The corporate group relief measures contained in sections 41 to 47 of the ITA largely protect qualifying transactions from the normal tax consequences (taxable income and capital gains, dividend tax, recoupment of allowances, etc.) of such transactions. However, the details of these provisions are exceptionally intricate and often open to dispute regarding their precise interpretation and application. Furthermore, these provisions have been continually modified since their introduction.
In this year’s Budget, the Minister has proposed a further amendment to section 42 of the ITA, dealing with “asset for share transactions”.
Summary of how section 42 works
An asset-for-share transaction essentially contemplates a transaction where a person transfers an asset to a resident company in exchange for the issue of shares by that company.
The basic requirements that must be satisfied to make use of this provision include:
· the asset must be disposed of to a resident company;
· the transferor must, at the end of the day of the transaction, hold a ‘qualifying interest’ in the transferee company or, if the company’s business includes the provision of services, must be employed full time in that business or the business of a ‘controlled group company’;
· the market value of the asset being transferred must be equal to or exceed the tax cost of the shares to be issued; and
· the asset disposed of must retain its nature. Except where the transferor held the asset as a capital asset, the transferee company can acquire it as trading stock provided that the parties do not form part of the same group of companies.
The effect of applying section 42 is that the transferee effectively steps into the shoes of the transferor and any normal tax consequences that would have ensued, but for the application of section 42, will be rolled over to a later date (i.e. when the transferee subsequently sells the asset – provided another corporate group relief measure does not apply). In this context, the base cost of the shares will equal the base cost of the asset being transferred.
However, the section will not apply to transactions where a transferor disposes of an equity share in:
· a listed company (A); or
· a portfolio of an ‘equity’ CIS; or
· a portfolio of a hedge fund collective investment scheme, to a listed transferee company (B) and immediately thereafter B, together with any other transaction concluded on the same terms within 90 days, holds:
· at least 35% of the equity shares of A or the CIS; or
· at least 25% of the equity shares of A if no person other than B holds an equal or greater amount of shares in A or in the CIS.
Rather, a special rule, introduced pursuant to the 2010 amendments, applies. This rule is discussed further below.
Special rule in relation to listed shares
In 2010, a unified special rollover regime was introduced to address the tax cost tracing problem in listed share-for-share transactions. The regime provided relief for acquiring companies (transferee), allowing them to take over the tax cost of the target shares (A) at market value. In other words, as if the shares were acquired by the acquiring company for cash.
By treating the expenditure as if acquired for cash, the acquiring company enjoys a ‘step-up’ in base cost to market value and need not step into the shoes of the target shareholders. The date for the acquisition of the shares will be the date on which the transaction is concluded.
The regime only applies where:
· the target company is listed; and
· the acquiring company will hold at least 35% of the shares in the listed target company after the transaction (or 25% if no other shareholder holds an equal or greater shareholding).
The regime further allows the acquiring company to hold the target shares as trading stock or capital assets without regard to the previous target shareholders’ character – i.e., the asset need not retain its nature.
The above rule was incorporated in section 42 as a proviso to the definition of “asset-for-share” and was aimed at providing relief for listed share-for-share transactions by addressing the practical problems of tracing the character and tax cost of shares in a listed context – especially where the transferee is acquiring shares from a large number of minority shareholders.
As it currently stands, there is no limitation on the application of the relief. In other words, the relief will apply whether the transferee is acquiring shares from various minority shareholders or one major shareholder. This is the context within which the current proposed amendments must be understood.
Proposed amendment in Budget
The proposed amendment in this year’s Budget seeks to clarify the application of the rollover relief for listed shares in share-for-share transactions. Specifically, the amendment proposes limiting the special rollover regime relief to disposing shareholders holding less than 20% of the equity shares in the target company (transferor) before the transaction. This proposal is aimed at aligning the legislation with the original policy intent of National Treasury, which was introduced in 2010.
The effect of the proposal is that disposing shareholders holding more than 20% of the equity shares in the target company before the transaction will not be able to make use of the relief provided in the special rollover regime. As such, parties still wishing to make use of the rollover relief contemplated in section 42 will have to apply the tracing rules as to the nature and tax cost of the shares as envisaged in the provision.
However, it can be argued that the practical difficulties that exist in the case of minority shareholders are less prevalent in relation to shareholders who have a shareholding of 20% or more in the target company.
In conclusion, asset-for-share transactions are a crucial mechanism in corporate transactions. Understanding the intricacies of the provision is essential for taxpayers who wish to use the rollover relief available for such transactions. The proposed amendments in this year’s Budget seek to clarify the application of the rollover relief for listed shares in share-for-share transactions, ensuring alignment with the original policy intent of National Treasury. It is advised that taxpayers have a clear understanding of what constitutes an asset-for-share transaction and the specific requirements and limitations associated therewith. Failure to do so may have unintended (and costly) tax consequences.
