Companies that meet the requirements for headquarters company status enjoy various tax benefits, including relief from the controlled foreign company rules, but difficulties have been found with the treatment of foreign subsidiaries held by headquarter companies as South African tax residents under SARS’s approach to determining a company’s place of effective management.

The place of effective management is one of the two tests used to determine whether or not a company is a tax resident. In addition, the place of effective management test is also used as the “tie breaker” rule in many of the double taxation agreements (DTAs) that South Africa entered into with other countries, which applies to determine tax residency where a company could otherwise be considered a tax resident of both contracting states under their domestic laws.

SARS has therefore issued a discussion document, which is intended to invite comments from taxpayers and practitioners regarding their concerns in this area and to provide a framework for discussion of possible revisions to its Interpretation Note 6 (IN6) on the place of effective management, issued in March 2002.

From a practical perspective, it is pointed out that a determination that a foreign operating subsidiary of a headquarter company has its place of effective management in South Africa would negate many of the benefits offered by the South African tax regime.

In particular, that foreign operating subsidiary would have to re-compute its income each year as if it were a South African resident, determine its tax liability under the Income Tax Act 58 of 1962, and then claim a rebate for any foreign income taxes proved to be payable to the country in which it operates. The foreign operating subsidiary would also be subject to secondary tax on companies and the new dividend withholding tax, which is scheduled to come into effect in April 2012.

The general approach taken by IN6 is that a company’s place of effective management is “the place where the company is managed on a regular or day-to-day basis by directors or senior managers of the company, irrespective of where the overriding control is exercised, or where the board of directors meets.”

The current focus is therefore on the location where policy and strategic decisions are executed and implemented by a company’s senior management, while taxpayers and practitioners have, instead, pushed for an approach that would focus exclusively, or almost exclusively, on the place where the ultimate authority over the company is exercised by its board of directors or similar body.

SARS’s first proposal is to refine, without abandoning, the general approach of IN6. In particular, it would be clarified that the primary emphasis is upon those “top” personnel who “call the shots” and exercise “realistic positive management”. Those individuals would be the senior officers or executives who are responsible for actually developing or formulating key operational or commercial strategies and policies for, or taking decisions on key operational or commercial actions by the company (regardless of whether those strategies, policies and decisions are subject to formal approval by a board or similar body); ensuring that those strategies and policies are carried out.

In addition, in order to more closely align this approach with international norms, current references to the “implementation” of strategy and policy would be deleted. For example, it is said, a manufacturing company may have a head office in Johannesburg, where all of its senior management is based, and a main plant in Botswana, where the manufacturing takes place under the supervision of local management. In this situation, the company’s place of effective management would be its head office in Johannesburg. The result would be the same if the company’s board of directors met in Gaborone.

However, “given the wide variety of corporate practices, and the intensely factual nature of the enquiry”, IN6 would continue to take the position that no definitive rules can be given and that all relevant facts and circumstances must be examined to determine the place of effective management of a company.

The discussion document is limited to issues involving domestic and foreign companies. ‘Legal persons’ other than companies, such as foreign hybrid entities and trusts, present separate and distinct issues, and, it is said, will be addressed in a subsequent project.

Comments should be submitted to SARS no later than October 30, 2011.