Running through the maze of tax consequences for corporate restructuring

November 27th, 2015
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Tax Labyrinth
By Albertus Marais

Attorneys are often requested to assist with corporate restructures. A multitude of considerations then arise, specifically those linked to company law (including the necessary company secretarial work that would be required), contracts to be drafted and potentially considerations linked to the transfer of immovable property or share investments, to name but a few. One further important consideration is the tax consequences of the proposed transaction, which is, quite often, not the first consideration on the list of matters that needs to be dealt with. And rightly so, a transaction needs to make commercial sense and be legally feasible, before one should start thinking of its tax consequences. Unfortunately though, the mistake that is often made – and to clients’ detriment – is that the tax consequences of a corporate restructure are regarded as being inevitable and that these cannot be mitigated. This, however, is not the case.

Once the desired commercial outcome of a corporate transaction is determined, various provisions predominantly in the Income Tax Act 58 of 1962 (the Act) provides for relief mechanisms through which to achieve the desired commercial outcome on an income tax beneficial basis. Planning the restructure then becomes a bit like a maze. Once one knows both the point of departure, as well as the destination, it is only a matter of planning the route by which to arrive at that destination (ie how to structure it), and to do so in as tax efficient a manner as possible. Within this framework there is quite a bit of lee-way through which to plan any corporate restructure – whether big or small.

To give an example: Individuals A and B are partners in an unincorporated estate agency business, looking to transfer this business into a company of which they will each hold 50% of the issued shares. This is to ensure that they, in their personal capacities, are adequately protected against creditors of the business. By setting up a company and selling the business to that company will in all likelihood lead to significant tax costs in the form of income tax, capital gains tax, transfer duty and Value Added Tax. Securities Transfer Tax may even arise as part of the process through which the company, which is to hold the business is being set up, or in the event that the partnership owns share investments, which are also being sold to the company. By simply being aware of the provisions of s 42 of the Act the above transaction could have been structured as a sale of assets to the company in exchange for shares being issued to A and B, all at no tax costs whatsoever. It is, therefore, simply a matter of being aware of the mechanisms created in the Act (and other applicable tax Acts) specifically to allow for tax neutral restructures, and then to arrange one’s affairs accordingly. Section 42 utilised in this example is but one of many of the so-called ‘group relief provisions’ (ss 41 to 47 of the Act) available to provide relief where corporate restructures are involved. As further alluded to above, these group relief provisions go much further than merely to negate income tax effects – it also extends to the other applicable ancillary taxes (see specifically s 8(25) of the Value-Added Tax Act 89 of 1991, s 8(1) of the Securities Transfer Tax Act 25 of 2007 and s 9(1) of the Transfer Duty Act 40 of 1949).

Although the example above deals with a so-called ‘asset-for-share transaction’ (s 42), the same principles (and quite often, requirements) apply for ‘amalgamation transactions’ carried out in terms of s 44 (ie where the businesses of two companies merge), ‘asset-for-asset transactions’ in s 45 where assets can be transferred ‘tax free’ between companies forming part of the same group, s 46 ‘unbundling transactions’ (in terms of which a company distributes an investment in a company to its shareholder as an in specie dividend) or in terms of a ‘liquidation transaction’ as contemplated in s 47.

Referring again to the example of A and B above, in most circumstances the group relief provisions are employed to provide tax relief in relatively simple factual scenarios. However, these are also employed extremely effectively in a staggered fashion where more complex transactions are involved; this often entails, for example, the implementing of more than one group relief transaction in succession to one another. In these circumstances though one should typically be weary of entering into simulated transactions as part of such a staggered approach, or that steps are not inserted into a restructure the main purpose of which being to avoid income tax (in other words steps not necessary to achieve the desired commercial outcome).

Although the provisions above are often referred to as the ‘group relief’ provisions, this is somewhat of a misnomer. For some of the ‘group relief’ provisions to apply, it is a requirement that a ‘group of companies’ (defined in s 41) should exist within which a corporate restructure must be implemented. This generally involves one or more companies whom all share a common company as direct or indirect shareholder owning at least 70% of the effective interest. Non-tax resident companies are specifically precluded from forming part of a ‘group of companies’. While the requirement for a group of companies is certainly required for ‘asset-for-asset transactions’ as well as ‘liquidation transactions’ (and most ‘unbundling transactions’), it is quite possible to carry out an amalgamation or asset-for-share transaction (refer the example of A and B above) without a group of companies being present. The common misconception among practitioners that the ‘group relief’ provisions are only available where groups of companies exist is, therefore, misplaced.

It may at times be beneficial from a tax perspective not to utilise the group relief provisions. It is quite possible for example that, through a restructure, tax losses may be realised instead of tax profits. In such instances one would specifically elect out of the provisions of the applicable ‘group relief’ provision in the Act, even if its requirements are met, in order to realise such losses and not carry out the transaction on a tax neutral basis. The Act specifically allows for taxpayers to elect out of the relief provided, even where the transaction would meet all the requirements necessary for such relief to be utilised. This is one of the many compliance related requirements linked to the group relief provisions, irrespective whether they are utilised or not, wholly or in part. It is not surprising that beneficial tax regimes such as the group relief provisions carry such a high level of compliance requirements, and it is to be expected that South African Revenue Service (Sars) would want to actively monitor that transactions making use of this beneficial tax regime are implemented properly and that the provisions thereof are not abused to achieve tax benefits beyond what is intended to be afforded to taxpayers.

Irrespective of whether transactions are carried out as part of group relief. For any transaction in which companies are involved it is important to also appreciate the dividends tax and donations tax consequences involved with a transaction. For example, donations made between companies of the same ‘group’ (here less onerously defined than for ‘group relief’ purposes) are exempt from donations tax, and dividends declared from one South African tax resident company to another is also generally exempt from dividends tax. However, that is not to say that such transactions, although exempt from these taxes, will not attract other taxes (eg capital gains tax). It is further possible that certain transactions, as part of restructures, may constitute ‘reportable arrangements’ as defined (ss 34 to 39 of the Tax Administration Act 28 of 2011) and would thus be required to be reported to Sars when completed. Failing to do so carries a penalty ranging between R 50 000 and R 3,6 million (s 212).

Corporate restructures are an increasingly technical area of the law of taxation, with the statutory provisions in the various tax Acts being the subject of annual amendment to refine the applicable provisions. This year will be no exception if one has regard to the provisions of the Draft Taxation Laws Amendment Bill, 2015 released by National Treasury on 22 July 2015 (see www.treasury.gov.za). The group relief provisions are by far the single most referred topic to Sars requesting binding rulings to be issued, and unsurprisingly so, given the high values typically involved in these transactions and the need for taxpayers to obtain certainty regarding the interpretation by Sars too of the tax consequences of a transaction prior to implementation.

Irrespective though, of the simplicity or complexity of the transaction, where transactions with companies are involved two important principles apply: Tax considerations will inevitably arise for any such transaction and while these considerations should admittedly not be the primary purpose behind the proposed transaction, it is a reality that practitioners and clients alike sadly come to realise the onerous tax implications of a transaction at too late a stage, and that it could have been mitigated. The second principle is thus that the group relief regime is potentially available through which to negate tax costs, the ambit of which is by no means limited to those restructures which one reads of in the paper. It is a regime that has been introduced into fiscal legislation to benefit big and small business. The key, however, is to avail oneself of the provisions purposefully made available in the Act.

Albertus Marais (CA) SA BAcc LLB (Stell) PGDA (UCT) Adv Cert Tax (cum laude) (UP) MCom Tax (UCT) lectures in corporate restructures for Stellenbosch University’s MAcc Tax programme and is a tax adviser at AJM Tax in Cape Town.

This article was first published in De Rebus in 2015 (Dec) DR 34.