Page 300 - SAIT Compendium 2016 Volume2

IN 18 (3) Income Tax acT: InTeRPReTaTIon noTes IN 18 (3)
Example 32 – Application of section 6quat(1) to foreign taxes proved to be payable by an intermediate CFC which taxes relate to the net income of a lower tier CFC resident in another foreign country
Facts:
A resident company owns 100% of the shares in a CFC resident in Country A (CFC A). CFC A owns 100% of the shares in a CFC resident in Country B (CFC B). The above-mentioned companies have a December year-end. The following information is relevant for the 2015 year of assessment ending December:
CFC B derives passive income of R100 000. CFC B does not have a business establishment in Country B. CFC B is subject to tax in Country B on the passive income of R100 000. The foreign tax amounts to R10 000. CFC B distributes the after-tax income of R90 000 as a dividend to CFC A. Country B does not levy any withholding tax on the dividend declared by CFC B to CFC A. Country A has CFC rules similar to that of South Africa. The application of the CFC rules results in the attributed income which is included in CFC A’s taxable income (R100 000) being subject to tax in Country A at a rate of 30% which represents a tax liability of R30 000. Country A does not give CFC A any foreign tax credits. The dividend is exempt from tax in Country A.
Result:
Under South Africa’s CFC rules each CFC in a chain of CFCs is considered separately.
CFC B
Section 6quat(1A) speci cally provides that the foreign taxes proved to be payable to a sphere of a foreign government by any CFC in respect of the proportional amount attributed to the resident may qualify for a foreign tax rebate. CFC B’s passive income of R100 000 is attributed to and included in the resident company’s income under section 9D(2). Accordingly, the foreign tax paid by CFC B of R10 000 potentially quali es for a foreign tax rebate in the hands of the resident company under section 6quat(1).
The foreign taxes paid by CFC A also potentially qualify for a foreign tax rebate in the hands of the resident company because those foreign taxes are paid by a CFC and the passive income which was attributed to CFC A under Country A’s tax rules, and on which the foreign tax is payable, is the same income as that which was attributed to the resident company under section 9D(2).
CFC A
The dividend of R90 000 received by CFC A from CFC B constitutes a foreign dividend for purposes of calculating CFC A’s net income under section 9D(2A). However the full amount quali es for the participation exemption under section 10B(2)(a). Thus the net income of CFC A that is attributable to the resident company under section 9D(2) equals RNil. Even if the dividend had been included in net income for South African attribution purposes, the foreign taxes paid by CFC A in Country A would not qualify for a rebate under section 6quat(1) as the tax was paid on attributed notional income under Country A’s CFC rules and not on actual income (the dividend).
4.7.2 The three-step CFC limitation process
The amount of foreign taxes which qualify for a foreign tax rebate on the proportional amount of a CFC’s income which is attributed to the income of a resident is determined under a three-step limitation process. The three steps are as follows:
• Step 1 – Determine the amount of foreign tax incurred by the CFC which is attributable to the proportional amount of
net income included in the resident’s income.
• Step 2 – Determine if the proportional amount of foreign tax determined in step 1 is further limited to the relevant
amount of South African normal tax [paragraph (iA)(bb) of the proviso to section 6quat(1B)(a)].
• Step 3 – Apply the overall normal tax on taxable income limitation [section 6quat(1B)(a)] taking steps 1 and 2 into
account.
Step 1 – Determine the amount of foreign tax incurred by the CFC which is attributable to the proportional amount of net income included in the resident’s income.
A resident potentially quali es for a rebate on the foreign taxes proved to be payable by a CFC that relates to the proportional amount of that CFC’s net income which is included in the resident’s income under section 9D. In assessing whether the foreign tax is proved to be payable from the CFC’s perspective it will be necessary to consider the applicable foreign domestic tax law and any tax treaties that are applicable to the CFC and the other foreign country. The tax treaty between South Africa and the foreign jurisdictions will not be relevant in these circumstances. The amount of foreign taxes incurred by the CFC must be adjusted to –
(a) only re ect the resident taxpayer’s effective interest in the CFC (that is, the same interest referred to above when determining the proportional amount of net income requiring attribution); and
(b) restrict the amount of foreign tax qualifying when the foreign taxable income is greater than the attributable net income calculated according to South African tax principles.*
In circumstances where the restriction under (b) is applicable, the amount of foreign taxes is further limited by the amount that the net income (as determined under South African tax principles) bears to the foreign taxable income (as determined under foreign tax principles). For example, if the resident holds 75% of the participation rights only 75% of the foreign tax is potentially available for the foreign tax rebate. In addition, if the amount of net income is R1m and the amount of foreign taxable income (in rand) is R3m, then 75% of the qualifying foreign taxes will be further limited by a
* A gross up is not applicable when the foreign taxable income is less than the attributable net income calculated according to South African tax principles
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