The amendments to the term "group of companies" as contained in section 41 of the Income Tax Act, No. 58 of 1962 ("the Act") as promulgated in the Revenue Laws Amendment Act, No. 35 of 2007, may have far reaching consequences for certain South African groups that are owned by a foreign taxpayer, as it appears that sister companies which are wholly owned by a foreign taxpayer may very well be excluded from the roll over relief afforded by the provisions of section 45 of the Act.

Illustration of the problem

The problem can be illustrated as follows:

Two South African companies, Taxpayer 1 and Taxpayer 2, are wholly owned subsidiaries of Foreign Co, a company incorporated and tax resident in the United States of America.

Taxpayer 1 owns a share portfolio which it wishes to transfer to its sister company, Taxpayer 2. The parties would like to effect the transfer in terms of the provisions of section 45 of the Act. However, it is not clear whether Taxpayer 1 and Taxpayer 2 will form part of a "group of companies" for purposes of section 45 of the Act.

Group of companies

In terms of section 1 of the Act, a "group of companies" is defined as two or more companies in which one company ("controlling group company") directly or indirectly holds shares in at least one other company ("controlled group company") to the extent that:

at least 70% of the equity shares of each controlled group company are directly held by the controlling group company, one or more controlled group companies or any combination thereof; and

the controlling group company directly holds at least 70% of the equity shares in at least one controlled group companies.

Based on the above definition, Taxpayer 1 and Taxpayer 2 form part of the same "group of companies" for purposes of section 1 of the Act, since Foreign Co holds more than 70% of the equity shares of the companies.

However, the definition of a "group of companies" for purposes of Part III of the Act is narrower and excludes associations, corporations or companies incorporated under the law of any country other than the Republic or bodies corporate formed or established under such law (referred to in paragraph (b) of the definition of "company"), unless such a company has its place of effective management in the Republic.

Consequently, it seems that Taxpayer 1 and Taxpayer 2 will not form part of the same group of companies as per the narrower definition contained in section 41 of the Act. As a result, Taxpayer 1 will not be able to avail itself of the relief afforded by section 45 of the Act and the disposal of its share portfolio to its sister company, Taxpayer 2, will trigger a tax liability in Taxpayer 1’s hands.

Interpretation of the definition of "group of companies" contained in section 41 of the Act

It nevertheless appears that there are conflicting views in respect of the interpretation of the definition of "group of companies" contained in section 41 of the Act.

One view is that the narrower interpretation set out in section 41 of the Act only disqualifies the non-resident company and not the entire group from availing of the roll over relief afforded by sections 42 to 47 of the Act. Under this interpretation, Taxpayer 1 and Taxpayer 2 will be regarded as forming part of the same group of companies even though Foreign Co is a non-resident. The entire group is therefore not disqualified from the roll over relief afforded by Part III of the Act, even though the two sister companies’ holding company is a non-resident. This view is based on the premise that one should first determine whether a "group of companies" exists as defined in section 1 of the Act, whereafter the provisions of section 41 is applied to exclude certain companies from the group.

The second, opposing view is that the provisions of section 41 of the Act should be applied to determine whether a "group of companies" exists for the purposes of section 1 of the Act. This interpretation would therefore result in Foreign Co being excluded from the group as envisaged by paragraph (i)(aa) of the definition contained in section 41 of the Act and therefore this company will not be considered when the definition in section 1 of the Act is applied. Under this interpretation Taxpayer 1 and Taxpayer 2 will not have a "controlling group company" and therefore these entities will not be regarded as "controlled group companies".

It is uncertain which of the two views are supported by the South African Revenue Service ("SARS"). Discussions with officials at the Commissioner’s office have highlighted the issue and we are eagerly awaiting feedback from SARS in this regard.