EXPATRIATE TAX LAW CHANGE & MOZAMBIQUE IMMIGRATION REGIME

Controlled Foreign Companies –
South African Tax Considerations

Controlled Foreign Companies – South African Tax Considerations

South Africa’s tax system includes a Controlled Foreign Company (CFC) regime designed to address the taxation of income earned by foreign companies owned by South African tax residents.  

Where a South African tax resident holds or controls a foreign company, they may be subject to income tax in South Africa on the CFC’s foreign income, even if that income has not yet been distributed. This is an anti-avoidance measure to prevent South African tax residents from utilising foreign companies in the avoidance of South African tax.

What is a Controlled Foreign Company?

A CFC is broadly defined in section 9D of the Income Tax Act, No. 58 of 1962, as any foreign company where more than 50% of the total participation rights or voting rights are directly or indirectly held or exercisable by one or more South African tax residents.

Where this threshold is met, and unless a specific exemption applies, the net income of the CFC must be included in the income of the South African resident(s) in proportion to their participation rights, and taxed accordingly.

Taxpayers who fail to accurately account for a CFC’s income risk audit or reassessment by SARS, especially in light of increased global transparency and data sharing through mechanisms such as the Common Reporting Standard.

Key Features of the CFC Regime

• Deemed Income Inclusion: The net income of a CFC is deemed to accrue to South African resident shareholders.
• High Tax Exemption: A CFC’s income may be exempt from inclusion if it is subject to tax in a foreign jurisdiction at a rate of at least 67,5% of the South African tax that would have been payable, had the CFC been a resident of South Africa.
• Foreign Business Establishment (FBE) Exemption: Income earned through a “foreign business establishment” may be exempt where the CFC carries on substantial economic activity in its foreign jurisdiction. This is a factual enquiry and subject to rigorous scrutiny by SARS.
• Passive Income Rules: Passive income (such as interest, royalties, rental, and certain capital gains) is more likely to be caught by the CFC rules, particularly where there is no meaningful economic substance abroad.
• Anti-Avoidance and Transfer Pricing: The CFC rules operate alongside other anti-avoidance provisions, including transfer pricing rules and the general anti-avoidance rules, ensuring that offshore structures with little commercial rationale may still be taxed in South Africa.

Place of Effective Management and Corporate Tax Residency in South Africa

South Africa follows a residence-based system of taxation, meaning that resident companies are subject to tax on their worldwide income.

In terms of section 1 of the Income Tax Act, No. 58 of 1962 (the Act), a company is regarded as a South African tax resident if it is either:

1. Incorporated, established or formed in South Africa; or
2. Has its place of effective management (POEM) in South Africa,

unless a double tax agreement (DTA) provides otherwise.

The concept of POEM is central to determining a company’s tax residency, particularly where cross-border structures are involved. It affects both foreign companies with South African involvement and South African-incorporated entities that may be managed from abroad.

What is Place of Effective Management?

Although not defined in the Act, POEM has been interpreted through South African case law, SARS guidance, and international commentary, particularly the OECD Model Tax Convention and Commentary thereto.

Broadly, POEM refers to the location where key management and commercial decisions necessary for the conduct of the entity’s overall business are made, in substance and not merely in form.

The determination of POEM is a factual enquiry, and is not limited to formalities such as the registered office, place of incorporation, or location of board meetings. Instead, it focuses on:

• Who exercises strategic control, and
• Where such decisions are actually made and implemented.

Application in Cross-Border Contexts

POEM plays a critical role in determining corporate tax residency in both inbound and outbound scenarios:

• Inbound structures: Foreign-incorporated companies may be deemed South African tax residents if their effective management is located in South Africa, which is often the case where South African shareholders or directors run the business.
• Outbound structures: South African-incorporated companies may be treated as non-resident for tax purposes if their POEM is demonstrably situated offshore. However, this outcome requires real substance and consistent governance in the foreign jurisdiction.

Both scenarios must be carefully evaluated in light of South African domestic law and any applicable DTA.

Interaction with Double Tax Agreements

Where a company is regarded as resident in both South Africa and another jurisdiction, the relevant DTA will typically contain a tie-breaker clause to resolve the conflict.

Most of South Africa’s DTAs allocate tax residency to the country where the company’s POEM is located. However, some newer treaties apply a Mutual Agreement Procedure (MAP), requiring the tax authorities of both states to determine residence based on additional factors.

Correct DTA application is essential to avoid dual residency exposure and to obtain treaty relief on dividends, interest, royalties, and other income.

Practical Implications for Companies

Incorrect or dual tax residency status can expose a company to:

• Double taxation on the same income across two jurisdictions;
• Withholding tax complications, including denied treaty relief on dividends, interest, and royalties;
• Increased scrutiny by SARS, especially in outbound structures where POEM may be artificially shifted offshore; and
• Transfer pricing risk where management functions are split across jurisdictions.

Permanent Establishment – Tax Exposure in Cross-Border Contexts

As businesses expand across borders, one of the key tax risks they face is the inadvertent creation of a permanent establishment (PE) in a foreign jurisdiction. A PE may trigger foreign income tax exposure for a company even in the absence of incorporation or tax residency in that jurisdiction.

South African companies with offshore activities, or foreign companies with South African operations, must be aware of the PE concept, how it arises, and how it interacts with applicable Double Tax Agreements (DTAs).

What Is a Permanent Establishment?

A PE is generally defined in a DTA as a fixed place of business through which the business of an enterprise is wholly or partly carried on. Common examples include:

• A branch, office, factory, workshop, or place of management;
• A building site or construction project lasting more than a specified period (often 6 to 12 months); or
• The presence of a dependent agent who regularly concludes contracts on behalf of the foreign entity.

South Africa’s DTAs typically follow the OECD Model Tax Convention, and many incorporate updated provisions from the Multilateral Instrument (MLI), which narrows common avoidance strategies and expands the scope of PE risk.

Inbound vs Outbound Permanent Establishment Risk

• Inbound PE risk: A foreign company may be taxed in South Africa if its activities in South Africa amount to a PE under the applicable DTA. This could occur where there is a fixed place of business, staff performing core functions, or a local agent concluding contracts on behalf of the foreign entity.
• Outbound PE risk: A South African company operating abroad may face foreign tax exposure if it is deemed to have created a PE in the foreign jurisdiction, for example through a warehouse, a project office, or local contractors under its control.

Even short-term or project-based activities can give rise to PE risks if not carefully managed and monitored.

Consequences of a Permanent Establishment Finding

If a PE is found to exist:

• The host country gains taxing rights over the profits attributable to that PE;
• The company may be subject to corporate income tax, VAT registration, and payroll compliance obligations in the foreign jurisdiction; and
• Transfer pricing scrutiny may be triggered, especially in relation to intra-group transactions and profit attribution methods.

Non-compliance can result in penalties, double taxation, and reputational harm.

In a connected world, even limited physical or digital presence in a foreign country can create tax exposure. Managing PE risk is essential for international tax compliance and operational efficiency.

Controlled Foreign Companies –
South African Tax Considerations

South Africa’s tax system includes a Controlled Foreign Company (CFC) regime designed to address the taxation of income earned by foreign companies owned by South African tax residents.  

Where a South African tax resident holds or controls a foreign company, they may be subject to income tax in South Africa on the CFC’s foreign income, even if that income has not yet been distributed. This is an anti-avoidance measure to prevent South African tax residents from utilising foreign companies in the avoidance of South African tax.

What is a Controlled Foreign Company?

A CFC is broadly defined in section 9D of the Income Tax Act, No. 58 of 1962, as any foreign company where more than 50% of the total participation rights or voting rights are directly or indirectly held or exercisable by one or more South African tax residents.

Where this threshold is met, and unless a specific exemption applies, the net income of the CFC must be included in the income of the South African resident(s) in proportion to their participation rights, and taxed accordingly.

Taxpayers who fail to accurately account for a CFC’s income risk audit or reassessment by SARS, especially in light of increased global transparency and data sharing through mechanisms such as the Common Reporting Standard.

Key Features of the CFC Regime

• Deemed Income Inclusion: The net income of a CFC is deemed to accrue to South African resident shareholders.
• High Tax Exemption: A CFC’s income may be exempt from inclusion if it is subject to tax in a foreign jurisdiction at a rate of at least 67,5% of the South African tax that would have been payable, had the CFC been a resident of South Africa.
• Foreign Business Establishment (FBE) Exemption: Income earned through a “foreign business establishment” may be exempt where the CFC carries on substantial economic activity in its foreign jurisdiction. This is a factual enquiry and subject to rigorous scrutiny by SARS.
• Passive Income Rules: Passive income (such as interest, royalties, rental, and certain capital gains) is more likely to be caught by the CFC rules, particularly where there is no meaningful economic substance abroad.
• Anti-Avoidance and Transfer Pricing: The CFC rules operate alongside other anti-avoidance provisions, including transfer pricing rules and the general anti-avoidance rules, ensuring that offshore structures with little commercial rationale may still be taxed in South Africa.