Constitutional Court Clarifies Tax Exemption for Foreign Subsidiaries

South African Constitutional Court ruling clarifies tax exemption for foreign subsidiaries

Key Takeaways for Business Leaders

In a significant ruling, the South African Constitutional Court has provided clarity on how income from foreign subsidiaries should be taxed, a decision with important implications for companies operating internationally.

Case Background

• Parties: Coronation Investment Management SA (Pty) Limited (CIMSA) vs. Commissioner for the South African Revenue Service (SARS)
• Case Reference: [2024] ZACC 11
• Judgment Date: June 21, 2024
• Judges Involved: Chief Justice Zondo, Acting Justices Bilchitz and Chaskalson, Justices Madlanga, Majiedt, Mathopo, Mhlantla, Theron, and Tshiqi

The Core Issue

The central question was whether the income of Coronation Global Fund Managers (Ireland) Limited (CGFM), a foreign subsidiary of CIMSA, was exempt from South African tax under section 9D of the Income Tax Act for the 2012 tax year. This section provides exemptions for foreign business establishments (FBEs).

• Tax Court's Initial Ruling: CGFM was deemed an FBE, thus its income was exempt from tax.
• Supreme Court of Appeal: Reversed this, arguing CGFM did not meet the criteria for FBE status.
• Constitutional Court: Ultimately reinstated the Tax Court’s decision, ruling in favour of CIMSA.

Key Findings from the Constitutional Court

1. Exemption Criteria

The Court had to interpret whether CGFM's operations in Ireland qualified it as an FBE, thereby exempting its net income from South African tax.

2. Primary Operations

The focus was on CGFM’s business nature and whether it conducted its main operations from a fixed business location in Ireland, as required for FBE status.

3. Economic Substance

• SARS’s Position: Argued that outsourcing core functions meant CGFM lacked substantial business presence in Ireland.
• CIMSA’s Counter: Claimed that CGFM’s structure, which involved outsourcing, met FBE requirements under Irish law and business practices, ensuring local management and oversight.

The Court’s Analysis

1. Business Definition and Primary Operations

The Court explored section 9D of the Income Tax Act, identifying CGFM’s core activities as managing Irish-domiciled collective investment funds, not direct investment trading. It assessed if these activities were primarily conducted at CGFM's fixed place of business in Dublin.

2. Operational and Legal Context

CGFM, as a licensed fund manager under Irish law, outsourced investment management to specialized entities while managing compliance and oversight locally. This outsourcing was compliant with Irish regulations, making it a typical industry practice.

3. Economic Substance and Outsourcing

• SARS’s Argument: Outsourcing meant CGFM’s local activities were insignificant.
• CIMSA’s Defense: Argued that CGFM’s setup, involving local management and oversight of outsourced activities, was standard and substantial.

4. Two-Stage Inquiry by the Court

• Stage One: Identified CGFM’s business as fund management.
• Stage Two: Confirmed CGFM’s primary operations were conducted from its Dublin office, including licensing, compliance, and oversight functions.

5. Compliance with Section 9D(9)(b)

The Court determined CGFM’s Dublin operations met the definition of an FBE, as its business model involved essential functions managed locally.

6. Clarification of ‘Primary Operations’

The term “primary operations” included managerial and oversight activities conducted at CGFM’s Dublin office, fulfilling statutory requirements for FBE status.

Conclusion of the Constitutional Court

The Court reversed the Supreme Court of Appeal’s decision, ruling in favor of CIMSA:

• CGFM’s business in Ireland met the criteria for FBE status under section 9D.
  Outsourcing investment management did not disqualify CGFM, as key oversight and management functions were maintained locally.
• CGFM’s income was exempt from South African tax, aligning with both Irish regulatory requirements and the legislative intent of section 9D.

Impact on Businesses

This ruling clarifies the criteria for tax exemptions on foreign subsidiaries’ income, emphasizing that:

• Local management and oversight functions can fulfil “primary operations” requirements even if core activities are outsourced.
• Compliance with host country regulations is critical in qualifying for tax exemptions under South African law.

For businesses with international operations, understanding and structuring their subsidiaries to meet local regulatory and tax requirements is essential. This decision highlights the importance of demonstrating economic substance and local operational activities to benefit from South African tax exemptions.

This ruling reinforces the need for meticulous compliance and strategic planning in managing international business operations, making it a critical reference for multinational corporations and their tax advisors.

Dieter Schulze

Regional CEO and Head of Tax, Cape Town