Coronation's Pursuit of Legal Resolution for Tax Bill Reaches Constitutional Court

The Coronation tax case, which has received a lot of attention, appears to be heading to the Constitutional Court as the company seeks a resolution to its significant tax liability. Coronation has formally filed an application for leave to appeal a Supreme Court of Appeal (SCA) judgement that has saddled it with a tax obligation in excess of R700 million. Meanwhile, the Draught Taxation Laws Amendment Bill, which was released at the end of July, proposes to formalise the SCA’s decision. If ratified in its current form, this legislation could potentially expose a wide range of offshore entities to increased risk.

There have been numerous criticisms of the SCA’s decision. Dennis Davis, a well-known South African tax expert and former judge, expresses his concerns about the Coronation ruling, emphasising that the court imposed a specific business model on the company’s operations. Davis is unsure if this interpretation is consistent with the legislative intent.

Tax considerations pertaining to South Africa’s controlled foreign company (CFC) regulations and the exemption for foreign business establishments are at the heart of the matter. The main legal issue was whether the net earnings of Coronation Global Fund Managers (CGFM), based in Dublin, should be included in the taxable revenue of its South African holding company, Coronation Investment Management SA (Cimsa).

Under the Income Tax Act, Coronation (Ireland) was classified as a controlled foreign company because it outsourced aspects such as investment management. The South African Revenue Service (Sars) prevailed over the SCA, claiming that the Dublin-based company lacked the necessary workforce and resources to carry out its primary operations. According to the SCA, a controlled foreign company could only qualify for an exemption if it was a legitimate business entity.

Davis brings up an important point by demonstrating how the SCA has essentially established an objective standard for a company’s eligibility for foreign business exemption. He claims that such a standard is unlikely to be achievable in a globalised world. Peter Dachs, an ENSafrica tax executive, joins the discussion, claiming that the case’s resolution was incorrect. Dachs contends that determining a foreign entity’s primary operations, particularly after outsourcing, should rely on factual analyses rather than broad assumptions.

The central question arises: should the outsourcing of specific functions be regarded as integral to a company’s primary operations or as merely incidental activities? Davis expresses his concerns in a thorough analysis published in The Taxpayer. He observes that if the court accurately presented the facts from the initial pleadings, the decision can be interpreted as the court imposing its own model of fund management rather than acknowledging taxpayers’ diverse approaches. Davis adds that this is yet another example of questionable tax jurisprudence emanating from the SCA.

Joon Chong, a tax partner at Webber Wentzel, introduces the commercial rationale dimension, emphasising that South African businesses may choose to outsource their operational needs to foreign countries rather than opt for organic growth. Chong emphasises the cost-effectiveness, time efficiency, and reduced risks associated with outsourcing to established local service providers. She focuses on the fund management scenario, in which various aspects such as investment management, administration, and marketing are frequently outsourced to expert service providers in the global funds industry.

Chong points out that the Coronation decision made no mention of this objective external fact. She compares logistics chains involved in shipping and customs clearance, emphasising the importance of delivering goods to customers. Using a similar lens, the critical question arises: does a controlled foreign company need to manage international logistics functions internally, or can these be outsourced without jeopardising the company’s legitimacy?

In response to these complexities, a proposed legislative amendment aims to limit the outsourcing of significant functions by a controlled foreign company. Only a group affiliate located in the same country as the controlled foreign company’s fixed place of business may be outsourced by the entity. Chong, on the other hand, sees the January 1, 2024, effective date as problematic, particularly for entities with fiscal years ending in February, March, or June 2024, as they may become entangled in the proposed provisions, triggering uncertainties and potential tax liabilities.

As the debate continues, Davis advocates for the democratic and legal approach of amending legislation if it is being abused. He claims that it is not the role of the judiciary to perform legislative functions. Dachs anticipates that National Treasury will engage stakeholders through workshops and incorporate various comments, making the current wording unlikely to remain unchanged in the final bill.