In terms of section 47, a resident company (the “liquidating company”) can dispose of its assets on a tax neutral basis to its shareholders in the course of the liquidation, winding up or deregistration of that company, but only to the extent that the assets are so disposed of to another company (the “holding company”) which is a resident and which forms part of the same group of companies as the liquidating company. It is often the case, due to commercial circumstances, that companies in groups of companies become redundant or commercially not viable. Section 47 provides a useful mechanism to simplify such a group of companies by providing for the tax neutral relief on the termination of entities in the group.
To qualify for section 47 relief, the liquidating company must dispose of all of its assets, other than (i) assets it elects to use to settle any debts incurred by that company in the ordinary course of its trade and (ii) assets required to satisfy any reasonably anticipated liabilities to any sphere of government of any country and costs of administration relating to the liquidation or winding up.
Although the requirement to dispose of all assets makes sense from a tax perspective, it creates practical difficulties where, for example, the assets retained in respect of (i) or (ii) above exceed the eventual liabilities. If these circumstances arise, it may bring into question whether the initial disposal constituted a section 47 liquidation distribution transaction given the fact that not all assets other than assets used to settle liabilities were disposed of. The consequence would be that the disposal of assets from the subsidiary to its holding company will no longer qualify as a tax-neutral transfer and the subsidiary may realise taxable profits on the disposal of its assets.
Depending on the circumstances, an argument can potentially be made that the fact that a balance of assets remains in the liquidating company (after settling all liabilities) does not necessarily mean the section 47 relief is in jeopardy, instead, a separate “second” disposal or distribution can take place, which still forms part of the same section 47 liquidation distribution transaction. Although it practically seems like a disposal, followed by settling of liabilities, followed by another disposal, it is only a single disposal for purposes of section 47. Such an argument will be fact dependent, and it would still be important to be able to show that all assets are disposed of (as part of the first part of the section 47 transaction) and that only assets used to settle debts are retained (this determination should be commercially reasonable).
Even the simplest section 47 liquidation distribution transaction can have complex tax and practical considerations. We, therefore, recommend that expert tax advice be obtained in advance of entering into any section 47 transaction. In this regard, it should be noted that section 47 applies automatically, unless:
- The holding company is a public benefit organisation, recreational club or certain other exempt entities;
- The holding company and the liquidating company agree in writing that this section does not apply;
- The liquidating company has not, within 36 months, taken the necessary steps to liquidate or winding up or have withdrawn any such step.
The liquidation and deregistration of the liquidating company do not have to be finalised within the 36 month period; however, it is important that at least some of the necessary steps contemplated in section 41(4) have been implemented by the liquidating company in anticipation of its liquidation and deregistration. It is important to consider every transaction from a tax perspective, even in a group context to ensure that the correct tax consequences are accounted for.