The South African Revenue Service (SARS) has released a number of binding class and private rulings of late. One of the interesting rulings is Binding Class Ruling 033 (BCR 33) which deals with the capital gains tax consequences for a public company upon conversion, in terms of the Companies Act, No 71 of 2008, to a private company.
The issue is that a ‘disposal’ for purposes of paragraph 11 of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act) includes the ‘conversion’ of an asset. The SARS Comprehensive Guide to Capital Gains Tax (Issue 4) states that a ‘conversion’ involves a substantive change in the rights attaching to an asset and gives the example of the conversion of a company into a share block company as amounting to a substantive change in rights.
In BCR 33 it was noted that the conversion from a public company to a private company entailed limited amendments to the company’s memorandum of incorporation (MOI), restricted to the following:
Inserting provisions prohibiting the offering of the company’s securities to the public and restricting the transferability of its securities.
Deleting the provisions dealing with share warrants.
Removing the power of the directors of the company to apply for a stock exchange listing of the company’s securities.
Removing provisions anticipating the securities of the company being listed on a stock exchange.
Despite these minor amendments to the company’s MOI, it was held that the conversion would constitute a part-disposal of the shares held by the shareholders. That is, the ‘conversion’ will entail a change in rights in that the shareholders of the public company will now be bound by the new restrictions in the amended MOI. Despite there being a ‘disposal’, BCR 33 confirmed that the part-disposal of the shares held by the shareholders in the company will not result in any capital gain or capital loss as a result of paragraph 33(1), read with paragraph 31(3) of the Eighth Schedule to the Act.
Despite there being a ‘disposal’, BCR 33 confirmed that the part-disposal of the shares held by the shareholders in the company will not result in any capital gain or capital loss as a result of paragraph 33(1), read with paragraph 31(3) of the Eighth Schedule to the Act.
It is interesting to compare BCR 33 with Binding Private Ruling 83 (25 May 2010) (BPR 83), which considered whether steps taken by a company to convert to a protected cell company (PCC) under legislation governing its commercial activities, entailing amendments to its incorporation documentation and other related administrative actions, will give rise to a ‘disposal’ by the shareholders of that company. BPR 83 held that the steps taken by the company to be recognised as a PCC did not constitute a ‘disposal’ in terms of paragraph 11 of the Eighth Schedule to the Act. Importantly, the ruling notes that the conversion did not change the company into a different legal entity, nor did it replace existing shares with new shares. A number of other related rulings have also been issued by SARS.
These two rulings illustrate the fine line between there being a ‘disposal’ and no ‘disposal’ for purposes of the Eighth Schedule to the Act (even though no adverse tax consequences were triggered upon the conversion from a public company to a private company). Taxpayers entering into transactions involving some form of conversion must therefore carefully analyse their particular circumstances to establish whether there has been a substantive (or not so substantive) change in rights of the parties to determine whether there has been a ‘disposal’ for purposes of the Eighth Schedule to the Act.