Heinrich Louw August 28 2015 Ruling on issue of capitalisation shares Cliffe Dekker Hofmeyr | Corporate Tax - South Africa Heinrich Louw Corporate Tax FactsDecisionFactsOn August 13 2015 the South African Revenue Service (SARS) issued Binding Private Ruling 201. In this case, the applicant (a natural person) held 100% of the equity shares in a resident operating company. The operating company, in turn, owned 100% of the shares in a dormant resident company (the co-applicant). The parties wished to introduce a black-owned company as a shareholder in the operating company in order to improve its Black Economic Empowerment (BEE) credentials.In order to achieve this, it was proposed that:the operating company would dispose of its shares in the co-applicant to the applicant for nominal value;the applicant would dispose of its ordinary shares in the operating company to the co-applicant in exchange for ordinary shares in the co-applicant (ie, an asset-for-share transaction in terms of Section 42 of the Income Tax Act (58/1962);the applicant would then hold 100% of the equity shares in the co-applicant and the co-applicant would hold 100% of the equity shares in the operating company;the co-applicant would issue 10,000 capitalisation shares to the applicant for no consideration; andthe co-applicant would issue 25.1% ordinary shares to the BEE company for a negligible subscription price.The 10,000 capitalisation shares would:be participating, cumulative, redeemable preference shares;be redeemable at the option of the co-applicant at 100% of the current equity value of the operating company;have to be redeemed by the co-applicant only if a default were triggered by the co-applicant falling into financial distress;entitle the applicant to a cumulative preference dividend equal to the unredeemed balance of the redemption price of the shares, plus arrears, multiplied by 72% of the prime rate; andentitle the applicant to 1% of all distributions made in respect of the ordinary shares.DecisionSARS ruled that:the receipt by the applicant of the capitalisation shares would not be seen as a disposal of the applicant's ordinary shares in the co-applicant (presumably as a result of dilution), and the anti-avoidance provisions contained in Section 42(5) of the Income Tax Act would not be triggered;(1)the applicant would continue to hold a qualifying interest in the co-applicant subsequent to the issue of the capitalisation shares and Section 42(6) would not be triggered;the receipt of the capitalisation shares would not constitute gross income in the hands of the applicant – presumably because it was a capital receipt as opposed to a dividend – and would also not have to be included as an amount in respect of services rendered;the capitalisation shares would not be subject to Section 8C;the capitalisation shares would not constitute a dividend or a return of capital, as defined in Section 1;the exchange of the applicant's personal right to receive the capitalisation shares for the actual capitalisation shares upon receipt would constitute a disposal by the applicant, but would be disregarded for capital gains tax purposes (presumably because the base cost of the right would equal the proceeds – however, this was unfortunately not made clear);the expenditure incurred by the applicant in respect of the capitalisation shares would be deemed to be nil in terms of Section 40C; andno contributed tax capital would be created by the issuing of the capitalisation shares.SARS did not make this ruling subject to any conditions or assumptions, but it did clearly indicate that it did not extend to any issues regarding company law, accounting treatment or BEE accreditation.For further information on this topic please contact Heinrich Louw at DLA Cliffe Dekker Hofmeyr by telephone (+27 11 562 1000) or email ([email protected]). The DLA Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.Endnote(1) For further details please see "Asset-for-share transactions: proposed amendment to anti-avoidance rule".