Manager Research

There have been several headlines in the media following the recent SENS announcement from Coronation regarding their ongoing tax dispute with SARS relating to their international fund management business. This note explains the nature of this tax dispute and the potential impact on Coronation’s ability to manage portfolios on behalf of investors.

Explanation of the Dispute

The dispute relates to whether the profits of Coronation’s international fund management business, based in Ireland, should accrue to the Coronation Group’s income statement based here in South Africa. If these earnings are deemed to accrue to the South African domiciled parent company, then they are subject to South African taxes.

Coronation’s standpoint is that these profits should not accrue back to South Africa. They base this view on a clause within the Income Tax Act 58 of 1962 allowing for a tax exemption where the ‘primary function’ of an offshore (Irish in this case) business is conducted in that local domicile rather than in South Africa.

The heart of the dispute between SARS and Coronation lies in the definition of what the primary function of Coronation’s international fund management business is. Coronation argues that the primary function is ‘fund management’ while SARS argues that the primary function is ‘investment management’.

The distinction is important as ‘fund management’ is deemed by Coronation to mean that their international fund management business ensures compliance with the regulator in Ireland, communicates  to investors, conducts ongoing supervision of service providers and ensures that financial controls are in place for the funds it manages. They argue that ‘investment management’ is not a core function of their business in Ireland and as such the fact that this is outsourced to their South African business still allows their profits to be exempted from South African tax.

SARS argues that ‘investment management’ is the primary function of their business and as such the outsourcing of this to their South African business means that they do not qualify for a tax exemption under the Income Tax act 58 of 1962 - specifically Section 9d which is an exemption clause aiming to balance tax avoidance and global competitiveness.

We provide a brief timeline of the dispute below:

So what is the Impact?

Importantly, there is no impact to client funds nor the management of any funds by Coronation at this time. Coronation remains fundamentally sound and while a ruling in SARS’ favour will reduce net income to the business, it is unlikely to cause a material viability concern in the short run.

Investors may have noted that the Coronation share price has declined by over 10% since the announcement of the judgement in favour of SARS in this matter. This could lead to questions regarding Coronation’s ability to retain employees and their incentivization structure, which contains an element of deferred remuneration in the form of Coronation shares. With an adverse outcome, the attractiveness of the share scheme will reduce long term value to holders – both internal and external.

There are several other consequences as well arising out of a ruling in SARS’ favour:

• Local fund managers are increasingly transitioning their businesses to a higher global allocation, in part due to the revised Regulation 28 limits on offshore exposure (up to 45% from 30% ex Africa) and in part due to investor’s desire to externalize domestic investments as the risks in our local market remain high.  The cost structure of the global allocation then becomes increasingly important to compete in a market place where the number of direct global managers, with offshore based investment teams, fall outside of the local tax net and are therefore more cost effective on this front.

• Bear in mind the externalization of certain activities such as investment management to lower tax domiciles offshore has also reduced the domestic tax base - income tax and VAT - likely an unintended consequence of the regulatory change. SARS will want to plug this gap.

• With emigration on the menu for many businesses already, an adverse ruling could also create the tipping point for businesses to establish more formal offices and team functions outside of South Africa, expediting the shift of talent offshore.

• For investors, the ruling does raise questions around the future cost trajectory of global investments managed out of South Africa. If it goes ahead, the viability of this arrangement declines which is generally not going to benefit local investors.

In saying this, the dispute between Coronation and SARS does raise questions and potential concerns for other South African investment businesses which have created similar corporate structures for their offshore operations. This ruling, if not overturned in the coming years, creates legal precedent for SARS regarding the primary function of businesses and potential profits which should accrue back to South Africa.

We will keep you updated as to the progression of this dispute and its implications for global investments managed from SA.