Commissioner for the South African Revenue Service v Coronation Investment Management SA (Pty) Ltd

Coronation Investment Management SA (Pty) Ltd (CIMSA) is a South African holding company within the Coronation Group investment company structure. CIMSA was the 100% holding company of CFM (Isle of Man) Ltd, which in turn owned Coronation Global Fund Managers (Ireland) Limited (CGFM), a company tax resident in Ireland. CGFM was incorporated in Ireland in 1997 and licensed by the Central Bank of Ireland (CBI) as a UCITS management company to provide collective investment fund management services. CGFM adopted an outsourced business model, outsourcing investment management functions to Coronation Asset Management (Pty) Ltd (CAM) in South Africa and Coronation International Ltd (CIL) in the UK, while retaining regulatory compliance and oversight functions in Dublin with a staff of four employees. For the 2012 tax year, SARS assessed CIMSA's tax liability to include the entire net income of CGFM on the basis that CGFM was a controlled foreign company whose income should be imputed to its South African holding company. CIMSA objected, claiming CGFM qualified as a 'foreign business establishment' (FBE) under section 9D of the Income Tax Act and was therefore exempt from having its income imputed.

• Whether CGFM qualified as a 'foreign business establishment' (FBE) as defined in section 9D(1) of the Income Tax Act 58 of 1962, thereby exempting its income from being imputed to its South African holding company CIMSA
• Whether the 'primary operations' of CGFM's business were conducted in Ireland, notwithstanding the outsourcing of investment management functions to entities in South Africa and the United Kingdom
• Whether the nature of CGFM's business was that of investment management or merely the management and oversight of outsourced service providers
• Whether SARS was entitled to impose understatement penalties under section 222 of the Tax Administration Act 28 of 2011
• Whether SARS was entitled to impose underestimation penalties for provisional tax under paragraph 20 of the Fourth Schedule to the Income Tax Act
• Whether interest was payable under section 89quat(2) of the Income Tax Act

1. The appeal was upheld. 2. The order of the Tax Court was set aside and substituted with an order that: (a) CIMSA is directed to pay the additional tax imposed in respect of SARS's additional assessment dated 23 March 2017, and the interest imposed thereon in terms of section 89quat(2) of the Income Tax Act 58 of 1962; (b) SARS is to pay CIMSA's costs in the Tax Court, including the costs of two counsel. 3. CIMSA is to pay SARS's costs of the appeal, including the costs of two counsel.

The primary operations of a controlled foreign company's business must be determined by reference to the actual business for which it is licensed and conducts, not by the particular business model (such as outsourcing) it adopts. Where a company is licensed to conduct investment management as part of its fund management business, and derives its income from investment management fees, the fact that it outsources the actual investment trading functions does not change the nature of its primary business from investment management to mere oversight and regulatory compliance. A company cannot outsource functions that do not form part of its business in the first place - an agent cannot perform a function which does not fall within the ambit of the principal's business. For a controlled foreign company to qualify as a 'foreign business establishment' under section 9D(1) of the Income Tax Act and thereby be exempt from having its income imputed to its South African holding company, its fixed place of business must be suitably staffed, equipped and have suitable facilities to conduct the 'primary operations' of its business. Where the primary operations (here, investment management) are outsourced and not conducted in the jurisdiction where the FBE exemption is sought, the company does not meet the requirements for the exemption, even if it maintains regulatory compliance and oversight functions in that jurisdiction.

The Court made several observations on the policy rationale underlying section 9D. It noted that the section was introduced when South Africa moved from a source-based to a resident-based tax system, and was designed as an anti-deferral regime to immediately deem back South African owned foreign company income. The FBE exemption was introduced as a balancing mechanism between preventing tax avoidance (horizontal equity) and promoting international competitiveness. The Court observed that the exemption is not solely aimed at preventing diversionary, passive or mobile income from eroding the South African tax base, but also to limit situations where exemptions are obtained over earnings in low tax jurisdictions when the primary operations are not actually conducted there. The Court noted that outsourcing is a commercial reality, particularly in Ireland where 70-80% of businesses operate on an outsourcing basis, but emphasized that while many functions may be legitimately outsourced, a company cannot outsource its primary business operations if it wishes to qualify for the FBE exemption. The Court also observed, in the context of penalties, that the fact that a court ultimately finds against a taxpayer's legal position does not in any manner reflect on the bona fides of that taxpayer, any more than it reflects on the bona fides of any losing party in litigation.

This case provides important guidance on the interpretation and application of section 9D of the Income Tax Act, particularly the 'foreign business establishment' exemption in the context of controlled foreign companies. The judgment clarifies that: (1) the 'primary operations' requirement in the FBE definition must be determined by reference to the actual licensed business activities of the foreign entity, not merely by the business model adopted (such as outsourcing); (2) outsourcing core business functions does not transform the nature of the business or elevate managerial oversight functions into the 'primary operations'; (3) a company cannot outsource functions that do not fall within the scope of its business in the first place; (4) the FBE exemption serves to balance horizontal equity concerns (between South Africans earning income domestically versus abroad) with international competitiveness, and requires that essential operations be conducted within the low-tax jurisdiction to qualify for exemption; and (5) the approach to understatement penalties under the Tax Administration Act requires SARS to prove facts beyond mere speculation, and a bona fide reliance on professional tax advice may constitute a bona fide inadvertent error. The case has significant implications for South African companies with foreign subsidiaries operating on outsourced business models, clarifying when such entities will qualify for section 9D exemptions.