Proposed tax amendments to SA’s controlled foreign company (CFC) rules will adversely impact South African multinationals with foreign subsidiaries that have assessed tax losses, warns PwC International Tax.
The amendments which are intended to provide benefits for CFS that are in a loss making position are misleading and fundamentally flawed. “The proposed amendments will make it more difficult for local multinationals to compete with other corporations abroad amidst the current economic uncertainty,” says Cor Kraamwinkel, a tax partner in PwC’s International Tax division.
High tax exemption
The CFC rules are an anti-avoidance mechanism designed to prevent a company from artificially moving its profits abroad to a country with a more favourable or lower tax rate. Generally, most CFC rules include a tax rate exemption that exempts CFS subject to a tax rate above a certain level.
In South Africa, a foreign subsidiary will not be subject to the CFC rules if it qualifies under the ‘high tax exemption’. The high tax exemption compares the foreign tax payable by the CFC to the notional South African tax that it would have paid if it was a South African resident. This means if the foreign tax payable is at least 75% of the notional South African tax, then the high tax exemption will apply and the income of the CFC will be taxed in the hands of its South African shareholders.
Exclude assessed losses
“The high tax exemption displays the hallmarks of a fair benchmark. It allows for different principles in the recognition of income and deductions by setting the benchmark liability at 75% of the notional tax liability and requires that the notional liability to tax should take account of any foreign tax credits or rebates and any limitations on the amount of income that may be taxed pursuant to any double taxation agreement,” comments Kraamwinkel. In addition, it recognises that the distorting effect of assessed losses or group losses should not be taken into account in either the notional domestic tax calculation or the determination of the foreign tax liability for purposes of the comparison.
The requirement in our legislation to exclude assessed losses and losses of other companies in the foreign tax group was incorporated into the law in order that there should be a fair and morally defensible basis for comparison, adds Kraamwinkel.
Group taxation mechanism
The Taxation Laws Amendment Bill, 2016 proposes that the comparable foreign tax calculation be amended such that the effect of losses of other companies should not be ignored. The rationale for this proposal is that the original purpose for the introduction of the high tax exemption was to deal with situations in which little or no South African tax was at stake.
This explanation is misleading. There are a number of CFCs that are in a loss making position that do not benefit from the high tax exemption.
The proposal also fails to take into account the multitude of group taxation mechanism that may be encountered in other countries. For example, in the Netherlands, tax is assessed on the holding company in a fiscal unity and all companies within that fiscal unity are jointly and severally liable for the tax liabilities of the group.
Notional domestic tax liability
National Treasury has also overlooked the fact that the tax bases that are being compared are fundamentally notional. On the one hand there is a notional South African tax liability against which a notional foreign tax rebate must be compared. The explanation appears to suggest that an actual foreign tax liability should be compared with a notional domestic tax liability. It ignores that foreign laws may nevertheless make group members jointly and severally liable for all taxes incurred within the group and that any tax deferred by group losses may be recovered at a later date from the company that derived otherwise taxable income.
Amendment theoretically flawed
Kraamwinkel adds, ‘The current ‘high tax exemption’ is in place to provide reasonable assurance that the operations in a foreign jurisdiction are exposed to taxation that is comparable to South African taxation and that potential liability to tax is not being abused by establishing companies in low-tax or no-tax jurisdictions.” Destroying the very principle of comparability that should underpin the exemption defeats the purpose of the exemption.
The amendment will impact South African multinational groups adversely. Presently, 18 member states in the European Union permit group taxation. Group taxation is also permitted in the US, Australia and New Zealand. Many of these countries are major trading partners.
The amendment that is now before Parliament is theoretically flawed. The existing provision is fair and consistent with international norms.
Cor Kraamwinkel
Tax Partner, PwC International Tax Division
http://www.pwc.co.za/
cor.kraamwinkel@pwc.com
