It is often the case that South African tax resident shareholders wish to reorganise their South African group of companies, for a multitude of commercial reasons, without the ultimate shareholders changing. One of these could potentially be to create a single holding company structure.
The South African Income Tax Act allows for various so-called group relief provisions which can be used to reorganise a group, without triggering any immediate cash tax consequences for the shareholders. The first of these so-called group relief provisions is set out in section 42 of the Income Tax Act, being an “asset-for-share transaction”. Section 42 allows for shareholders (the transferors) to transfer their shares in a company (the asset) to another company (the transferee) without realising any capital gains. Section 42 effectively defers any potential capital gains tax until such time as the shareholders disposes of the asset to a third party. (Various other section 42 transactions are also possible which will not be discussed in this blog post.)
When will section 42 apply?
If a shareholder (the transferor) transfers its shares in a company (the asset being sold) to another company (the transferee), and the purchase consideration for the transfer of the asset is settled by the issuance of shares (the consideration shares) the transaction could potentially qualify for the roll-over capital gains tax relief provided for in section 42. The following further requirements also need to be met:
- The market value of the asset that will be disposed of must be equal to or exceed its base cost.
- The transferor must hold a qualifying interest in the transferee at the close of the day of the asset-for-share transaction.
- The asset must be held by the transferor as a capital asset and acquired by the transferee as a capital asset.
Should the requirements of an “asset-for-share transaction” be met, the relief provided for in section 42 will apply automatically unless the parties in writing elect otherwise.
What is a qualifying interest?
The term “qualifying interest” is defined in the Income Tax Act. Given the current scenario, a qualifying interest would be an equity share held by the transferor in the transferee that constitutes at least 10% of the equity shares and that confer at least 10% of the voting rights in the transferee.
What is an equity share?
For tax purposes, an “equity share” is any share in a company other than a share that does not carry rights to participate beyond a specified amount in respect of dividends and returns of capital. If the shares being issued as consideration shares will be similar to that of a debt instrument (for example, a preference share with limited participation in dividends and capital), the possibility exists that SARS will not see the shares as “equity shares” and the relief provided for in section 42 will not find application.
It is important to ensure that any group reorganisations are properly implemented, taking cognisance of the Income Tax Act, Companies Act and company secretarial requirements. Furthermore, the transactions entered into should be appropriately accounted for and disclosed to SARS.