Page 645 - SAIT Compendium 2016 Volume2

IN 75 (2) Income Tax acT: InTeRPReTaTIon noTes IN 75 (2)
Example 2 – Interpretation of the de nition in section 41(1)
Facts:
Companies A, B, C and D are incorporated and effectively managed in South Africa. A directly holds 100% of the equity shares in B and C. These shares are held on capital account and there are no contractual obligations, rights or options to purchase or sell the shares under particular circumstances. C directly holds 100% of the equity shares in D. These shares are held as trading stock.
Result:
Application of the de nition in section 1(1) to A, B, C and D
A, B, C and D meet the requirements of the de nition in section 1(1) because A directly holds at least 70% of the equity shares in B and C. As such, B and C are ‘controlled group companies’ as de ned. A indirectly holds at least 70% of the equity shares in D through another controlled group company, namely, C. C and D meet the requirements of the de nition in section 1(1) because C holds at least 70% of the equity shares in D.
Application of the proviso to the de nition in section 41(1) to A, B, C and D
Paragraph (ii)(aa) of the proviso deems all D’s shares not to be equity shares because C holds them as trading stock. D cannot therefore be a ‘controlled group company’ as de ned in the de nition in section 1(1) and is excluded from consideration as part of the group of companies in the de nition in section 41(1). None of the exclusions in paragraph (i) or deeming provisions in paragraph (ii) of the proviso apply to A, B or C. The de nition in section 1(1) must now be re-applied to A, B and C to determine if there is a group of companies for the purposes of the corporate rules, bearing in mind that D has been eliminated as part of the group.
Application of the de nition in section 1(1) to A, B and C
A, B and C still meet the requirements of the de nition in section 1(1) because A directly holds at least 70% of the shares in B and C. As such, B and C are ‘controlled group companies’ as de ned. Accordingly, A, B and C are a group of companies for purposes of the corporate rules.
4.2 Tax discrimination under tax treaties
Article 24(5) of the OECD Model Tax Convention on Income and on Capital* provides as follows:
‘5. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the rst-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected
requirements to which other similar enterprises of the rst-mentioned State are or may be subjected.’
In HM Revenue and Customs v FCE Bank Plc† a company resident in the United States of America (USA) owned and controlled two companies resident in the United Kingdom (UK). Under the UK’s group taxation provisions the one subsidiary wished to ‘surrender’ its assessed loss to the other subsidiary. The Commissioners for Her Majesty’s Revenue and Customs (HMRC) refused to permit the transfer of the assessed loss on the grounds that the two subsidiaries did not form part of a group of companies because of the exclusion of their USA parent company from the group for group taxation purposes. The court held that HMRC’s refusal to allow the transfer of the assessed loss amounted to discrimination under Article 24(5) of the Double Taxation Convention between the UK and the USA and dismissed HMRC’s appeal. The court’s reasoning was that had the two subsidiaries had a resident parent company they would have
been entitled to transfer the assessed loss and accordingly there was discrimination.
The question arises whether this judgment could nd application under the corporate rules, for example, when a
foreign incorporated parent company, which is not effectively managed in South Africa, holds shares in two resident subsidiaries and the subsidiaries are denied roll-over relief on a transfer of assets between them under section 45 because of the operation of the proviso. The parent company in this example would be a non-resident for income tax purposes.‡
In deciding this question it is necessary to determine whether two resident subsidiaries of a resident parent company which are in a similar position would be denied group relief.
The proviso does not discriminate against resident companies because they are wholly or partially owned or controlled, directly or indirectly, by one or more non-resident parent companies. Rather it does so because the parent companies are not liable to taxation in South Africa except on South African-source income and capital gains on South African immovable property and assets of a permanent establishment in South Africa. The relief is also denied to resident subsidiaries of a resident parent company when the parent company is exempt or partially exempt from normal tax. For example, subsidiaries of the following resident companies are excluded from a group of companies under paragraph (i) of the proviso:
• A co-operative [paragraph (i)(aa)].
• An association formed in South Africa to serve a speci ed purpose, bene cial to the public or a section of the public
[paragraph (i)(aa)].
• A portfolio of a collective investment scheme in property that quali es as a REIT [paragraph (i)(aa)].§
• A ‘non-pro t company’ as de ned in section 1 of the Companies Act No. 71 of 2008 [paragraph (i)(bb)].
* (July 2010) issued by the Organisation for Economic Co-operation and Development.
† [2012] EWCA Civ 1290 (17 October 2012).
‡ The parent company would be a company contemplated in paragraph (i)(ee) of the proviso and would not form part
of a group of companies with its South African subsidiaries
§ The requirement that a collective investment scheme in property must qualify as a REIT was inserted by section 4(1)
(f) of the Taxation Laws Amendment Act No. 31 of 2013 and applies to years of assessment commencing on or after 1 January 2015
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