What is it and when is it relevant?
Are you considering a restructure of your business- or asset holdings, but you are concerned about the tax consequences? An “asset-for-share transaction”, as defined in section 42 of the Income Tax Act, No. 58 of 1962 (the “Act”), may be the way to go for you – whether as a once-off transaction or as a step within a series of transactions as part of a larger corporate restructure.
A section 42 asset-for-share transaction generally involves the disposal by a person of an asset to a resident company in exchange for the issue of an equity share in that company to that person.
Pursuant to section 42 of the Act, no adverse normal tax consequences will arise as a result of the disposal because the asset is deemed to be disposed of for an amount equal to its base cost (capital asset) or its tax cost (trading stock). If the asset is an allowance asset, no recoupments will be included in the person’s taxable income either.
The requirements:
The requirements that need to be met for the transaction to qualify for the roll-over tax relief are summarised as:
- the market value of the asset must be greater than or equal to its base cost (in the case of a capital asset) or the tax cost (in the case of trading stock);
- at the close of the day of the disposal, the person must hold a “qualifying interest” in the company; and
- the company must acquire the asset as a capital asset where that person held it as such, or the company must acquire the asset as trading stock where that person held it as such or where that person held it as a capital asset but the company and the person do not form part of the same group of companies.
A “qualifying interest” is defined in section 42 of the Act to include an equity share in a listed company and equity shares in a private company that constitute at least 10 per cent of the equity shares and that confer at least 10 per cent of the voting rights in that company.
Interestingly, a person can also dispose of assets, such as investments in equities or fixed income securities, to a portfolio of a collective investment scheme in securities or a portfolio of a hedge fund collective investment scheme in exchange for participatory interests in that portfolio and still qualify for the roll-over relief under section 42. This is because section 41 of the Act includes such portfolios as part of the definition of “company”, and section 42 includes participatory interests as part of the definition of “qualifying interest”.
Pitfalls:
It is important to note that there are a number of pitfalls surrounding section 42 asset-for-share transactions. If the transaction is not implemented correctly, unwanted tax consequences may follow.
Some of these pitfalls are that:
- if the value of the asset disposed of does not equal the value of the shares issued, a deemed capital gain or a deemed dividend may arise in the hands of the company; and
- if the person who disposed of the asset ceases to hold a qualifying interest within 18 months of the asset-for-share transaction, the remainder of his shares will be deemed to be disposed of at market value on the day of the asset-for-share transaction – thus reversing the roll-over relief.
There are more pitfalls. Furthermore, there are other taxes to be cognisant of when planning a restructure involving an asset-for-share transaction, such as value-added tax, transfer duty and securities transfer tax.
To be sure that you do not end up with costly tax consequences, contact your tax experts for advice before you plan and implement a restructure.