TO BE OR NOT TO BE – DO YOU HAVE AN FBE?
TO BE OR NOT TO BE – DO YOU HAVE AN FBE?
By Hylton Cameron, Director
The current international tax hot topic is, does your controlled foreign company (CFC) have a foreign business establishment (FBE)?
To recap, if South African residents own more than 50% of a foreign company, then such foreign company is a CFC. Per our CFC rules the starting point is the income from such CFC is taxed in the SA shareholders hands even if no income/dividend/interest etc is paid by the CFC to the SA shareholder.
Fortunately the above rule is not be applicable if the CFC pays tax which is at least 67.5% of the tax that would have been paid had the CFC been a SA tax resident – the so called high tax exemption alternatively if the income of the CFC is attributable to its FBE (there are of course exceptions).
The reason for these two exemptions is clear, Treasury would like South African companies to expand their business off-shore and tax should not prohibit such expansion, provided such expansion is not a sham.
This document focuses on the issue of whether there is a FBE, or can there be more than one FBE?
Most times its clear if the requirements for a FBE are met, but there are circumstances where the issues are not clear.
Without going into too much detail in essence for there to be a FBE:
- There must be a fixed place of business in a country (not SA) that will be used for the carrying on of the business of the CFC where:
- That business is conducted through one or more structures;
- That fixed place of business is suitably staffed with employees of the CFC who conduct the primary operations of that business;
- That fixed place of business is suitably equipped for conducting the primary operations of that business;
- That fixed place of business has suitable facilities for conducting the primary operations of that business; and
- That fixed place of business is located outside SA, mainly for non-tax reasons.
We shall ignore the last point and assume the fixed place of business is outside SA for non-tax reasons.
In determining whether there is a fixed place of business, lets call it CFC 1 may take into account the above mentioned facilities, employees, or equipment of another group CFC, if that other group CFC in the same country has such as CFC 1.
Current Problems
An issue which requires clarity is what happens if you outsource part of your operations, alternatively if you have two FBE’s in two different countries.
Earlier this year the first issue was dealt with in CSARS v Coronation Investment Management SA (Pty) Ltd (Coronation), in which the Supreme Court of Appeal, per the facts said the company, (CGFM, which was a CFC of Coronation) in Ireland did not have an FBE as it had outsourced its primary operations.
Per the facts of the case, CGFM had outsourced its investment activities to another company in another country.
Without going into detail, the court stated that on the facts:
“I conclude that the primary operations of CGFM’s business (and, therefore the business of the controlled foreign company as defined) is that of fund management which includes investment management. These are not conducted in Ireland.”
Due to the above CGFM did not have a FBE.
One can find sympathy for SARS (not always easy), in that by all accounts CGFM earned a significant amount of income and CGFM did not employ the staff/have the facilities to earn such income – arguably the intent of the FBE legislation. Therefore as it did not have the staff/facilities etc to earn its income (the investment income), it did not have a FBE.
We understand the matter had gone on appeal to the Constitutional Court.
In view of the ruling and ignoring the appeal the rules seems rather clear that one cannot outsource the CFC’s primary operations.
However what happens if you have your own staff, equipment etc in two different counties can you have two or more FBE’s? The envisaged scenario is one where there are two (or more) different businesses of the company. Many examples come to mind, e.g. a CFC may buy and then sell (two primary operations of that business), it may buy, sell and deliver (three primary operations of that business), etc.
The above is not that unusual for a company and there a numerous examples of companies having branches in different countries performing different business operations.
From a policy perspective one would expect that if a CFC had say 100 people working at the head office in one country and another 80 at branch in another country SARS would not be concerned. There are clearly legitimate operations being undertaken.
In terms of the high tax exemption one would probably be fine but what about the FBE exemption if the CFC does not meet the high tax exemption?
At face value the law seems to cater for two different FBE’s. Let’s use the buy / sell company and assume each business is equally important, then there could be a fixed place of business in two different counties.
Further each fixed place of business would be suitably staffed/equipped to conduct the primary operation of that business (either buying or selling).
In terms of the law, arguably, the issue is not whether the fixed place of business is suitably staffed to conduct the primary operations of the CFC but whether its suitably staffed to conduct the primary operations of that business.
If we argue that part of the business is to buy goods, then one simply needs to check if that fixed place of business meets the above requirements to conduct the primary operations of that business (the buying of goods)?
A similar point is then raised for the other requirements of the FBE, i.e. does that fixed place of business (for the buying of goods) have the staff and is it suitably equipped / have suitable facilities to conduct the primary operations of that business (the buying of goods)? If the answer is yes, arguably there is then a FBE at that location.
In further support of the above the specific section which prevents the income from the CFC being attributed back to the shareholder asks - is the income attributable to any FBE of the CFC?
Such reference clearly takes into account the fact that there could be more than one FBE. There is a counter argument that one could have more than one FBE in the same country. Nevertheless it would seem in terms of the Act and one would think from a policy perspective such operations would be acceptable.
Unfortunately, if we return to Coronation the judge states (per the above comment) that the primary operations of CGFM’s business is the business of the CFC as defined. From this statement it would seem that the full bench of the SCA, on the facts are stating that the primary operations of the CFC (which is arguably not what the act says as it says primary operations of that business) are the primary operations of the business.
From this comment it would not seem possible to argue that you can have two (or more) primary operations which one thinks can’t have been the original intention of the law – at least from a policy perspective.
The updated Policy
Per the draft amendments which were recently released, in my view Treasury seems to be obsessed with taxpayers trying to dodge the rules and are losing the bigger picture of allowing South Africans to invest off-shore and be competitive.
If we analyse the one amendment (which is effectively repeated) the current wording (before the amendment) is that the fixed place of business must be suitably staffed with employees who conduct the primary operations of that business. This will be amended to state:
the fixed place of business must be suitably staffed with employees who perform all the important functions of that business for which the CFC is compensated.
It is clear from the above that the intent is to restrict the FBE legislation even further and look not simply at the business but at the important functions for which the CFC is compensated.
One hopes this amendment does not remain as it would seem far too broad. A simple example of delivery of goods being sold could be regarded as an important function. This logistics function could then not be outsourced or be part of an FBE in another country. To expand on the example, on the basis that logistics is regarded as important what staff do we need, especially if we transport via sea? - one could say such logistics are an important function however going by sea will mean the CFC does not have a FBE, as the fixed place of business won’t have staff to perform all the important functions as they (assuming the CFC needs to hire the ship and employ the crew) will not be at the fixed place of business they will be on the high seas! An exaggerated example but easily plausible.
A final mention deserves to be made in regard to the effective date of the proposed amendments – basically for the CFC it will apply for years ending on or after 1 January 2024, which means that for many CFC’s the legislation will already be effective!
Coming back from the high seas where are we?
One hopes the Coronation matter will be heard in the Constitutional Court as soon as possible – with a more favourable outcome, or at least a ruling which may not directly assist the case but would not apply such a narrow interpretation.
More importantly any gains from a favourable Coronation case (for the taxpayer) would potentially be removed by the current proposed amendments.
In view of the above, if you have any CFC’s which may be caught up in such amendments or in terms of the Coronation case, you should make sure your feet remain on the ground and you act quickly - for some it may already be too late.