SARS recently issued the above Binding Private Ruling which deals with the question whether the buy-back of ordinary shares by a company at an amount in excess of the market value of the shares, in circumstances where the purpose of the buy-back was to maintain the BBBEE status of the company, has donations tax effects or would invoke paragraph 38 of the Eighth Schedule.
The facts, briefly, were that Company A concluded a BBBEE transaction in terms of which it acquired 40 percent of the ordinary shares of the Applicant. As is common with such structures, Company A financed the acquisition through the issue of redeemable preference shares to various investors, the majority of which were subscribed for by a financing house. The equity shares in the Applicant were used as security for the issue of the preference shares. In terms of the security arrangement, should Company A fail to redeem the preference shares when due, the preference shareholders may take cession of the equity shares in the Applicant. With the first of the preference share funding periods coming to a close, the Applicant wished to ensure that Company A does not default on its redemption obligations, which could lead to the possible loss of the Applicant’s favourable BBBEE status.
To avoid such a loss of status the buy-back of approximately half of the equity shares held by Company A in the Applicant was proposed, at an amount in excess of the current market value of the shares. It is not clear from the facts supplied how much in excess of the current market value of the shares the buy-back will be. The buy-back will equate to that of approximately 20 percent of the entire issued ordinary share capital in the Applicant. The purpose of the buy-back is to ensure that Company A can pay outstanding dividends accumulated over the period and to enable that company to redeem all of the preference shares.
The ruling is to the effect that the proposed buy-back will not constitute a ‘donation’ as defined in section 55(1) of the Income Tax Act, nor a deemed donation in terms of section 58(1) and that paragraph 38 of the Eighth Schedule would not be applicable to the buy-back. No reasons are given for the ruling, but it is probably on the basis that the transaction is not gratuitous which would eliminate the possible application of section 55(1) and that, because of the perceived value in the maintenance of the BBBEE status of the Applicant, the consideration received by the Applicant in exchange for the money with which it was parting is not, in the opinion of the Commissioner, inadequate, which would eliminate the possible application of section 58(1). It is generally believed that section 58(1) may apply regardless of the taxpayer’s motives. Along similar lines, paragraph 38 requires that an asset be disposed of either by means of a donation, for a consideration not measurable in money or to a connected person for a consideration which does not reflect an arm’s length price. It is also possible that Company A and the Applicant are not ‘connected persons’, depending on the composition of the majority voting rights in the Applicant, which information is not supplied in the ruling. An interesting question is whether the retention of BBBEE status might not be a ‘consideration not measurable in money’, which would mean that paragraph 38 should apply (once again depending on the composition of the majority voting rights in the Applicant).
Another interesting aspect to consider is just how far companies can ‘push the envelope’ in attaching value to BBBEE status for purposes of the above provisions. It is unfortunate that more information is not supplied in the ruling.