By Lavina Daya (ENS Tax Ensight)
In the 2012 Budget Review it was stated that a specific carve out will be created for foreign funds which have active South African investment managers who provide guidance regarding African assets of such funds. It was stated that the investment managers’ presence in South Africa may trigger various tax risks. In particular South African investment managers may cause the effective management of the foreign fund to be in South Africa, resulting in the foreign fund being brought into the South African tax net and being subject to South African tax on a world-wide basis. This is because South Africa taxes "residents” on their world-wide income, whereas non-residents are taxed only on income sourced in South Africa or deemed to be from a source in South Africa.
A South African resident is defined in the Income Tax Act No 58 of 1962 ("Income Tax Act”) as a person (other than a natural person) which is incorporated, established or formed in the Republicor which has its place of "effective management” in the Republic, but does not include any person who is deemed to be exclusively a resident of another country for purposes of the application of any Double Tax Agreement entered into by South Africa.
Therefore if a foreign fund is effectively managed in South Africa as a result of the activities of the South African investment manager, it would be regarded as being a resident for income tax and as such, be subject to South African tax on its world-wide income.
In order to mitigate this tax risk, the South African investment manager’s ability to make decisions may have been limited, undermining the very purpose of utilising a South African investment manager. Alternatively the South African investment manager may have been forced to relocate abroad.
The draft Taxation Laws Amendment Bill, 2012 ("TLAB”) which was released for comment on 5 July 2012 has proposed suggested amendments to the tax legislation to deal with the above.
In particular, National Treasury has attempted to address the issue of subjecting foreign funds to tax in South Africa as a result of the activities of a South African investment manager, by proposing amendments to the definition of a "resident” in section 1 of the Income Tax Act.
In particular, the TLAB provides for a specific carve-out from the effective management test for foreign investment funds. In terms of the proposed amendment, the "effective management” test in relation to the "foreign investment entity” will not take into account financial services (as defined in the Financial Advisory and Intermediary Services, Act 2002 (Act No. 37 of 2002) ("FAIS Act”)) or any incidental services in respect of an exempt financial product provided by a company that qualifies as a licensed "financial services provider” under the FAIS Act (i.e. a South African investment manager). The foreign fund must, however, meet the following requirements:
The fund must be incorporated, formed or otherwise established in a foreign country;
The fund must operate in a comparable fashion to a local collective investment scheme and must carry on its business outside of South Africa;
The sole assets of the fund must consist of cash or listed financial instruments (or financial instruments determined with reference to listed financial instruments, such as derivatives or rights to receive such assets);
The fund must have no employees, directors or trustees that are engaged in the management of that company or trust on a full time basis; and
- South African residents may not directly or indirectly own more than 10 per cent of the value of the shares, units or participatory interests in the fund.
Although the explanatory memorandum to the TLAB states that the purpose of this carve-out is to remove the potential for South African worldwide taxation due to the full and free use of a South Africa investment manager, in our view, this amendment does not address the South African tax implications which arise as a result of receiving South African sourced income.
As mentioned above, non-residents are only subject to tax in South Africa on income that is sourced or deemed to be sourced in South Africa. Therefore even if the foreign fund does not qualify as a resident as defined, on the basis that it is not effectively managed in South Africa, any income which it derives as a non-resident may still be subject to tax in South Africa if the source of such income is located in South Africa. As such, the income of the foreign fund may be brought into the South African tax net if the source thereof by virtue of the activities of the investment manager is located in South Africa.
It is proposed that the amendment will come into operation on 1 January 2013 and apply in respect of years of assessment commencing on or after that date.