During 2012, Coronation Investment Management SA (Pty) Ltd (CIMSA) was a 90% subsidiary of Coronation Fund Managers Limited and the 100% holding company of Coronation Management Company and Coronation Asset Management (Pty) Ltd (CAM), both registered for tax in South Africa. CIMSA was also the 100% holding company of CFM (Isle of Man) Ltd, tax resident in Isle of Man. CFM (Isle of Man) Ltd, in turn, was the 100% owner of Coronation Global Fund Managers (Ireland) Limited (CGFM) and Coronation International Ltd (CIL), which were registered and tax resident in Ireland and the United Kingdom respectively. At issue was whether the net income of CGFM should be included in the taxable income of CIMSA, or whether a tax exemption in terms of s 9D of the Income Tax Act 58 of 1962 (the Act) was applicable to the income earned by CGFM. This depends on what the primary functions of CGFM in Ireland are. If the primary operations are conducted in Ireland, then the s 9D exemption applies. Of particular significance is that CGFM has adopted an outsource business model and the attendant ramifications that may have for its tax status. Aligned to this is whether the primary business of CGFM is that of investment (which is not conducted in Ireland), or that of maintaining its licence and managing its service providers (which is conducted in Ireland). The tax authorities assessed the tax liability of CIMSA for the 2012 tax year to include the entire ‘net income’ of CGFM. The tax authorities accepted that CGFM met the FBE definition, in all respects but one: economic substance. As at 2012, CGFM had offices in Dublin with a staff component of four people, consisting of a managing director, two accounting officers and a compliance officer. All the staff were resident in Ireland. It was not disputed that CGFM had conducted its business for more than a year through one or more offices in Dublin (s 9D(1)(a)(i)), or that it had ‘a fixed place of business’ in Ireland (s 9D(1)(a)(ii)) which was suitably staffed and equipped with suitable facilities (s 9D(1)(a)(ii), (iii) and (iv)). The tax authorities also accepted that the business was located in Ireland for a reason other than the postponement or reduction of South African tax (s 9D(1)(a)(iv)). However, it contended that CGFM did not meet the economic substance requirements, as ‘the primary operations’ referred to in s 9D(1)(a)(ii),(iii) and (iv) were not based in Ireland. Accordingly, the Dublin office was not suitably staffed with employees, not suitably equipped, nor did it have the suitable facilities to conduct ‘the primary operations’ of CGFM’s business. An appeal was filed and the Tax Court set aside the assessment. The court found that CGFM was a ‘foreign business establishment’ (FBE) as defined in s 9D(1) of the Act and, accordingly, qualified for a tax exemption. Hence, no amount of income from CGFM should be included in CIMSA’s income under s 9D of the Act. An appeal was then filed by the tax authorities with the Supreme Court of Appeal. Judgement of Court The Court set aside the decision of the Tax Curt and issued a decision in favour of the tax authorities. Excerpt “[54]   The essential operations of the business must be conducted within the jurisdiction in respect of which exemption is sought. While there are undoubtedly many functions which a company may choose to legitimately outsource, it cannot outsource its primary business. To enjoy the same tax levels as its foreign rivals, thereby making it internationally competitive, the primary operations of that company must take place in the same foreign jurisdiction. [55]   On these particular facts, I conclude that the primary operations of CGFM’s business (and, therefore, the business of the controlled foreign company as defined) is that of fund management which includes investment management. These are not conducted in Ireland. Therefore, CGFM does not meet the requirements for an FBE exemption in terms of s 9D(1). As a result, the net income of CGFM is imputable to CIMSA for the 2012 tax year in terms of s 9D(2).” Click here for translation ...

The South African Supreme Court of Appeal, by a majority of the court, upheld an appeal against the decision of the Tax Court, in which it was held that contracts between companies in the Sasol Group of companies, for the supply of crude oil by a company in the Isle of Man to a group company in London, and the on sale of the same crude oil to Sasol Oil (Pty) Ltd in South Africa, were simulated transactions. As such, the Tax Court found that the transactions should be disregarded by the Commissioner for the South African Revenue Service, and that the Commissioner was entitled to issue additional assessments for the 2005, 2006 and 2007 tax years. On appeal, the Court considered all the circumstances leading to the conclusion of the impugned contracts, the terms of the contracts, the evidence of officials of Sasol Oil, the time when the contracts were concluded (2001), and the period when Sasol Oil may have become liable for the income tax that the Commissioner asserted was payable by Sasol Oil (2005 to 2007). It held that the uncontroverted evidence of the witnesses for Sasol Oil was that in 2001, when the contracts were first concluded, the witnesses had proposed them not in order to avoid tax (residence based tax introduced in mid-2001) but because they had a commercial justification. In any event, the liability for residence based tax would have arisen only when one party to the supply agreement, resident in the Isle of Man, became a foreign controlled company in so far as Sasol Oil was concerned. That had occurred only in 2004. A finding of simulation would have entailed a finding that many individuals and corporate entities, as well as several firms of auditors, were party to a fraud over a lengthy period, for which there was no evidence at all. The Court thus found that the Commissioner was not entitled to issue the additional assessments and that Sasol Oil’s appeal to the Tax Court against the assessments should have been upheld. See the prior dicision of the Tax Court here Case 28/2018 Click here for translation ...

The taxpayer is registered and incorporated in the Republic of South Africa and carries on business in the petrochemical industry. It has some of its subsidiaries in foreign jurisdictions. Business activities include the importation and refinement of crude oil. This matter concerns the analysis of supply agreements entered into between the XYZ Corp and some of its foreign subsidiaries. It thus brings to fore, inter alia the application of the South African developing fiscal legal principles, namely, residence based taxation, section 9D of the Income Tax Act 58 of 1962 and other established principles of tax law, such as anti-tax avoidance provisions and substance over form. Tax avoidance is the use of legal methods to modify taxpayer’s financial situation to reduce the amount of tax that is payable SARS’s ground of assessment is that the XYZ Group structure constituted a transaction, operation or scheme as contemplated in section 103(1) of the Act. The structure had the effect of avoiding liability for the payment of tax imposed under the Act. The case is based on the principle of substance over form, in which event the provisions of section 9D will be applicable. Alternatively the respondent’s case is based on the application of section 103 of the Act. XYZ Group denies that the substance of the relevant agreements differed from their form. It contends that both in form and substance the relevant amounts were received by or accrued to XYZIL from sale of crude oil by XYZIL to SISIL. XYZ Group states that in order to treat a transaction as simulated or a sham, it is necessary to find that there was dishonesty. The parties did not intend the transaction to have effect in accordance with its terms but intended to disguise the transaction. The transaction should be intended to deceive by concealing what the real agreement or transaction between the parties is. Substance over form: If the transaction is genuine then it is not simulated, and if it is simulated then it is a dishonest transaction, whatever the motives of those who concluded the transaction. The true position is that „the court examines the transaction as a whole, including all surrounding circumstances, any unusual features of the transaction and the manner in which the parties intend to implement it, before determining in any particular case whether a transaction is simulated. Among those features will be the income tax consequences of the transaction. Tax evasion is of course impermissible and therefore, if a transaction is simulated, it may amount to tax evasion. But there is nothing impermissible about arranging one’s affairs XYZ as to minimise one’s tax liability, in other words, in tax avoidance. If the revenue authorities regard any particular form of tax avoidance as undesirable they arefree to amend the Act, as occurs annually, to close anything they regard as a loophole. That is what occurred when s 8C was introduced. Once that is appreciated the argument based on simulation must fail. For it to succeed, it required the participants in the scheme to have intended, when exercising their options to enter into agreements of purchase and sale of shares, to do XYZ on terms other than those set out in the scheme. Before a transaction is in fraudem legis in the above sense, it must be satisfied that there is some unexpressed agreement or tacit understanding between the parties. The Court rules as follows: The question is whether the substance of the relevant agreements differs from form. The interposition of XIXL and the separate reading of “back-to-back” agreements take XIXL out of the equation. Regrettably no matter how the appellant’s witnesses try to dress the contracts and their implementation, the surrounding circumstances; implementation of the uncharacteristic features of the transaction point to none other than disguised contracts. The court can only read one thing not expressed as it is; tax avoidance. Based on the evidence the court concludes that the purpose of relevant supply agreements was to avoid the anticipated tax which would accrue to XYZIL, a CFC if it sold the crude oil directly to XYZ. The court has concluded that the whole scheme and or the implementation of supply agreements is a sham. The court, therefore cannot consider the facsimile argument in isolation to support the averment that the contracts were concluded in IOM. Furthermore there is nothing before court to the effect that XYZIL has an FBE with a truly active business with connections to South Africa being used for bona fide non- tax business purposes. There is not even a shred of evidence alluding to the existence of an FBE. Section 76 (2) empowers SARS with a discretion to remit a portion or all of the additional tax assessment in terms of section 76 (1). Additional tax prescribed in Section 76(1) is 200% of the relevant tax amount. The appeal is dismissed. The assessments by the South African Revenue Services for 2005, 2006 and 2007 tax years as well as interest and penalties, are confirmed ...

This case concerns the sale of extended warranties to third-party customers of Dixons, a large retail chain in the UK selling white goods and home electrical products. The DSG group captive (re)insurer in the Isle of Man (DISL) insured these extended warranties for DSG’s UK customers. Until 1997 this was structured via a third-party insurer (Cornhill) that reinsured 95% on to DISL. From 1997 onwards the warranties were offered as service contracts that were 100% insured by DISL. The dispute concerned the level of sales commissions and profit commissions received by DSG. The Tax Tribunal rejected the taxpayer’s contentions that the transfer pricing legislation did not apply to the particular series of transactions (under ICTA 88 Section 770 and Schedule 28AA) – essentially the phrases ‘facility’ (Section 770) and ‘provision’ (Schedule 28AA) were interpreted broadly so that there was something to price between DSG and DISL, despite the insertion of a third party and the absence of a recognised transaction between DSG and the other parties involved. The Tax Tribunal also rejected potentially comparable contracts that the taxpayer had used to benchmark sales commissions on similar contracts on the basis that the commission rate depended on profitability, which itself depended on the different level of loss ratios expected in relation to the products covered. A much more robust looking comparable provider of extended warranty cover offered as a benchmark for the market return on capital of DISL was also rejected owing to its differing relative bargaining power compared to DISL. This third-party re-insurer was considered to be a powerful brand providing extended ‘off-the-shelf’ warranty cover through disparate distributors – the tribunal noted that DSG had a strong brand, powerful point of sales advantage through access to customers in their shops and could easily have sourced the basic insurance provided by DISL elsewhere. The overall finding of the Tax Tribunal was that, to the extent that ‘super profits’ were available, these should be distributed between the parties according to the ability of each party to protect itself from normal competitive forces and each party’s bargaining power. The Tax Tribunal noted in this context that DISL was entirely reliant on DSG for its business. According to the facts of this case, the super profits were deemed to arise because of DSG’s point-of-sale advantage as the largest retailer of domestic electrical goods in the UK and also DSG’s past claims data. DISL was considered to possess only routine actuarial know-how and adequate capital, both of which DSG could find for itself. As a result, the tribunal thought that a profit-split approach was the most appropriate, whereby DISL was entitled to a market return on capital, with residual profit over and above this amount being returned to DSG via a profit commission. This decision offers valuable insights into consideration of the level of comparability demanded to support the use of comparable uncontrolled prices; Selection of the appropriate ‘tested party’ in seeking to benchmark a transaction; The importance of bargaining power; Approval of profit split as the most appropriate methodology; That a captive insurer that is underwriting ‘simple’ risks, particularly where the loss ratios are relatively stable and predictable, and that does not possess significant intangibles or other negotiating power, should not expect to earn more than a market return to its economic capital ...