In the current economic climate where third party funding may not be easily available, an issue which merits to be revisited is the tax implications in respect of a cross-issue of shares.

This issue impacts amongst others on transactions where a company (the transferee company) wishes to acquire a number of assets from another company, including shares in such other company (the transferor company). Where third-party financing is not available, an accessible manner of funding such transaction is by issuing shares in the transferee company in consideration for the acquisition of the assets, including the shares in the transferor company.

Section 24B of the Income Tax Act No. 58 of 1962 ("the Act") deals with the disposal of assets in return for the issue of shares and provides, in section 24B(1), that where a company acquires any asset from any person as consideration for shares issued by that company, the company is deemed to have actually incurred an amount of expenditure in respect of the acquisition of that asset, which is equal to the lesser of the market value of the asset immediately after the acquisition or the market value of the shares immediately after the acquisition, and that person is deemed to have disposed of the asset for an amount equal to the market value of the shares immediately after the acquisition.

As an exception to this, section 24B(2) of the Act provides that if a company acquires any share which is issued to that company directly or indirectly in exchange for the issue of shares by that company or any connected person in relation to that company, that company is deemed not to have incurred any expenditure in respect of the acquisition of that share so acquired.

Section 24B was inserted by the Revenue Laws Amendment Act No. 32 of 2004. In the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2004 ("the Explanatory Memorandum"), the reason for the insertion of section 24B is that assets acquired in consideration for an issue of shares may be acquired at a base cost of zero, which creates a significant hindrance to company formations and other forms of share financing. The Explanatory Memorandum states that such zero principle stands in contrast to widespread international practice, despite support for the principles found in case law.

As regards the cross-issue of shares, which is not afforded the special treatment in section 24B(1), the Explanatory Memorandum explains the reason to be as follows:

"Shares issued in exchange for the direct cross-issue of shares create special problems. Unlike the standard issue of shares for property, the dual cross-issue of shares is wholly tax-free to both parties in the transaction. This dual tax-free nature of the transaction creates an easy opportunity for artificially inflating the value of both sets of shares issued. The proposed rules retain the zero principle for the cross-issue of shares and extend the principle to the indirect cross-issue of shares (proposed section 24B(2)) as well as to connected person situations."

Accordingly, in the example set out above, section 24B will, broadly speaking, have the effect that the transferor company will acquire all of the assets, save for the shares in the transferor company, at a base cost equal to the market value of the assets, but will acquire the shares in the transferor company at a base cost of nil. There is accordingly a mismatch between the tax treatment of the acquisition of shares in the transferor company and the acquisition of other assets, where such acquisitions are funded by share financing. One of the reasons set out in the Explanatory Memorandum for this divergent treatment is that the dual issue of shares is tax free in both parties' hands. What is ignored is that the issue of shares is in any event not a taxable event, whether in consideration for another issue of shares or for a cash consideration. For example, should the transferee company obtain third party funding in order to acquire the shares in the transferor company, the issue of the shares in the transferor company will still be on a tax free basis, but the transferee company will acquire the shares at a base cost equal to the subscription amount. Section 24B(2) accordingly results in exactly what section 24B sought to prevent, i.e. the preferential tax treatment of third party funding over share financing.

We submit that such distinction is not well-founded especially taking into account that the courts have more recently recognized that the issue of shares in settlement of an obligation constitutes "expenditure actually incurred" for purposes of the Act. The most recent case in this regard is the case of C:SARS v Labat Limited [2010] 72 SATC 75 where the North Gauteng High Court held that the issue of shares by a company in exchange for a brand name constitutes "expenditure" actually incurred (see also ITC 1801 [2006] 68 SATC 57 and ITC 1822 [2007] 69 SATC 200). In light hereof, it appears that the courts are moving away from the view that as the issue of shares by a company does not result in an economic loss or diminution of the company such does not constitute expenditure incurred by the company, towards a view which recognises that the issue of shares in effect incurs an expenditure equal to the subscription price forgone, in cases where shares (or other assets) are so acquired.

Until such time as section 24B(2) has been removed, however, clients will be well advised to bear this provision in mind when implementing restructures and merger transactions.