"Overruled: SARS expresses an interesting view on an amalgamation transaction" reported on Binding Private Ruling 231, in which the South African Revenue Service (SARS) ruled on whether the rollover relief provisions in Section 44 of the Income Tax Act (58/1962) could be applied. This update discusses Binding Private Ruling 232, which also deals with these provisions, although the context and facts of the ruling are somewhat different. Section 44 states that parties to an amalgamation transaction will qualify for rollover relief, whereby certain tax liabilities that would arise in the normal course are deferred, provided that the requirements of Section 44 are met.
The applicant in this ruling is a company incorporated in and a resident of South Africa. The three co-applicants in this ruling are:
- the amalgamated companies (South Africa-resident companies that will be wound up as part of the amalgamation transaction);
- the shareholders of the amalgamated companies (all South Africa-resident companies); and
- the resultant company (a South Africa-resident company that will remain in existence after the amalgamation transaction).
The applicant and the co-applicants decided to rationalise the administration of their businesses, which have an identical underlying nature, by amalgamating the businesses in a single entity and terminating the existing companies. The applicant and the co-applicants have significant interests in investments in fixed properties, which they hold individually or jointly. The nature of the investments is similar in each case, comprising shares in companies that own fixed property which is let to derive rental income. The amalgamation will result in the transfer of the assets and liabilities of the amalgamated companies to the resultant company, in exchange for shares in its corporate structure. Those shares will be issued on behalf of the amalgamated companies, after which the amalgamated companies will be wound up.
The resultant company will issue shares of different classes. Each class of shares will be linked to a designated property investment. The holders of these shares will each be entitled to a distribution of income and capital, attributable to the income and capital generated by the designated property. The distributions will not be limited to specified amounts. In the event of a winding-up, if any surplus remains after satisfying the interests of the shareholders of each class, each shareholder shall be entitled to share equally in the surplus. The rights of each class of shareholder will be documented in the memorandum of incorporation.
The provisions of the Income Tax Act that are relevant for this ruling are Sections 44(1) and 1(1).
Section 44(1)(a) defines an 'amalgamation transaction' as a transaction:
- in which any resident company disposes of all of its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade, assets required to satisfy any reasonably anticipated liabilities to any sphere of government of any country and costs of administration relating to the liquidation or winding-up) to another resident company by means of an amalgamation, conversion or merger; and
- as a result of which the existence of that amalgamated company will be terminated.
Section 1(1) of the Income Tax Act defines an 'equity share' as any share in a company, excluding any share that, neither as respects dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution.
SARS ruled that the disposal by the amalgamated companies of their businesses to the resultant company will meet the requirements of an amalgamation transaction as defined in Section 44(1). The shares of the different classes to be issued by the resultant company will each constitute an 'equity share' as defined in Section 1(1).
The definition of an 'amalgamation transaction' in Section 44(1)(a) refers to the disposal of assets by a "company which is a resident". Whereas this phrase in the definition might have suggested that there may be only one amalgamated company to qualify for the rollover relief, the ruling could provide support for the argument that the assets of more than one amalgamated company may be transferred to a resultant company. In other words, the ruling could suggest that under certain circumstances, it might not be necessary for each amalgamated company to conclude a separate amalgamation transaction with the resultant company to qualify for the rollover relief in terms of Section 44.
The ruling regarding the shares of different classes issued by the resultant company is also important in the context of Section 44(2) and Section 44(4) of the Income Tax Act. Section 44(2) states, among other things, that any capital gain that would have occurred had the property been disposed of in the normal course will not trigger the payment of capital gains tax and is deferred until the resultant company disposes of the property. However, Section 44(4)(a) states that this rollover relief will apply only "to the extent that such asset is so disposed of in exchange for consideration other than… an equity share or shares in the resultant company". It is therefore crucial that the shares issued by the resultant company constitute equity shares as defined.
In terms of the explanatory memorandum on the Taxation Laws Amendment Bill, 2010 (EM 2010), the definition of 'equity share' was originally drafted to ensure that preference shares with limited dividend rights fell outside the definition so that, among other things, the benefits of Section 44 applied only where equity shares were issued as consideration for the capital asset received. The ruling seems to confirm that this was the intention. Although the distribution of the income and capital received by the shareholder of a certain class of shares is dependent on the property investment to which the class of shares is linked, such shares still constitute equity shares, as defined, provided that the distributions are not limited to specific amounts.
Taxpayers should still keep in mind that this ruling is binding only on the parties to the transaction and that SARS will not necessarily adopt this approach in all similar instances.
For further information on this topic please contact Dries Hoek at Cliffe Dekker Hofmeyr by telephone (+27 21 481 6300) or email ([email protected]). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.