Big blow to South African taxman

The South African Revenue Service (SARS) was recently hit with a major legal blow in the final step of its years-long tax dispute with asset manager Coronation.

Tax attorneys at Tax Consulting SA, Bronwin Richards and Micaela Paschini, outlined how this battle led to a major victory for Coronation – and saved one of South Africa’s top fund managers a tax bill of almost R800 million.

The legal battle was initiated when Coronation disputed SARS’ assessment of the find manager’s taxable income in 2012.

This assessment attributed the net profits of the company’s Irish subsidiary, Coronation Global Fund Managers (CGFM), to the asset manager’s South African operations. 

This finding resulted from CGFM being considered Coronation’s controlled foreign company (CFC). Effectively, as a CFC, CGFM’s profits would be included in Coronation’s taxable income.

Coronation disputed SARS’ assessment because it argued that CGFM meets the foreign business establishment (FBE) exemption. 

This exemption acts as a relief mechanism and is specifically included in section 9D of the Income Tax Act to exempt the income of a CFC where it can substantiate that the CFC amounts to an FBE.

In simple terms, if Coronation’s controlled foreign company fits the definition of a foreign business establishment, that company’s income is exempt from Coronation’s taxable earnings.

However, SARS argued that CGFM does not meet the requirements of an FBE, and its income should thus be imputed to Coronation. 

This contention led to the years-long journey that culminated in the highest court in the country ruling in Coronation’s favour.

The matter was initially brought before the Tax Court, which sided with Coronation. However, SARS took the case to the Supreme Court of Appeal (SCA), which ruled in favour of the taxman.

The Appeal Court determined that CGFM’s profits should be included in Coronation’s taxable income.

The SCA judgment considered the requirements a taxpayer must fulfil to successfully rely on the FBE exemption. A core aspect of this enquiry was whether CGFM’s primary operations included investment management functions.

After hearing testimony from key representatives of the Coronation Group, the SCA held that CGFM outsourced its investment management functions, which formed part of its primary functions. 

Outsourcing these primary functions meant that CGFM did not meet the “economic substance” requirements to qualify as an FBE.

Therefore, the SCA ruled that, in addition to the additional taxes, Coronation had to pay the interest accrued on the amount assessed by SARS and costs. The SCA dismissed SARS’ claim for penalties.

After this ruling, Coronation applied to the Constitutional Court for leave to appeal the SCA judgement.

However, the SCA’s ruling was considered an obligating event. This means that Coronation had a present obligation to pay the additional taxes and interest, which includes years of assessments from 2012 to 31 March 2024.

Therefore, Coronation’s total obligation payable to SARS in 2023 for this matter amounted to R716 million.

However, the tides turned when the matter was brought before the Constitutional Court.

In the unanimous judgment of Majiedt J, the Constitutional Court disagreed with SARS and the SCA’s decision.

The court considered CGFM’s business and found that it consisted of fund management activities rather than investment management activities. This means that the investment management activities that CGFM outsourced were not its primary functions.

The evidence before the court included the licence conditions under which CGFM could operate, the prudential considerations, and the fact that the evidence went uncontested.

To the Constitutional Court, this evidence conclusively proved that CGFM’s core business did not extend to investment management.

Therefore, in finding that the primary operations of CGFM were not outsourced, the court held that CGFM’s day-to-day operations in Ireland met the “economic substance” requirements of the FBE exemption. 

The net income of CGFM could, therefore, not be imputed to Coronation and should accordingly not be included in its taxable income. 

The long-awaited conclusion to this dispute will save one of South Africa’s top fund managers a tax bill of almost R800 million, Richards and Paschini said.

“This groundbreaking ruling underscores the importance of a substantial business presence abroad to qualify for the FBE exemption and reminds us of the enormous tax consequences that may follow when this exemption is not correctly applied,” the tax attorneys said.

“The clear disconnect between the judgments of the SCA and Constitutional Court, notwithstanding that the same evidence and tax principles were considered reveals that there remains a large degree of varying interpretation of the law concerning the taxability of CFCs.”

They cautioned taxpayers with offshore entities to obtain robust tax advice in light of the contradicting judgments handed down.