Harsh Tax Changes Proposed For Foreign Trust Company Structures
22 August 2017
By David Warneke, Head of Tax Technical at BDO South Africa
Structures whereby a foreign trust holds a controlling stake in a foreign company are in for a rough ride in terms of proposals contained in the Draft Taxation Laws Amendment Bill of 2017.
At present, if the foreign trust and foreign company have their places of effective management outside of SA and are therefore not SA tax-resident, foreign dividends declared by the foreign company to the foreign trust and distributed to a SA tax-resident beneficiary may be subject to income tax at a favourable rate of 20 percent in the hands of the beneficiary or may not be subject to income tax at all. Capital gains realised by the foreign trust and distributed may also not be subject to tax in SA.
The proposal, in the case where the beneficiaries of the foreign trust are persons other than companies, is that any amount received by, or accrued to the resident beneficiaries will in future be taxed in the hands of the beneficiaries at their marginal rates of tax. Similar treatment is proposed in relation to foreign foundations that hold controlling interests in foreign companies. It appears from the wording of the proposal that there would be no difference in treatment between capital gains and revenue amounts distributed by the foreign trust to SA resident beneficiaries, but it is interesting that existing provisions dealing with the taxation of capital gains distributed by foreign trusts to SA resident beneficiaries are not proposed to be amended or repealed.
In the case where one or more SA tax residents hold an interest in a foreign trust or foreign foundation which in turn directly or indirectly holds more than 50 percent of the total participation or voting rights in a foreign company, it is proposed that the foreign company will be deemed to be a ‘controlled foreign company’ (CFC) in relation to the SA tax residents. To make sense in its context, it appears that in order to be said to ‘hold an interest’ in the foreign trust or foreign foundation, a right to participate in the profits or capital of the foreign trust or foreign foundation must exist. This right to participate would not exist in the case of a discretionary beneficiary of a trust where there is the mere hope or spes of participation.
In general terms, the consequences of CFC treatment result in a pro-rata inclusion of the net income of the CFC in the SA resident’s taxable income on an annual basis.
There appears to be an unintended overlap between the above proposals in that the holder of an interest in a foreign trust would presumably also be a beneficiary of the trust and therefore both of the above treatments would appear to apply. It also appears that the foreign company would be deemed to be a CFC regardless of whether the combined interests held by SA residents in the foreign trust was greater or less than 50 percent. This is probably intended although it appears counter-intuitive to label an arrangement a CFC if SA residents only hold a combined effective stake of 50 percent or less in the company in question.
A further proposal seeks to align the IFRS consolidation rules with the CFC rules. It states that a foreign company will be regarded as a CFC in all cases where IFRS 10 requires the financial results of the foreign company to be included in consolidated financial statements of a SA resident company. For purposes of calculating the inclusion of the net income of the CFC in the hands of a SA resident company one should use the percentage reflected in the consolidated financial statements in terms of IFRS 10 of the SA resident holding company. The use of the percentage holding of the SA resident holding company that produces consolidated financial statements however does not appear to take cognisance of the fact that participation rights may be held indirectly by a SA resident holding company through SA resident subsidiaries.
All things considered the above proposals, if enacted, will have a severely detrimental consequence for many SA taxpayers who have the above structures and it is important for such taxpayers to seek professional advice from a specialist in this area.
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