The South African Revenue Service (SARS) recently released Binding Private Ruling 159 (Ruling), which deals with the disposal of assets, being shares, in terms of an amalgamation transaction immediately after having acquired those shares in terms of an asset-for-share transaction.
The facts were that companies A and B are controlled by various shareholders (individuals and family trusts).
The shareholders wanted to hold their investments through a single company and not through both companies A and B.
The proposed transaction entailed the following:
- A new company C would be formed as a wholly-owned subsidiary of B.
- Company B and C would enter into an asset-for-share transaction in terms of which B would dispose of its assets (except for selected assets) to C in return for shares in C in terms of s42 of the Income Tax Act No 58 of 1962 (Act).
- C would assume certain of B’s debts as payment for the selected assets and section 42 of the Act would not apply to these assets.
- C would also recognise an amount of goodwill in its books.
- After the implementation of the said asset-for-share transaction, the only assets held by B would be the shares in C.
- Companies A and B would then enter into an amalgamation transaction in terms of section 44 of the Act whereby B would dispose of its newly acquired shares in C to A, in exchange for shares in A.
- B would then distribute the shares that it has acquired in A to the shareholders.
- B would be wound up.
Generally, when a person acquires shares in terms of an asset-for-share transaction in terms of s42 of the Act, there are restrictions imposed on the disposal of those shares within a certain time period.
A direct restriction is contained in s42(5) of the Act. It provides that:
- should a person dispose of shares acquired in terms of an asset-for-share transaction within 18 months of the transaction; and
- more than 50% of the market value of the assets that the person transferred to the company (in terms of any transaction) is attributable to allowance assets or trading stock, the person must be deemed to have disposed of the shares as trading stock to the extent that any amount received by or accrued to the person in respect of the disposal is less than or equal to the market value of the shares at the beginning of the 18 month period.
A further, more indirect, restriction is contained in s42(6) of the Act. It provides that, should a person cease to hold a qualifying interest in the company (by for example disposing of its shares) within 18 months of the asset-for-share transaction, any roll-over relief obtained by virtue of s42 of the Act would effectively be reversed.
However, explicit exceptions exist in s42(5) and 42(6) of the Act for when the shares are disposed of (or the qualifying interest lost) as a result of a transaction in terms of s45 (intra-group transaction), 46 (unbundling transaction) or 47 (liquidation distribution) of the Act. There is no exception in respect of s44 of the Act (amalgamation transaction).
In the current instance, the issue facing company B was that it would presumably fall foul of s42(5) of the Act in that it would dispose of the shares in company C within 18 months of the asset-for-share transaction by entering into the amalgamation transaction. It is assumed that more than 50% of the value of the assets transferred would be attributable to allowance assets or trading stock. It is not clear from the Ruling whether company B would also have fallen foul of s42(6) of the Act.
SARS effectively ruled that the shares would not be treated as trading stock in terms of s42(5) of the Act. The reason given is that, based on all the facts and circumstances, including all the transaction steps, as a whole the parties involved would not deal with the assets as trading stock.
In respect of s42(6) of the Act it is merely stated that that section would not find application.
From the Ruling it is clear that SARS is willing to bend the rules in certain circumstances, even though s42 of the Act does not make provision for relief where the relevant shares are disposed of as a result of entering into an amalgamation transaction in terms of s44 of the Act within 18 months.
A further interesting aspect in respect of the Ruling relates to the treatment of the goodwill. In terms of paragraph (a)(i) of the definition of ‘asset-for-share transaction’ in s42(1) of the Act, the disposal of goodwill is excluded from the ambit of an asset for-share transaction.
However, for purpose of s42(5)(b), the value of the goodwill transferred must be taken into account in establishing whether 50% of the market value of the assets transferred to the company is attributable to allowance assets or trading stock.
Author: Heinrich Louw – Senior Associate at DLA Cliffe Dekker Hofmeyr