The South African Revenue Service (SARS) has traditionally adopted a conservative approach in issuing rulings which approve a tenuous interpretation of the Income Tax Act (58/1962) in favour of the taxpayer. However, in Binding Private Ruling 231, issued on May 10 2016, SARS adopted an interesting interpretation of the corporate rollover relief provisions in Section 44 of the act, raising a number of questions.
Under Section 44(2) of the Income Tax Act, a company qualifies for certain corporate rollover relief (in that the transfer of capital assets or trading stock will not trigger the inherent tax gain) if a transaction constitutes a Section 44 transaction in terms of Section 44(1)(a) or 44(1)(b).
Section 44(1)(a) defines an 'amalgamation transaction' as a transaction where any resident company (ie, the amalgamated company) disposes of all of its assets to another resident company (ie, the resultant company) through an amalgamation, conversion or merger – with the exception of those assets:
- used to settle any debts incurred in the ordinary course of its trade; or
- required to satisfy any reasonably anticipated liabilities to any government of any country and costs of administration relating to the liquidation or winding up.
The virtually identical Section 44(1)(b) applies where the amalgamated company is a foreign company and the shares in the amalgamated company are held as capital assets.
However, Section 44(2)(a) further states that the shares must be acquired by the resultant company as capital assets or trading stock.
The applicant was a South African resident company that was held 74% by a foreign company (ForeignCo) and 26% by black economic empowerment (BEE) shareholders. ForeignCo was a wholly owned subsidiary of another foreign company (HoldCo). There were also a number of co-applicants, including three companies that were majority-owned by BEE shareholders (BeeCo 1, BeeCo 2 and BeeCo 3). BeeCo 2 was a wholly owned subsidiary of BeeCo 1. BeeCo 2 and BeeCo 3 each participated in two separate unincorporated joint ventures.
The applicant and the relevant subsidiary co-applicants intended to rationalise and simplify their South African group structure by entering into four separate transactions which would eliminate the unincorporated joint ventures and unnecessary companies in the structure. The second, third and fourth transactions were Section 44 transactions, while the third transaction was an asset-for-share transaction in terms of Section 42 of the act. This update focuses on SARS's ruling regarding the first and second transactions.
In the first transaction, the group wished to eliminate the intermediate holding of the applicant's shares by ForeignCo. Hence, ForeignCo planned to dispose of its shares in the applicant for a new issue of shares in the applicant in terms of a Section 44 transaction. The new shares in the applicant would be distributed by ForeignCo to its sole shareholder HoldCo in terms of the relevant amalgamation agreement. ForeignCo would then be liquidated in terms of that agreement.
The second planned transaction would be similar. BeeCo 1 would dispose of its shares in BeeCo 2 for a new issue of shares in BeeCo 2 in terms of a Section 44 transaction. The new shares in BeeCo 2 would be distributed by BeeCo 1 to its shareholders in terms of the relevant amalgamation agreement and BeeCo 1 would then be liquidated in terms of that amalgamation agreement.
Regarding the first transaction, SARS ruled that:
- the transfer by ForeignCo of its shares to the applicant under the amalgamation agreement would constitute a Section 44 transaction in terms of Section 44(1)(b) of the act and qualify for corporate rollover relief;
- the repurchased shares of the applicant would be cancelled on repurchase; and
- no dividends tax would be payable on the distribution of the newly acquired shares of the applicant to HoldCo.
Regarding the second transaction, SARS ruled that:
- the transfer of assets by BeeCo 1 to BeeCo 2 under the amalgamation agreement would constitute a Section 44 transaction in terms of Section 44(1)(a) of the act and qualify for corporate rollover relief;
- the repurchased shares of BeeCo 2 would be cancelled on repurchase; and
- no dividends tax would be payable on the distribution of the newly acquired BeeCo 2 shares by BeeCo 1 to its shareholders.
The SARS ruling does not necessarily include all facts provided to it by the applicants. However, it is possible that ForeignCo and HoldCo may have been liable to pay capital gains tax in terms of Paragraph 2(1)(b)(i) of the Eighth Schedule to the Income Tax Act if it had disposed of its shares outside the ambit of the corporate rollover relief provisions.
Paragraph 2 of the Eighth Schedule states that a non-resident company is liable for capital gains tax in South Africa if, on disposal:
- it holds more than 20% of the shares in a South Africa-resident company; and
- 80% of the market value of the South Africa resident company's shares are directly or indirectly attributable to immovable property.
This might explain why the parties wish to make use of the rollover relief in Section 44. However, on closer scrutiny, it appears that some of the requirements of Section 44 might not have been met.
Section 44(2)(a)(i) states that where an amalgamated company disposes of a capital asset, the resultant company will qualify for rollover relief only if it "acquires it as a capital asset". In the first transaction, ForeignCo would have concluded a Section 44 transaction in exchange for the applicant issuing new shares to it. The subsequent cancellation of these repurchased shares raised issues: the cancellation was an unavoidable outcome and thus the applicant could never have held the shares as capital assets. Should Section 44(2) or 44(3) of the act not apply, the repurchase could constitute a dividend and trigger a dividend withholding tax charge. A further consequence of Section 44(2) or 44(3) not applying would be that the distribution of shares by the amalgamated company would not be income tax and dividends tax neutral.
Section 41 of the act defines a 'capital asset' as any asset defined in the Eighth Schedule except trading stock. The Eighth Schedule essentially defines an 'asset' as any property or any right in such property. The definitions of 'trading stock' in Sections 1 and 41 of the act essentially state that trading stock is anything acquired by the taxpayer:
- for the purposes of sale; or
- on disposal of which the proceeds would form part of the taxpayer's gross income.
The shares of the applicant and the shares of BeeCo 2 that would be bought back in terms of the first and second transactions would therefore not be acquired as capital assets or trading stock in terms of the repurchase transactions. Under Section 44(6)(c), the transfer of capital assets or trading stock to the shareholders of the amalgamated company would qualify for rollover relief only if the requirements of Section 44(2)(a) were met. As it appears that these requirements would not have been met, a capital gain could have been triggered when ForeignCo disposed of the newly issued shares of the applicant to HoldCo.
This argument is supported by the fact that a company cannot acquire rights against itself, as well as by Section 35(5) of the Companies Act (71/2008), which states that once shares have been repurchased by a company, they no longer have the status of issued shares, but have the same status as authorised unissued shares. In commercial terms, these shares are thus not reflected on the balance sheet of a company as assets.
The same comments apply to the second transaction, in terms of which BeeCo 1 would have disposed of its shares in BeeCo 2 in exchange for the issue of new shares in BeeCo 2.
For further information on this topic please contact Dries Hoek at Cliffe Dekker Hofmeyr by telephone (+27 21 481 6300) or email (firstname.lastname@example.org). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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