The South African Revenue Service (SARS) released Binding Private Ruling 208 (Ruling) on 8 October 2015. The Ruling concerned the use of subscription proceeds to repay a shareholder loan.
Company A and Company B each held 50% of the issued shares in Company C. Company A wanted to acquire Company B’s shares (Shares) in Company C.
Company B had a loan claim against Company C, which was used to finance operational expenditure of Company C.
Company A only wanted to acquire the Shares and not the loan claim.
It was proposed that the loan claim be settled before Company A bought the Shares.
The proposed transaction would be achieved as follows:
- Company A would subscribe for a single share in Company C at a premium equal to the loan claim;
- Company B would subscribe for a single share in Company C at a nominal value of R1 only; and
- Company C would use the subscription proceeds to settle the loan claim in full.
Effectively, Company B would first capitalise its loan claim against Company C, and then sell the Shares to Company A.
As is generally the case with the capitalisation of shareholder loans, there is a risk that the parties could trigger the debt reduction rules contained in s19 of the Income Tax Act, No 58 of 1962 (Act), or paragraph 12A of the Eighth Schedule to the Act. This was clearly also the concern for the parties in this particular Ruling.
However, SARS ruled that debt reduction rules contained in s19 of the Act and paragraph 12A of the Eighth Schedule to the Act would not be applicable to the proposed transaction.
The Ruling did not make any mention as to whether actual funds would flow between Company B and Company C, or whether the obligation of Company B to pay the subscription proceeds to Company C, and Company C’s obligation to pay Company B in terms of the loan claim, would be extinguished by way of set-off.
SARS has now issued a number of rulings indicating that the capitalisation of shareholder loans would not trigger the debt reduction provisions. However, taxpayers should take note that these rulings only apply to the specific parties who applied for those rulings and were dependant on the relevant facts of each case. In this particular Ruling, the parties made it a condition precedent of the sale agreement relating to the Shares that an advance tax ruling would first be obtained from SARS in respect of the capitalisation of the loan claim.
Taxpayers are advised to adopt a prudent approach, as there is no guarantee that SARS would not argue that the capitalisation of a shareholder loan would not trigger the debt reduction provisions in the absence of an advance tax ruling by the specific parties.