|In order for the ownership of assets to pass from a seller to a buyer it is necessary that the parties agree three essential elements: price, terms and structure. These three elements are interdependent in any transaction. For instance, after agreeing the price of a transaction, i.e. the number of rands or rand value of other consideration the seller will receive, the parties will need to agree the terms such as whether the price will be paid by means cash, debt and/or shares as well as the timing of these payments.
Commercial transactions can be structured on the basis that instead of a cash payment for the acquisition of an asset, shares are issued by the purchaser in favour of the seller, usually referred to as an “asset for share” transaction. The issue of shares as consideration will give rise to a number of tax consequences which should be considered carefully before implementing the proposed transaction. Thus, after agreeing the price and the terms the parties will need to agree the structure of the transaction, namely, whether it should be structured as a taxable or a tax-deferred transaction. That careful consideration should be given to these matters is particularly the case given the ever changing tax legislative provisions.
Of particular relevance in a taxable transaction where shares are issued as consideration for the acquisition of assets are the anti-avoidance provisions addressing value mismatches. Complex tax systems such as South Africa’s invite taxpayers to carry our certain transactions by according them special tax advantages. Yet, attempts to access these advantages might be susceptible to challenges under the general anti-avoidance rule because the transaction was motivated, at least in part, by the desire to access the tax advantage, or legislative amendments might be enacted to block such tax advantages.
According to National Treasury, schemes which allowed for shares to be issued in exchange for assets where there is a mismatch in their respective values did not trigger the appropriate amount of tax. The Income Tax Act contains a number of provisions stipulating that in specific circumstances the disposal of assets will be deemed to take place at market value. For example, paragraph 38 of the Eighth Schedule contains a deemed market value provision in circumstances where an asset is disposed of by means of a donation, for a consideration not measurable in money or for a price that is not arm’s length between connected persons. Where a formal connected person relationship is absent the buyer and seller could easily structure their transaction to fall outside the paragraph 38 market value deeming provisions.
Therefore, the anti-avoidance provisions are not limited to the Eighth Schedule. Additional anti-avoidance provisions have been inserted in the Income Tax Act to address circumstances where value is transferred without triggering the appropriate tax, specifically where the parties concerned are not “connected persons”.
A number of questions arise from the application of the above sections in practice.
Taxpayers will be well advised to perform a tax due diligence to ascertain the implications of entering into a transaction of this nature. The taxpayer’s commercial requirements will have to be reconciled with the tax consequences. For instance, the taxpayer may seek to minimise any capital gains tax payable or ensure that the base cost of any assets acquired is as high as possible. However, these tax requirements may not always be easily achievable given the surrounding factual circumstances when considered in conjunction with the anti-avoidance provisions contained in the Income Tax Act.
Natalie Napier – Director