Proposed amendments in the draft bill
The controlled-foreign-company rules, which deem the taxable income of a foreign company to be that of its RSA resident individual shareholders, notwithstanding the non-declaration of a dividend, have to date been easily circumvented by means of the interposition of a foreign trust as shareholder (the CFC Rules were amended in 2017 for resident companies but not for individuals).
The reason is that the definition of a ‘controlled foreign company’ requires that RSA individual residents must hold more than 50% of the participation or vesting rights of the foreign company, which is not the position if the shareholder is a nonresident trust.
The result of such an interposition is that taxable income and capital gains could be deferred until such time (if ever) that the RSA individual beneficiaries of the foreign trust enjoy a tax accrual or receipt upon the award by the trustees of a vested right to them.
The proposed amendments to the rules provide not for a deemed ‘see-through’ of the trust to the company under s 9D but a less invasive recharacterisation of exempt dividends and capital gains.
A. Participation exemption re dividend removal (s 10B(2)(a) and s 7(8)(aA))
In the determination of the income-attribution under a donation or soft loan to a foreign trust owning 50% or more of a foreign company, the dividend exemption (which applies if a person holds at least 10% of the equity or voting rights in the foreign company) is ignored. Simply put, the intermediation of a foreign trust to hold the shares of a foreign company (instead of a holding of such shares directly in a RSA resident’s own name) is penalized, since any income is recharacterised as fully taxable income.
B. Participation vested right exemption re dividend removal (s 25B)
A vested right (distribution) to capitalized dividend income accruing or received by a trust beneficiary will be treated as fully taxable income, with no s 10B(2)(a) dividend exemption.
C. Participation exemption removal re capital gains (paras 64B and 72 of the Eighth Schedule to the act)
In the determination of the capital-gain-attribution in circumstances described in A above (attribution owing to a donation or soft loan) the capital gain exemption is ignored; thus the full gain is subject to the CGT.
D. Participation exemption removal re capital gains (para 80 of the Eighth Schedule)
When a beneficiary obtains a vested right to a capital gain, the full gain is subject to the CGT, since the s 64B exemption (which applies if a person holds at least 10% of the equity or voting rights in the foreign company) is ignored.
If the proposed amendments are adopted, the effective date will be 1 March 2019. The proposals are only in draft form, and may be amended after public submissions are considered.