Asset-for-share transactions

taxation2Section 42 of the Income Tax Act of 1962 (the Act) provides for tax roll-over relief in respect of asset-for-share transactions as defined. Such a transaction generally entails the disposal by a person of an asset to a company, and the issue of new shares by that company to the person, as consideration.

One of the requirements is that the nature of the asset must be retained. In other words, if the person held the asset as trading stock, the company must acquire it as trading stock, and if the person held it as a capital asset, the company must acquire it as a capital asset. If the person held the asset as a capital asset, the company may acquire it as trading stock if the person (where the person is a company) and the company do not form part of the same group of companies.

However, asset-for-share transactions can create an opportunity for a person holding assets as trading stock, to dispose of such assets to a company by way of an asset-for-share transaction, and subsequently sell the shares as capital assets.

To prevent such an abuse of asset-for-share transactions, section 42(5) of the Act contains an anti-avoidance provision. If a person disposes of any share received in terms of an asset-for-share transaction within 18 months after the date of acquisition, and immediately prior to such disposal more than 50% of the market value of all the assets disposed of by that person to the company is attributable to allowance assets or trading stock, that person will be deemed to have disposed of the relevant shares as trading stock.

The deeming provision only operates to the extent that the amount received by the person for the disposal of the shares is less than or equal to the market value of the shares at the beginning of the 18 month period. In other words, the person disposing of the shares will be deemed to have disposed of the shares on revenue account, but only up to the amount of the market value of the shares at the beginning of the 18 month period. If the person receives more than that as consideration for the disposal of the shares, the normal rules will apply in respect of determining whether the disposal is on revenue or capital account.

The restriction does not apply to the disposal of a share by means of:

  • An intra-group transaction in terms of section 45 of the Act.
  • An unbundling transaction in terms of section 46 of the Act.
  • A liquidation distribution in terms of section 47 of the Act.
  • An involuntary disposal in terms of paragraph 65 of the Eighth Schedule to the Act.
  • The death of the person.

An amalgamation transaction in terms of section 44 is not excluded. However, see Binding Private Ruling No 159, in which the South African Revenue Service ruled that, based on the particular facts at hand, shares acquired in terms of a section 42 transaction could be disposed of by way of a section 44 amalgamation transaction and would not be deemed to be on revenue account but on capital account.

One of the amendments in the Taxation Laws Amendment Bill 2015 concerns the clarification of section 42(5) of the Act. There appears to be a concern that the current wording “creates unintended anomalies and potentially converts the nature of the equity shares to assets held as trading stock”.

It is proposed that, instead of formulating the anti-avoidance provisions as a deeming provision, whereby the person is deemed to dispose of shares as trading stock, the person must rather be directly obliged to include the relevant consideration in income. The inclusion in income will, therefore, not be as a result of the shares being deemed to be trading stock, which could have caused confusion considering accompanying transactions.

It is important to appreciate that the restriction contained in section 42(5) should be read together with the requirement that the person must retain a “qualifying interest”, as defined, in the company for a period of at least 18 months. The consequences for not doing so are described in section 42(6) of the Act. Even though it is possible for the person to dispose of the shares received within 18 months of the implementation of the transaction without section 42(5) necessarily applying (for example, if less than 50% of the value of the assets is
attributable to trading stock), the person should take care not to dispose of so many shares as would cause the person to no longer hold a qualifying interest in the company.

Cliffe Dekker Hofmeyr
ITA: Sections 6, 42, 44, 45, 46, 47 and paragraph 65 of the Eighth Schedule
BPR 159

Editorial comment: Published SARS rulings are necessarily redacted summaries of the facts and circumstances. Consequently, they (and articles discussing them) should be treated with care and not simply relied on as they appear.