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28 Jun 2021
BY Nicolette Smit

Asset-for-share transactions: a new potential pitfall

The corporate reorganisation rules contained in section 42–47 of the Income Tax Act, 1962 (“Act”) provide taxpayers, in broad terms, with a mechanism to defer the tax implications that would otherwise result from certain restructure transactions, for example, where a group of companies seeks to reorganise its operations to achieve commercial objectives or benefits.

Section 42 of the Act, in particular, is a useful provision where a natural person seeks to transfer business assets to a company and where a group of companies seeks to restructure or move assets to different companies or reporting lines within the group.

Section 42 applies to “asset-for-share transactions”, which is any transaction in terms of which a person (“Transferor”) disposes of an asset, the market value of which is equal to or exceeds, in the case of an asset held as a capital asset, the base cost of that asset on the date of that disposal, to a company which is a resident (“Transferee”), in exchange for the issue of an equity share in that company (“exchange shares”) and that person at the close of the day on which that asset is disposed of, holds a “qualifying interest” in that company.

A “qualifying interest” includes a 10% equity shareholding in a company or an equity share held in a company where the Transferor and Transferee form part of the same group of companies.

There are further requirements in relation to the intention with which the Transferee acquires the relevant assets vis-a-vis the intention of the Transferor which must also be met.

If all the requirements are met, in relation to capital assets, the Transferor is deemed to have disposed of the assets at their base cost and the Transferee is deemed to have acquired the assets at that same base cost, ie, the Transferee steps into the shoes of the Transferor. The same principles apply in relation to assets held as trading stock and in addition, no recoupments arise for the Transferor in respect of deductions and allowances previously claimed.  

In relation to the exchange shares, the Transferor obtains a deemed base cost in the exchange shares equal to the base cost of the assets transferred (assuming the exchange shares are acquired and held as capital assets).

The section 42 relief is often used in the context of the transfer of a business to a company and often the debts attached to the business are assumed by the Transferee. Section 42(8) then becomes relevant and applies where an asset which is transferred in terms of an asset-for-share transaction secures a debt and such debt is assumed by the Transferee. If the debt falls into certain categories, broadly speaking, the amount of such debt must be added to the proceeds when the exchange shares are disposed of by the Transferor.

In broad terms, section 42(8) applies to the following categories of debt (“qualifying debts”):

  • A debt (or an equivalent amount of debt) which secures any asset transferred where the debt was incurred by that person -
  • more than 18 months before that disposal; or
  • within a period of 18 months before that disposal—

(aa) and that debt was incurred at the same time as that asset was acquired by that person; or

(bb) to the extent that debt constitutes the refinancing of any debt in respect of that asset incurred as contemplated in (i) or (aa) above; and

  • where any business undertaking as a going concern is disposed of and that disposal includes any amount of debt that is attributable to, and arose in the normal course of that business undertaking.

Therefore, if the Transferee company assumes any Qualifying Debts, the face value of such debts will be deemed to be proceeds for the Transferor in the event of a disposal of the Exchange Shares.  

The corporate reorganisation rules are often used in combination to achieve a restructure. For example, a Transferor may, subsequent to an asset-for share transaction, dispose of all the exchange shares in terms of a transaction which also qualifies for relief in terms of the corporate reorganisation rules. In this scenario, since the Transferor (now the transferee) is deemed to have disposed of the exchange shares at its (inherited) base cost and since this base cost is rolled over to the purchaser of the exchange shares under the subsequent reorganisation transaction, section 42(8) has no impact, ie, no “additional proceeds” will be realised by the Transferor on disposal of the exchange shares.

However, as part of the tax proposals pursuant to the Budget Speech delivered on 24 February 2021, the following was stated:

“The asset‐for-share transaction rules contain an anti‐avoidance measure aimed at preventing a permanent loss to the fiscus (instead of a tax deferral) when a person disposes of an asset that was acquired using debt and the debt is assumed by the company acquiring that asset……

However, the rules that trigger additional consideration on disposal are undermined when the shares are subsequently transferred in terms of corporate reorganisation transactions because the applicable corporate reorganisation rules will enforce the rolled‐over base cost of the previous asset‐for‐share transaction…..”

It was thus proposed that the additional consideration in terms of section 42(8) should be taken into account in relation to all transactions which qualify for relief in terms of any of the corporate reorganisation rules until the shares are disposed of in a transaction that falls outside these rules. Therefore, it seems that the additional proceeds resulting from section 42(8) would “follow” the exchange shares and ultimately be added to the proceeds of the holder of such shares that disposes of these shares outside the corporate reorganisation rules.

It remains to be seen how the legislation will be amended to achieve this objective and what the effective date of such changes will be (and in particular whether they would have retrospective effect), but it is important to bear this possible change in mind when implementing asset-for-share transactions.

Nicolette Smit

Tax | Executive

nsmit@ENSafrica.com

+27 82 872 6166