Is Your Overseas Company a CFC?
This blog explores CFC compliance in South Africa for residents with foreign companies, helping you understand when the rules apply and what they mean.
We’ll begin with when the CFC rules don’t apply and then explain when they do and what that means in practice.
When the CFC Rules Don’t Apply
The Controlled Foreign Company (CFC) rules in Section 9D of the Income Tax Act are intended to tax South African residents on income earned through foreign companies they control. However, there are several exemptions.
Under Sections 9D(2A) and 9D(9), certain types of income are excluded from CFC treatment:
- Income that is taxed at a level comparable to South Africa in the foreign jurisdiction;
- Income already taxed in South Africa;
- Income from genuine business operations outside South Africa, with sufficient economic substance.
The third category refers to income earned through a Foreign Business Establishment (FBE). For a company to qualify as an FBE, all of the following conditions must be met:
- The business must operate through a fixed physical location (e.g. office, warehouse, retail space);
- The premises must be staffed with on-site management and operational employees of the CFC;
- The location must be adequately equipped to carry out the company’s core business functions;
- The necessary infrastructure must be in place to support its operations.
Understanding the company’s core business model is essential to determining whether these conditions are satisfied. Some activities – such as mining, agriculture, or construction – may naturally meet the FBE requirements when carried out abroad.
In addition, under Section 9D(2), proviso (A), a South African resident who holds less than 10% of the participation or voting rights in a foreign company is exempt from the CFC rules.
When the CFC Rules Apply
A foreign company qualifies as a Controlled Foreign Company under Section 9D(1) if any of the following conditions are met:
- More than 50% of the participation rights are directly or indirectly held by one or more South African residents (excluding headquarter companies);
- More than 50% of the voting rights are indirectly exercisable by South African residents (excluding headquarter companies); or
- The financial results of the foreign company are consolidated into the financial statements of a South African company (excluding headquarter companies), as required by IFRS 10.
The term “participation rights” refers to:
- The right to share in benefits (excluding voting rights) attached to a share or similar interest in the foreign company; or
- Where no person holds a determinable right, the right to exercise voting rights in that company.
What Does It Mean If a Non-SA Company Is Classified as a South African CFC?
If the CFC definition is met and no exemptions apply, you must include your proportional share of its income in your South African tax return, as if you earned it personally.
While you may be able to claim a rebate for foreign taxes paid under section 6quat(1)(b), the South African tax rate may be higher than the rate applied in the foreign jurisdiction. As a result, you could end up paying more tax overall than if the company were not treated as a CFC for South African tax purposes.
Due to the complex nature of these rules and the nuanced differences in individual cases, it is important to seek professional tax advice tailored to your unique position to avoid unintended consequences.
If you need any CFC support, please contact Savanna McAllister on +27 (0)21 300 2380 or email sm@eoacc.com.