Controlled foreign companies and the Coronation case: Where to From Here?

By Gerhard Nienaber, Director, KISCH Tax Advisory 

On 21 June 2024, the Constitutional Court handed down its judgment in Coronation Investment Management SA (Pty) Ltd v Commissioner for the South African Revenue Service CCT47/23, providing much-needed clarity for local companies with offshore subsidiaries engaged in similar business models (especially where they outsource/subcontract certain business activities to another jurisdiction).  

The Court held that the taxpayer, Coronation Investment Management SA (Pty) Ltd, had a foreign business establishment (“FBE”) in Ireland, despite the Irish business outsourcing some of its functions. This meant that Coronation Investment Management’s Irish subsidiary (Coronation Global Fund Managers) was not subject to tax in South Africa. The reason for this is that Section 9D of the Income Tax Act 58 of 1962 (“ITA”) provides that a proportional part of the income of a foreign company of which more than 50% of the shares or voting rights are directly or indirectly held by South African tax residents, is taxed in the hands of the South African residents. However, the income attributable to a FBE in relation to a CFC is excluded from its net income, and therefore not taxed in the hands of the holders of the shares or voting rights in that CFC.  

The Constitutional Court unanimously ruled in favour of Coronation Investment Management stating that it met all the exemption criteria necessary for an FBE, with its core function being conducted in Ireland. The Court looked at Coronation Global Fund Managers’ (“CGFM”) “actual business” (delegated business model, with fund management as its core function conducted in Ireland) rather than a theoretical or "notional business" approach in determining FBE eligibility. The Court also stated that outsourcing activities do not automatically disqualify a company from FBE exemption, if the company maintains economic substance (CGFM's day-to-day operations in Ireland satisfied this requirement) and oversight. 

With the current international changes, it will be interesting to see if the Income Inclusion Rule (“IIR”) in Pillar Two will replace the CFC tax system i.e.: will each country decide the level of foreign tax paid or assume the global minimum rate of 15%, and will a parent country be entitled to tax the CFC? This will depend on the parent country’s domestic rate and the factors determining the low-tax jurisdiction. If the parent country has a high tax rate in comparison to the global minimum rate, CFC rules will most likely apply if the foreign country’s effective tax rate is low. Here, CFC rules would remain attractive for developed countries, as substituting CFC rules with the IIR would equate to decreased tax revenue. However, if a country’s tax rate is lower than 15% and CFC rules are applied evenly, the IIR could potentially play the same role as CFC rules (or be more attractive), depending on how the multinationals alter their business decisions. 

On 17 June 2024, the G20/OECD Inclusive Framework published additional administrative  guidance on the implementation of the Pillar Two (“the Guidelines”) together with details of the procedure for deciding that countries’ local implementations of the Pillar Two rules are ‘qualified’. The Guidelines state that, in terms of the allocation of cross-border current taxes, some countries allow for ‘cross-crediting’ i.e.: foreign taxes paid on one source of income potentially giving rise to foreign tax credits that can be used against income arising in another country. The new Guidelines offer notably expanded guidance on ‘cross-crediting and set out a mechanism for determining the allocations of covered tax amounts to each permanent establishment where cross-crediting rules apply to the main entity. The mechanism makes use of a four-step process (with allocation keys) to apportion amounts. Modifications apply where cross-crediting involves taxable distributions and/or is applied by reference to separate ‘baskets’ of foreign income. The same principles also apply in respect of the ‘cross-crediting’ of taxes on CFCs (other than taxes arising under a ‘blended CFC tax – here the specific guidance issued in February 2023 remains in place). In terms of the allocation of cross-border deferred taxes, the Guidelines provide expanded direction on the principles relevant to?allocating deferred taxes between group entities?where a deferred tax balance in the financial accounts of one entity arises due to the income of a different Pillar Two entity. The guidance centres on deferred tax in relation to CFC rules and sets out a five-step approach?for calculating the Pillar Two?re-allocation of associated deferred tax amounts of a parent to its CFC. In terms of allocation of profits and taxes in groups including flow-through entities, the Guidelines also verify how CFC taxes, originally attributable to a flow-through entity, should be treated under the general reallocation rules for flow-through entities. 
If you have any queries on the above or require any tax advice, please contact: 

Gerhard Nienaber 
Director
KISCH Tax Advisory 
+ 27 82?771 9549
Gerhardn@kisch-ip.com