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S.Africa: CFC rules to stay after latest budget speech

Controlled foreign company rules

Prior to 2012, certain so-called diversionary transaction rules existed which sought to impute into the income of South Africa residents, certain sales income derived by CFCs in relation to those residents, from the sales of goods that were sourced by the CFCs from connected parties in South Africa. The bad news is that these rules are to make a comeback.

The diversionary transaction rules relating to sales of goods by CFCs were acknowledged to have been introduced as an alternative to using the transfer pricing rules to ensure that profit was not unjustifiably shifted abroad through the use of intermediary sales companies located outside South Africa. In 2011, it was announced that these diversionary transaction rules would be repealed, because they were no longer necessary. Treasury explained that “[the] diversionary rules associated with South African exports to a CFC will be completely removed. Additional protection is not required, because the value-adding activities largely occur on-shore – all of which make the task of enforcing arm’s length transfer pricing principles more manageable”. Clearly there has been a change of heart, as it has been announced that these rules are to be reinstated as they are more effective than the transfer pricing rules in addressing profit shifting by South Africa companies. This will not be welcomed by taxpayers. It was acknowledged by Treasury in the past that the previous rules were “overly mechanical” in their application and it will be interesting to see when the new rules are drafted, what steps have been taken to address this concern.