“does the south african controlled foreign company regime ...€¦ · “does the south african...

10 October 2016

Welcome to this UCT-IBFD Workshop on the New Global Tax Order:

“Does the South African Controlled Foreign Company regime overprotect the

tax base and cause harmful economic effects?”

Agenda08:00 – 10:00

International Perspective & Practical Challenges in South Africa

1. Welcome – Prof Roeleveld (Director of the UCT Tax Institute).

2. International Perspective – Dr Shee Boon Law (IBFD).

3. Key practical challenges – Prof Osman Mollagee (PwC).

10:00 – 10:30 Coffee break

10:30 – 12:00

Davis Tax Committee & Panel Discussion

4. Recommendations for the SA CFC regime – A/Prof Deborah Tickle (member Davis Tax Committee).

5. Panel Discussion moderated by A/Prof Johann Hattingh (UCT).

6. Summary & Closing – Prof Roeleveld (UCT).

http://www.tax.uct.ac.za/sites/default/files/image_tool/images/304/2016-02-18%20-%20Part%20I%20Morning%20Seminar%20-%20Technical%20Service%20Fees.pdf

http://www.tax.uct.ac.za/sites/default/files/image_tool/images/304/2016-02-18%20-%20Part%20II%20Morning%20Seminar%20-%20Technical%20Service%20Fees.pdf

CFC Rules in International Context

Shee Boon Law, IBFD, The NetherlandsCape Town, 10 October 2016

IBFD

Action 15: Multilateral instrument

• Action 5: Harmful tax practices • Action 6: Prevent treaty abuse• Action 13: Country by Country (CbC) reporting only• Action 14: Dispute resolution

Minimum standards

• Action 7: Permanent Establishment (PE)• Actions 8 - 10: Transfer Pricing• Action 13: Master file and local file

Strengthening existing international standards

• Action 1: Digital economy• Action 2: Hybrid mismatch arrangements • Action 4: Interest deductions

Common approach

• Action 3: Controlled foreign company (CFC) rules • Action 12: Aggressive tax planning arrangements Best practices

BEPS Final Reports – CFC Rules in the Hierarchy

4 © 2016 IBFD

BEPS and CFC Rules

© 2016 IBFD 5

http://www.oecd.org/home/0,3305,en_2649_201185_1_1_1_1_1,00.html

http://www.oecd.org/home/0,3305,en_2649_201185_1_1_1_1_1,00.html

Equity treatment = Control

Impact of CFC Rules in Home Countries

Rules that empower a State to tax its resident taxpayers on income derived by foreign entities controlled by them

B Co qualifies as a controlled foreign company of A Co

A Co taxable in Country S on 250, plus 150 under the CFC rules

Complex calculation rules and tracing rules to eliminate double taxation

A Co

B Co

Country P

Country SPayments

Profits = 150

Profits = 250

6

BEPS 3 – Overview of Recommended CFC Rules

OECD discusses seven CFC building blocks:

(1) CFC definitions.

(2) Threshold CFC requirements.

(3) Definition of CFC "control."

(4) Definition of CFC "income."

(5) Rules for computing CFC income.

(6) Rules for attributing CFC income.

(7) Rules to prevent or eliminate double taxation.

© 2016 IBFD 7

Objective and Scope of CFC Rules

Objective: Anti-deferral rules to discourage resident taxpayers from diverting their income to low-taxed CFCs thereby deferring their tax liability until the CFC profits are repatriated to them

Target CFCs in countries that do not have a comparable tax systems using comparably taxed criteria, effective tax rate, or listing approach (e.g. Tax havens); or

Target mobile income that can be easily moved (e.g. passive income such as interest, dividends, royalties and rent)

8

Active income exemption Finance company exception Active foreign holding company or sub-holding company

not in a black list country (e.g. Russian rules) Same country exception Comparable effective tax rate exemption Excluded territories (e.g. treaty countries, EEC, etc.) De minimis thresholds – e.g. tainted income exempt from

sub-part F if less than US $1 million, no CFC charge if CFC profits less than GBP50k

Low margin exception Temporary period exemption – e.g. CFCs created

temporarily during a restructuring

Common Exceptions Internationally

© 2016 IBFD 9

Capital import neutrality vs. Capital export neutrality Protection against profit diversion and round-tripping

structures Compliance costs are high when bona fide CFCs are caught

by the rules Active income exemption enhances competitiveness

But what to do with the interest costs of exempt foreign profits? Fat capitalization rules…

Spill over effects for investment countries???

Tax Policy Considerations

© 2016 IBFD 10

Application of CFC Rules to Holding Companies

Dividend/Capital Gains

CFC Rulesapplicable?

Affiliates

Tax FavoredHold Co

SA Parent

Equity

© 2016 IBFD 11

Application of CFC Rules to Low Tax Finance/IP/Service Companies

SA Parent

equity

Subsidiary Low tax Finance /IP/Service Company

© 2016 IBFD 12


Loans, Licences and Service Agreements

Interest, Royalties or Service Fees

Application of CFC Rules to Principal Companies

SA Parent

Customers

Contracts with Customers $$$

Local Buy/SellContract Manufacturer

ServicesServices

© 2016 IBFD 13

Low Tax Subsidiary


Thank You!!!

© 2016 IBFD 14

Key practical challenges – Prof Osman Mollagee (PwC).

SA’s CFC regime– Some practical difficulties

(Prof) Osman Mollagee7 October 2016

http://uct.us8.list-manage2.com/track/click?u=89c77ae585909ac137420a03f&id=0d6725bd7a&e=fe90037ec1

http://uct.us8.list-manage2.com/track/click?u=89c77ae585909ac137420a03f&id=0d6725bd7a&e=fe90037ec1

http://uct.us8.list-manage1.com/track/click?u=89c77ae585909ac137420a03f&id=e56f1721c3&e=fe90037ec1

http://uct.us8.list-manage1.com/track/click?u=89c77ae585909ac137420a03f&id=e56f1721c3&e=fe90037ec1

PwC

Applying section 9DSome practical difficulties faced by SA-based multinationals

• Foreign company

• Participation

• Foreign business establishment Exemption

• High tax Exemption

• “Roll-over” relief

Practical difficulties in applying SA's CFC regime17

PwC

Is the entity a “foreign company”?

Hybrid entitiesIf it’s not a “company”, it can’t be a CFC

• “foreign partnership” excluded from “company” definition

• Requires case-by-case analysis of foreign tax law and attributes of the entity

[S1(1) ITA: Definitions of “company” and “foreign partnership”]

POEM and DTT tie-breakIf it’s SA-resident, it’s not a CFC

• SA’s “resident” definition defers to DTT tie-break

• Uncertainty of POEM = Uncertainty of CFC status

• Even greater uncertainty when DTT tie-break is “mutual agreement”

[S1(1) ITA: Definitions of “resident” and “foreign company”]


PwC

Participation

Preference shares

CFC definition envisages SA holding in excess of “50 per cent of total participation rights” (or voting)

• No basis for excluding preference shares from “total” participation

• No guidance on relationship between ordinary and preference shareholding. Aggregation? Weighting?

CFC

SA-resident

Non-resident

Preference shares

Ordinary shares

[S9D(1): Definitions of “controlled foreign company” and “participation rights”]


PwC

Participation

Special and conditional rights

Participation rights may vary annually —e.g. subject to profitability

• Foreign company may become a CFC in some years, and cease to be a CFC in others?

CFC

SA-resident

Non-resident

• 60% of first $50M• 40% thereafter

• 40% of first $50M• 60% thereafter

50% 50%

[S9D(1): Definitions of “controlled foreign company” and “participation rights”]


PwC

FBE (“foreign business establishment”) Exemption

Substance: Outsourcing and sub-contracting

FBE definition requires CFC’s “fixed place of business” to be:• “suitably staffed” and “suitably equipped” (etc.)• to conduct the “primary operations”• of “that business”

Does SARS contemplate only business models where:• all/most functions are undertaken in house by the

CFC’s own in-country employees?• All/most assets are owned by the CFC?

Foreign OpCo(CFC)

SA Parent

SA OpCo

Service-providersand Sub-contractors

(Connected / unconnected)(SA / Foreign)

[S9D(1): Definition of “foreign business establishment”]


PwC


Substance: Shared resources

FBE definition does contemplate situations where a CFC uses resources of a fellow (same-country) CFC

(1) Difference between “own” substance and “shared” substance?

(2) What if CFC-1 is not “subject to tax” in-country?

CFC-2(Country A)

SA Parent

“Suitable” substance

CFC-1 (Country A)

[S9D(1): Proviso to definition of “foreign business establishment”]


PwC


Substance: Shared resources

FBE definition does contemplate situations where a CFC uses resources of a fellow (same-country) CFC

(3) Is the “same country” requirement reasonable? CFC-2(Country B)

SA Parent


(Country A)

CFC-1 (Country A)


(Country B)

[S9D(1): Proviso to definition of “foreign business establishment”]


PwC


Intellectual property: Ownership, use and disposal

FBE exemption covers royalties and disposal-CGT only if the CFC:

• “regularly” and “directly”

• “creates, develops or substantially upgrades”

that IP

[S9D(9)(b) and s9D(9A)(a)(v)&(vi)]

Contract-R&D?

IP that does not require “regular” development or upgrading?


PwC


Foreign dividends from CFCs that derive income from SA

Anti-round-tripping rule in s10B(4) attacks payments that are:

• Deductible by the SA payer

• but “not taken into account” in the recipient CFC’s “net income”

[S9D(9)(b) and s10B(4)]

CFC

SA ParentParticipation exemption

denied?

Income from foreign and SA

customers

Foreign dividend


PwC

High-tax Exemption

Group losses

HTE compares actual foreign tax paid against notional SA tax liability

• Reasonableness of ignoring group losses

• Mechanism (in CFC’s home country) for group relief

[Further proviso to s9D(2A)]


PwC

High-tax Exemption

Timing of foreign taxes

HTE compares actual foreign tax paid against notional SA tax liability

But recognises only foreign taxes that are:

• “payable”

• “in respect of the foreign tax year” (that foreign tax year?)

[Further proviso to s9D(2A)]

CFC

Foreign interest income

Year 2: PaymentForeign WHT

liability

Year 1: AccrualInclusion in notional SA

taxable income


PwC

Roll-over relief

• “conflict” between SA rules and foreign re-organisation mechanisms

• Gaps in disposal relief (e.g. inadequate protection from “degrouping” claw-backs)

[Ss 42- 47; s9H; Para 64B, 8th Sch. ITA]


PwC

Questions?

“The information contained in this publication by PwC is provided for discussion purposes only and is intended to provide the reader or his/her entity with general information of interest. The information is supplied on an “as is” basis and has not been compiled to meet the reader’s or his/her entity’s individual requirements. It is the reader’s responsibility to satisfy him or her that the content meets the individual or his/ her entity’s requirements. The information should not be regarded as professional or legal advice or the official opinion of PwC. No action should be taken on the strength of the information without obtaining professional advice. Although PwC take all reasonable steps to ensure the quality and accuracy of the information, accuracy is not guaranteed. PwC, shall not be liable for any damage, loss or liability of any nature incurred directly or indirectly by whomever and resulting from any cause in connection with the information contained herein.”

© PwC Inc. [Registration number 1998/012055/21](“PwC”). All rights reserved. PwC refers to the South African member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.co.za for further details.


Davis Tax Committee Presentation – A/Prof Deborah Tickle (KPMG).

DTC Report on BEPS - Controlled foreign companies

Deborah Tickle- DTC BEPS Sub-committee; Partner KPMG—

October 10, 2016

32© [year] [legal member firm name], a [jurisdiction] [legal structure] and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

Document Classification: KPMG Confidential

Agenda

• DTC’s mandate• Background to DTC BEPS Report• OECD Action 3• DTC Recommendations and Closing remarks.

DTC’s mandate and Background to DTC BEPS Report



DTC’s MandateDavis Tax Committee (DTC) formed on 17 July 2013, to inquire into the role of South Africa’s tax system in the promotion of inclusive economic growth, employment creation, development and fiscal sustainability.

The DTC is expected to take into account recent domestic and international developments and, in particular, the long term objectives of the National Development Plan.

On the international front, the DTC is required to address BEPS concerns as identified by the OECD.

However, acknowledgedTax no ‘silver bullet’- To induce to ‘Divert in’ needs other policy changes.



BackgroundThe conceptual framework of the DTC’s BEPS report is premised on:• cognizance of national sovereignty; • specific constitutional perspective; • the fiscal and economic policy in the National Development Plan;• principles of a good tax system. South Africa: part of G20 and OECD Associate Country participating in BEPS Action Plan. In responding to the OECD’s BEPS concerns, South Africa cannot take action without considering:• the global environment and other countries’ responses;• It ensures a balanced approach that preserves the competiveness of the

economy and does not stifle FDI;• the responses to BEPS by its trading partners as well as the country’s

place in the global economy as an emerging economy in Africa.



BackgroundOECD: Implementation Measures:

Minimum Standards

Common Approaches and Best Practices for Domestic Law (includes Action 3 on CFC’s):The DTC analysed all the legislation currently in place, compared it to the best practices recommended by the OECD, and then provided recommendations as to how this can be made more effective in curtailing BEPS without unduly hindering foreign investment or increasing compliance and administrative costs for taxpayers and revenue authorities.

Action Points to Reinforce international Standards.

OECD Action 3



OECD BEPS Action 3Shared policy considerations: • The role of the CFC rules as a

deterrent measure;• How the CFC rules complement

transfer pricing rules;• The need to balance effectiveness

with reducing administrative and compliance burdens; and

• The need to balance effectiveness with preventing or eliminating double taxation.

Jurisdictional policy considerations• Strike balance between tax and

competitiveness;• Preventing base stripping.

Six Building Blocks• Rules for defining a CFC

(including a definition of control);• CFC exemption and threshold

requirements;• Definition of CFC income;• Rules for computing income;• Rules for attributing income; and• Rules to prevent or eliminate

double taxation



OECD Action 3To Note:

• Recognised that success of Action 3 proposals depends on willingness of larger OECD member countries to adopt proposals;

• One particular structure of concern:• Companies indirectly ‘control’ further foreign ‘subsidiaries’ (IFRS 10)

via an offshore trust or foundation. • Exemptions and Threshold requirements:

• Tax rate exemption;• De minimus rule;• Anti-avoidance requirement (purpose based).

• Substance testing• Options



OECD Action 3To Note:

• Substance testing options:• Threshold test: facts and circumstances ie employees factually

contribute to CFC’s income earning activity;• Group’s significant functions to determine whether CFC is most likely

to own assets/risks if independent;• Sufficient business premises and nexus to country of residence and

skills to perform CFC’s core functions.• Nexus approach: IP regimes require substantial activity

DTC Recommendations



DTC Recommendations• South Africa should adopt the position of protecting its own interests. • Follow and not lead or set the trend. • South Africa’s CFC legislation is already sophisticated and comparable

to other G20 countries; there is thus no need to strengthen this legislation at this stage.

• In summary, since South Africa already has robust CFC legislation, the DTC recommends that it should not be significantly changed until it is clear what other countries intend to do.

• Recommendations thus address only other points.



DTC Recommendations:Defn of CFC (including control); and Rules for attributing incomeInclude Trusts

CFC exemptions and thresholds Retain De minimus Rule

• Consider imputing income of these companies to the ‘parent’ South African company, based on the IFRS methodology for consolidation (But refer first to the Final DTC Estate Duty report for its recommendations, for consistency).

• The current SA legislation includes a low tax threshold (75% rule) and a de minimis rule. The de minimus rule (financial instrument income not exceeding five per cent of a CFC’s total receipts and accruals excluding passive type income) covers this aspect satisfactorily and should be maintained. However:



DTC Recommendations:Reconsider low tax rule mechanics

Definition and computation of income + attributionReview substance

• Reconsider appropriateness of mechanics of the 75% rule, given the global trend of reducing tax rates: the UK: 15% by 2020, average rate of corporate tax in 2015 for Europe: 20.24% e.g. Ireland:12.5%, Hungary:19%; and Asia: 21.91% e.g. Singapore 17%,and Thailand 20%; unless the South African tax rate is likewise reduced (reducing likelihood of diversionary income anyway).

• Does SA regime require enough substance under FBE test? More aggressive taxpayers may satisfy the test with as little as one managerial employee, one operational employee, a small fixed office (which may even be shared), and a modest amount of office equipment. Thus, review substance-see Action 3.



DTC Recommendations:Consider legislation on outsourcing

Royalties versus services

• Review tax base risks associated with outsourcing and thereafter implement automatic tainting legislation to this practice.

• Investigate the artificial labelling of certain portions of IP income as ancillary services in order to avoid CFC imputation. This artificial labelling works best when the local countries involved treat services preferentially vis-à-vis royalties. Consider classifying ancillary services as royalties under the SA CFC rules (or at least if the amounts are characterised as royalties for local country tax purposes).



Closing Remarks/ Recommendations:

Relaxing of other regimes’ CFC Rules.

Consider compliance burden

Refine anti-diversionary rules

• SA CFC regime is largely in line with CFC systems used by many developed countries. But some European systems have softened their CFC systems since 2000 e.g. UK and Netherlands. SA cannot afford to be a leader in this field but must follow the practice set by others. Consider adopting a regime similar to UK or Netherlands to improve South Africa’s tax competitiveness in the long term, but beware this may open loopholes.

• SA’s CFC rules are complex. Ensure limited CFC compliance burden.

• Ensure legitimate business establishments not hindered e.g. re service income anti-diversionary rules for FBE. Consider refining the anti-diversionary rules as necessary.



Closing Remarks/ Recommendations

Simplify legislation

Monitor

• SA CFC rules are complex. Explaining inter alia them in Explanatory Memoranda that have no legal effect, when the law is not clear should be avoided. Legislation itself should be clear. Consider simplifying the legislation and reduce the cost of administration for business.

• Monitor OECD recommendations and refine CFC rules when necessary.



DTC RecommendationsSouth Africa should adopt the position of protecting its own interests. Follow and not lead or set the trend. South Africa’s CFC legislation is already sophisticated and comparable to other G20 countries; there is thus no need to strengthen this legislation at this stage. In summary, since South Africa already has robust CFC legislation, the DTC recommends that it should not be significantly changed until it is clear what other countries intend to do.

Thank you

Panel Discussion.

“Does the South African Controlled Foreign Company regime overprotect the tax base and

cause harmful economic effects?”

Thank you.

www.tax.uct.ac.za www.ibfd.org

“does the south african controlled foreign company regime ...€¦ · “does the south african...

Documents