFC) were that of fund management which included investment management which were not conducted in Ireland. As a result, CGFM did not meet the requirements of the FBE and the net income of CGFM was imputable to CIMSA for the 2012 tax year.