On 19 July 2017 National Treasury published the Draft Taxation Laws Amendment Bill, 2017 (Bill) in terms of which it proposes to clarify the tax implications arising when a person assumes contingent liabilities under the corporate reorganisation rules contained in s41 to s47 of the Income Tax Act, No 58 of 1962 (Act) (Corporate Reorganisation Rules).
The South African Revenue Service (SARS) previously issued Interpretation Note No. 94 dated 19 December 2016, which addressed the tax implications of contingent liabilities assumed in the acquisition of a going concern (Interpretation Note). In paragraph 3 of the Interpretation Note, SARS explained their understanding of a “contingent liability” as follows:
A contingent liability means an obligation whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events and, if confirmed, will result in expenditure being incurred to settle the confirmed obligation.
To explain the concept of a “contingent liability”, SARS used the example of a provision for bonuses that will be paid out to employees if they are still employed by the employer on a specific date. In such instance, the Interpretation Note stated that:
- there is a distinct obligation to pay the bonus under specific circumstances;
- the existence of the liability can be confirmed only on a specific date; and
- to the extent that it is confirmed, it will result in expenditure being incurred to settle it.
The Interpretation Note focused on the treatment of “free-standing contingent liabilities”, which are independent of the assets disposed of, in the hands of both a seller and purchaser when a business is transferred as a going concern. Examples of free-standing contingent liabilities include warranty claims and employee-related provisions such as bonus provisions, leave pay and post-retirement medical aid provisions.
In terms of s42 of the Act (asset-forshare transactions) and s44 of the Act (amalgamation transactions), a person may dispose of assets to a company that is a resident in exchange for the issue of equity shares or the assumption of debt. The debt must have been incurred more than 18 months prior to the disposal of the assets. In the event that the debt was incurred within a period of 18 months prior to the disposal, the debt must for instance have constituted refinancing of a debt incurred more than 18 months prior to the disposal or the debt must have been attributable to and arose in the ordinary course of a business undertaking disposed of as a going concern.
In the context of a transfer of a going concern, the Interpretation Note stated that SARS accepts that “debt” as used in s42(8)(b) of the Act includes free-standing contingent liabilities. It was stated that s42(8)(b) specifically deals with the transfer of a business as a going concern and that the legislature clearly envisaged that such a transfer would include the assumption of free-standing contingent liabilities as other consideration. Similarly, it was stated that SARS accepts that debt in the context of s44(4)(b)(i)(bb)(B) will be interpreted to include free-standing contingent liabilities which are assumed as other consideration for assets acquired as part of the acquisition of a going concern.
However, the Explanatory Memorandum on the Draft Taxation Laws Amendment Bill, 2017 (2017 Memorandum) that was published with the Bill, states that the concept of debt as contemplated under the Corporate Reorganisation Rules refers to an existing and real obligation to pay another party and that the other party must have a legal right to collect or receive the payment. It is therefore proposed to expand on this concept of debt for purposes of the Corporate Reorganisation Rules. The proposal is to insert a new definition in s41 of the Act which expressly states that debt for purposes of the Corporate Reorganisation Rules includes contingent debt. This will accordingly clarify the position.
According to the 2017 Memorandum, all restrictions that currently apply to debt for purposes of the Corporate Reorganisation Rules (for example the 18-month rule) will also apply to contingent debt.
It is proposed that the amendment will come into effect on the date of promulgation of the Bill.