An evaluation of the South African controlled foreign company rules within the digital economy

Abstract

South Africa has controlled foreign companies (CFC) rules aimed at combating South African residents from shifting their taxable income outside the South African tax net by investing or transacting through South African-owned/controlled foreign companies. South African multinational enterprises (hereafter referred to as MNE’s) have become companies with a world-wide presence and operate internationally through businesses that pose a negligible risk of tax avoidance to the South African fiscus due to avoidance measures included in the South African tax law. Electronic commerce (hereafter referred to as an e-commerce) allows for substantial business to be conducted in a country without having a fixed place of business in that country. South Africa’s CFC rules have remained predominantly unchanged and it has been argued that they have over time, become less flexible. This is particularly so in relation to meeting the foreign business establishment test. This study analysed the South African CFC rules within the context of e-commerce businesses to establish whether there are grounds to review the rules to cater for e-commerce businesses. The background to the CFC rules was given and the challenges that e-commerce poses to the South African CFC rules were discussed. The design of the UK, Australian and German CFC rules was studied, as well as responses by international organisations to the challenges posed by e-commerce. The results of this study indicate that, due to the design approach followed, the South African CFC rules are highly mechanical compared to rules in certain developed countries on which the prescripts of the South African CFC legislation are based. This study found that the current design of the regime does not cater for certain income generated by e-commerce businesses, considered as active income and therefore not targeted by the CFC rules. It was further revealed that the South African CFC rules approach to defining CFC income by targeting all income of a CFC and then only excluding income regarded as active income captures income generated by legitimate e-commerce businesses. These aspects of the South African CFC legislation are grounds for the rules to be reviewed. The paper recommends how the challenges identified can be addressed.