The definition of ‘controlled group company’ and ‘equity share’

transfer pricing 102The South African Revenue Service (SARS) released Binding Private Ruling No 205 (Ruling) on 11 September 2015. The Ruling considers the meaning of ‘controlled group company’ and ‘equity share’.

An approved venture capital company (VCC) in terms of section 12J of the Income Tax Act of 1962 (the Act), resident company A (Company A), and resident company B (Company B), proposed to incorporate a new company (RentalCo).

RentalCo would lease certain movable goods under operating leases to existing clients of Company A.

The VCC would subscribe for 20% of the issued shares in RentalCo, but at a disproportionate subscription price of 75% of the issued share capital of RentalCo. The VCC would be issued with class A ordinary shares.

Company A and Company B would subscribe for class B and class C ordinary shares respectively, totalling 80% of the issued shares in RentalCo.

The class A ordinary shares would entitle the VCC to a first distribution of profits or capital equal to the capital invested and a return of prime plus 2%.
Once the distributions in respect of the class A shares have been settled, the holders of the class B and C shares would be entitled to a second distribution of profits or capital equal to prime plus 2% in proportion to their respective shareholding.

Thereafter all ordinary shares would rank pari passu.

All ordinary shares would at all times carry equal voting rights. The VCC intends to enter into similar transactions in future with partners whereby companies would be incorporated for purposes of leasing goods to clients. The
VCC will always hold less than 70% of the shares in issue because a ‘qualifying company’ for purposes of section 12J of the Act may not be a controlled group company in relation to the VCC. The VCC will always subscribe for cash.

SARS ruled that the class A ordinary shares would constitute ‘equity shares’ for purposes of the definition of ‘qualifying share’ in section 12J(1) of the Act. In other words, they are not shares that “neither as respects dividends nor as respects returns of capital, carr[y] any right to participate beyond a specified amount in a distribution”.

SARS also ruled that the company into which the VCC will invest (such as RentalCo), would not constitute a ‘controlled group company’ for purposes of the definition of ‘qualifying company’ in section 12J(1) of the Act to the extent that the VCC holds less than 70% of the number of equity shares in issue. This is so despite the fact that the VCC might invest more than 70% of the share capital.

The company into which VCC will invest would not be a ‘qualifying company’ as defined if the sum of the ‘investment income’ derived during any year of assessment exceeds 20% of gross income.

‘Investment income’ includes rental from immovable property, but not movable goods. SARS therefore ruled that the rental income received by the company into which the VCC will invest would not constitute’ investment income’ as defined in section 12E(4)(c) of the Act.

Cliffe Dekker Hofmeyr
ITA: Sections 12E and 12J
BPR 205

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.

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