Author: BDO – South Africa
On 22 September 2014 SARS released Issue 2 of Interpretation Note 75 (‘IN75′). IN75 deals with the exclusion of certain companies and shares from a ‘group of companies’ as defined in section 41(1) of the Income Tax Act (‘the Act’) for purposes of the corporate rules.
The issue that IN75 addresses is a contentious one which has given rise to much uncertainty in the past. Simply put, for the purposes of the corporate restructuring rules in sections 42 to 47 of the Act, the definition of a ‘group of companies’ is more restrictive than the general definition of ‘group of companies’ in section 1 of the Act. The ‘corporate rule’ definition of a group commences with the definition as contained in section 1, but thereafter excludes certain shares from being considered as equity shares and certain companies, most notably non-resident companies (unless they are effectively managed in South Africa) as well as companies with their place of effective management outside of South Africa.
At issue is whether a company that is excluded from the definition results in controlled group companies in relation to the non-resident company also being excluded, or whether it is only the non-resident company itself that is excluded. The wording of the ‘corporate rule’ definition is ambiguous in this respect.
The interpretation favoured by SARS is the more restrictive of the two possibilities, namely, that one has to exclude the non-resident company and its controlled group companies from the definition. This interpretation may be considered unfortunate in that it excludes South African resident companies that are controlled group companies in relation to a non-resident controlling group company from participating in the rollover relief provided by many of the corporate rules which require the transfer of assets to take place between a ‘group of companies’ per the section 41 definition.
On 24 October 2013 SARS released the first version of IN75. Paragraph (i)(ff) of the proviso to section 41(1) of the Act, which excludes a company with its place of effective management outside South Africa from a ‘group of companies’, became operative on 1 January 2013 and applies to transactions entered into on or after that date. Reference to the above exclusion of such companies from the definition of a section 41(1) ‘group of companies’ is the only substantive addition (aside from grammatical and cosmetic changes) to Issue 2 of IN75. The remainder resembles the 2013 predecessor.
However, there is a view that there is no requirement to reapply the section 1 ‘group of companies’ definition to the companies remaining after the exclusion of certain companies as per the section 41(1) proviso. If this alternative interpretation is applied, one would end up in the situation of one or more controlled group companies without a controlling group company, which would still constitute a ‘group of companies’ as per section 41. This view is not consistent with SARS’ view as expressed in IN75.
Below, Example 1 as per the current IN75 illustrates SARS’ interpretation:
A, a company, was incorporated in the United States of America and is effectively managed in that country. It directly holds 100% of the equity shares in two companies that are incorporated and effectively managed in South Africa, namely, B and C.
C directly holds 100% of the equity shares in D, which is also incorporated and effectively managed in South Africa.
All of the shares are held on capital account and there are no contractual obligations, rights or options to purchase or sell the shares under particular circumstances.
Application of the definition in section 1(1) to A, B, C and D A, B, C and D meet the requirements of the definition in section 1(1) because A directly holds at least 70% of the equity shares in B and C. As such, B and C are ‘controlled group companies’ as defined. A indirectly holds at least 70% of the equity shares in D through another controlled group company, namely, C.
C and D meet the definition in section 1(1) because C holds at least 70% of the equity shares in D.
Application of the proviso to the definition in section 41(1) to A, B, C and D A is excluded from consideration as part of the group of companies by paragraph (i)(ee) of the proviso, as it is a foreign incorporated company which is effectively managed in the United States of America. None of the exclusions in paragraph (i) or deeming provisions in paragraph (ii) of the proviso apply to B, C or D.
The definition in section 1(1) must now be re-applied to these companies (B, C and D) to determine if there is a group of companies for the purposes of the corporate rules, bearing in mind that A has been eliminated as part of the group.
Application of the definition in section 1(1) to B, C and D Neither B nor C is a controlled group company because A has been excluded from consideration and as a result there is no company still under consideration that alone or together with other permitted companies holds 70% or more of the equity shares in B or C. In the absence of a controlling group company and a controlled group company, B and C are not a ‘group of companies’ as defined.
C and D are a group of companies for purposes of the corporate rules because –
- C is a ‘controlling group company’ while D is a ‘controlled group company’; and
- C satisfies the requirement that ‘the controlling group company’ directly holds at least 70% of the equity shares in at least one ‘controlled group company’.