Buying a house and paying transfer duty Separate rights equals separate obligations

Author: Louis Botha (Associate at Cliffe Dekker Hofmeyr).

In our recent Tax and Exchange Control Alert of 13 October 2017, we referred to the number of tax court judgments that were recently published by SARS on its website. One of these cases is the matter of Ms A and Mr B v The Commissioner for the South African Revenue Service (Case No IT13974 & 13993) (as yet unreported), handed down by the Tax Court on 24 March 2017. In this case Ms A and Mr B (Taxpayers) appealed against SARSs decision regarding the transfer duty payable on a property which they purchased in terms of a written sale agreement.


The Taxpayers are life partners and entered into a written sale agreement on 7 August 2007, in terms of which they purchased a sectional title unit together with two parking bays (Property) from the seller. In terms of the sale agreement, Mr B would acquire the right of habitatio and Ms A would acquire the bare dominium for a total purchase price of R4.2 million. The agreement also stated that the Taxpayers would acquire the rights of habitatio and the bare dominium respectively but jointly. The Taxpayers each filed separate transfer duty declarations (TD2 declaration) with SARS. Ms A indicated in her TD2 declaration form that transfer duty was payable on an amount of R2,869,103.40 and Mr B indicated an amount of R1,330,896.60, which, together, totaled R4.2 million. Based on these declarations, the Taxpayers owed transfer duty in the amount of R225,998.49, but SARS argued that transfer duty must be calculated on the total purchase price of R4.2 million, in which case the transfer duty would be R281,000 and about R55,000 more than the transfer duty calculated by the Taxpayers. The Taxpayers paid the amount of R281,000, but appealed against SARSs decision.

Arguments raised by the parties

The main basis of the Taxpayers appeal was that on a proper reading of the sale agreement, they acquired two separate real rights, namely the right to habitatio and the right to bare dominium, and therefore transfer duty should be payable on two distinct and divisible transactions and not on the full amount of R4.2 million recorded in the sale agreement. Mr B testified that the sole reason for structuring the transaction in the manner which they did was to protect the Property against his potential creditors, who could hold him personally liable as he was a director of a law firm.

On the other hand, SARS argued that the written sale agreement failed to make provision for separate considerations of the two distinct rights and as such deemed the contract indivisible. It argued that more than one property was acquired in one transaction with one composite consideration being the amount of R4.2 million. SARS conceded that if the amounts reflected in the TD2 declarations had been apportioned in the agreement, the transfer duty that was payable according to the Taxpayers would have been correct.


The Tax Court first considered the legal scheme of the Transfer Duty Act, No 40 of 1949 (Act). Section 1 of the Act defines property as land in South Africa and any fixtures thereon, including any real right in land, but excluding any right under a mortgage bond or a lease of property other than a lease for the right to minerals or to mine minerals. Section 2 of the Act states that transfer duty is levied on the value of any property acquired by any person after the date of commencement of the Act and that the value must be determined with reference to s5, s6 and s7 of the Act. Section 3(1) of the Act states that transfer duty is payable by the purchaser within six months from the date of acquisition. With regard to determining the value of the Property, the Tax Court referred to s5 of the Act, which states that where consideration is payable by the purchaser, the transfer duty is payable on the amount of the consideration.

The Tax Court held that to determine whether a contract, as in the present instance, is divisible or not for the purpose of paying transfer duty, it is necessary to interpret the contract. With reference to previous case law on the issue, the Tax Court held that one must look at whether the contract provides for separate considerations (amounts). Where the parties have not divided the consideration and there is nothing to show what consideration should go to each portion, the contract would normally be regarded as indivisible. The Tax Court relied on the decision in Natal Joint Municipal Pension Fund v Endumeni Municipality 2012 (4) SA 593 (SCA), where the Supreme Court of Appeal held, amongst other things, that in interpreting a contract one must look at the language of the provision, read in context and having regard to the purpose of the provision, and the background to the preparation and production of the document. The Tax Court rejected SARSs argument that the sale of the rights of habitatio and bare dominium in the contract were indivisible and found it to be misguided. It held that when viewed objectively and having regard to the purpose of the provision and the background to the preparation of the document, two different persons acquired two different forms of property distinct from each other. This was despite the agreement referring to one composite amount of R4.2 million. It was not in dispute that the value of the right to habitatio was correctly computed by the parties.

SARS also tried to argue that the agreement was indivisible because the Taxpayers would have to act together if they wanted to cancel the agreement and because they could only sue for the composite purchase price (R4.2 million) and not for two separate considerations. The Tax Court rejected this argument and held that the purchase price can only be regarded as a guideline for the purposes of paying transfer duty. Furthermore, it held that if either of the purchasers wanted to sue the seller to enforce the provisions of the agreement, they could only sue the seller for the rights to which they were entitled in terms of the agreement. If the seller wanted to sue Ms A or Mr B, it could only claim the proportionate amount, which each of them stipulated in their TD2 declarations.

The Tax Court therefore upheld the Taxpayers appeal and found that they only had to pay transfer duty as calculated in their TD2 declarations. It also awarded costs in their favour.


Ruling on unitised incentive scheme does not provide much clarity

An employee incentive scheme that is commonly used works as follows: A company forms a trust. The company funds the trust, and the trust then uses the funds to buy shares in the company. The employees of the company are given units in the trust, usually free of charge. The units entitle the employees to receive distributions from the trust on the underlying shares. The employees forfeit their units in certain circumstances and may generally not dispose of their units. The trust may “repurchase” the units from the employees in certain circumstances.

Section 8C of the Income Tax Act, No 58 of 1962 (Act) generally applies to such schemes. Put simply, that provision states that, if an employee acquires a restricted equity instrument by virtue of her employment, she must pay income tax (and not capital gains tax (CGT)) when the instrument vests.

An equity instrument includes not only a share but also a unit in a trust as indicated above.

An instrument will be restricted if the employee may not freely dispose of the instrument, or forfeits it when the employee leaves the employment of the company within a specified period or is dismissed for cause.

An instrument vests when the restrictions that apply to the instrument come to an end.

The income tax is determined on the difference between the amount (if any) paid by the employee to acquire the instrument and the market value of the instrument at the time it vests.

The company or the trust must withhold employees’ tax (PAYE) on the amounts accruing to the employees.

The application of s8C of the Act is generally relatively clear in schemes such as the one described above.

What is not always clear is the interaction between s8C of the Act and the incidence of tax in the hands of the trust.

A scheme similar to the one described above was the subject of Binding Private Ruling No 261 (Ruling), issued by the South African Revenue Service (SARS) on 30 January 2017. The trust repurchased the units of the employees. However, to fund the repurchase price, the trust had to sell some of the shares in the company.

SARS ruled as follows:

  • The proceeds received by the trust on the disposal of the shares accrue to the trust, which must calculate any capital gain or capital loss arising on the disposal.
  • For CGT purposes the trust must reduce the base cost of the shares by the amount of the contributions made by the relevant companies to enable the trust to acquire the shares. This must be done under paragraph 20(3)(b) of the Eighth Schedule to the Act (Eighth Schedule) which states, among other things, that a taxpayer must reduce the cost of an asset by any amount that has been paid by any other person.
  • If the trust realises any capital gains on the disposal, those gains will not be taxable in the trust under paragraph 80(2) of the Eighth Schedule. Paragraph 80(2A) of the Eighth Schedule will not apply.
  • As the repurchase of the units results in vesting, s8C of the Act will apply and any gain determined in respect of the vesting is subject to employees’ tax, which the trust must withhold.

Paragraph 80(2) of the Eighth Schedule essentially provides that, where a trust realises a capital gain on the disposal of an asset, and the beneficiary has a vested interest in the capital gain but not in the asset, the beneficiary (and not the trust) must account for CGT.

Paragraph 80(2A) of the Eighth Schedule applies where a beneficiary of the trust holds an equity instrument to which s8C of the Act applies. The provision states that, in that case, paragraph 80(2) of the Eighth Schedule does not apply in respect of a capital gain that is vested in the beneficiary by reason of (i) the vesting of that equity instrument in the beneficiary, or (ii) the disposal of that equity instrument under s8C(4)(a) and s8C(5)(c) of the Act.

In this regard, the Ruling suggests that paragraph 80(2) of the Eighth Schedule will apply in respect of any gains realised on the disposal of the shares, and must be disregarded by the trust where the gains are vested in the beneficiaries. However, the Ruling is silent as to whether any such gains must be taken into account for purposes of calculating the beneficiaries’ aggregate capital gains or losses. The Ruling does not explicitly state whether the beneficiaries should account for CGT.

It is possible that SARS is saying that there is no CGT at all, and that the only tax that arises is income tax in the hands of the beneficiaries on the repurchase of the units under s8C of the Act.

Unfortunately, the Ruling does not provide certainty on the interplay between CGT and income tax in schemes such as that described above. Generally, that issue is a vexed one and greater clarity from SARS or the legislature would be very welcome.


Tax and Exchange Control Alert

by Ben Strauss

Tax consequences of the part waiver of a loan and the reduction of the interest rate

Heinrich Louw, Gigi Nyanin and Mark Morgan.

On 10 October 2016, the South African Revenue Service (SARS) issued binding private ruling 252 (Ruling) which determines the donations tax and capital gains tax (CGT) consequences of the waiver of a portion of a loan and the reduction of interest on the remaining balance of the loan to 0%.

By way of background, debt relief in South Africa has become somewhat of a norm due to the current stressed economic climate. One of the most common means of debt relief by creditors has been the waiver of the whole or part of a debt. For the years of assessment commencing before 1 January 2013, the reduction of debt was subject to income tax, donations tax and/or CGT, which had the result of effectively undermining the economic benefit of the debt relief.

As a result, SARS introduced a uniform system that provides relief to persons under financial distress in certain circumstances in the form of s19 (which deals with the income tax implications of debt reduction) and paragraph 12A of the Eighth Schedule (which addresses the CGT consequences) of the Income Tax Act, No 58 of 1962 (Act).

In the Ruling, SARS had to determine the donations tax and CGT consequences of the part waiver of a loan and the reduction of the interest rate on the remaining balance of the loan to 0% (Proposed Transaction). The parties to the Proposed Transaction are a South African resident company (Applicant) and a South African resident trust (Trust), the beneficiaries of which are employees of the Applicant who are historically disadvantaged persons as contemplated in the broad-based socio-economic empowerment Charter for the South African Mining and Minerals Industry.

The Applicant is in the business of processing mining residues and waste material in order to extract precious metals which are sold to third parties. In order to conduct the processing activities, the Applicant had a precious metals refining licence (Licence) as required in terms of the Precious Metals Act, No 37 of 2005 (Precious Metals Act).

Against this backdrop, the Applicant established the Trust in order to meet its Black Economic Empowerment (BEE) objectives. Upon the creation of the Trust, the Applicant issued some of its ordinary shares to the Trust at market value. The subscription price for such shares was financed by the Applicant on loan account and the interest thereon was to be levied at the “official rate of interest” as prescribed by the Seventh Schedule to the Act. More specifically, paragraph 2(f) of the Seventh Schedule states that where a loan has been granted to an employee by his employer and (i) no interest is payable, or (ii) interest is payable at a rate lower than the official rate of interest, the difference between the official rate of interest and the interest paid by the employee is a fringe benefit.

The loan balance had not significantly reduced due to the capitalisation of interest and the Applicant was of the view that the outstanding balance of the loan exceeded the market value of the shares held by the Trust. Furthermore, based on current forecasts, it would take the Trust approximately 41 years to repay the full loan amount.

The regulations published under the Precious Metal Act require the Applicant to provide “meaningful economic participation” to the beneficiaries of the Trust, in order to maintain the Licence. In light of the anticipated repayment period, two empowerment agencies confirmed that the Trust might not be able to provide the required meaningful economic participation and accordingly, the Applicant was at risk of losing the License.

As a result, the Applicant proposed to waive approximately one third of the loan (which includes capitalised interest) and reduce the interest rate on the balance remaining to 0%.

SARS ruled that:

  • donations tax will not be levied under s54 of the Act in respect of the part waiver of the loan and the amendment of the loan agreement to reduce the interest rate to 0%;
  • the part waiver of the loan and the amendment of the loan agreement to reduce the interest rate to 0%, will not be deemed to be a donation in terms of s58 of the Act; and
  • the Trust will be required, under paragraph 12A read with paragraph 20 of the Eighth Schedule of the Act, to reduce its base cost for the shares to the extent that the original loan capital is to be waived.

The Proposed Transaction would be entered into for purposes of meeting both the Applicant’s BEE objectives and statutory requirements for maintaining the Licence. Accordingly, it could arguably not have constituted a donation for purposes of s54 of the Act. However, it is particularly interesting to note that the reduction of the debt would not be seen as the disposal of property for inadequate consideration in terms of s58 of the Act. Presumably the argument was that adequate consideration would be received in the form of the benefit of maintaining the Licence. It was not indicated whether the Trust claimed any deductions in respect of the interest on the loan (to the extent that it may have qualified).


Commercial property: three ways to save tax

capetownThe effective rate of capital gains tax (CGT) has increased dramatically in recent years.

When CGT was introduced in South Africa in 2001 the effective rate for companies was 15%. The effective rate is now 22.4%. So, since 2001 the effective rate of CGT for corporates has increased by nearly 50%.

In addition, when a company distributes a profit after tax to its shareholders, they pay dividends tax at a rate of 15% (unless the shareholders qualify for an exemption, or a reduced rate).

So, when a company realises a capital profit, and distributes the profit to the shareholders the effective tax rate is 34.04%. In other words, more than one third of the profit goes to the taxman.

A close corporation is treated the same way as a company for tax purposes.

It has accordingly become more important than ever for taxpayers to reduce their tax bill on immovable property.

Here are three ways to reduce the tax:

1. Hold the property in your own name.

Natural persons pay CGT at a maximum effective rate of 16.4%. And dividends tax does not apply. So, if you hold the property in your own name you pay less than half the tax you would pay if you held shares in a company which in turn owns the property.

Naturally, you should not only take into account the incidence of CGT and dividends tax when deciding whether to hold property in your own name or not. For example, if you hold commercial property in your own name and you let the property, depending on the amount of rental you generate, you may need to register and account for value-added tax (VAT).

Also, you are personally liable for the debts relating to the property. So, if you borrow money from a bank to finance the property, the bank would also be able to attach your other assets – and not only the property – to satisfy its claim.

You could also hold the property in a trust – an effective vehicle to hold property from a tax and commercial perspective. However, there have been rumblings recently on the part of policy-makers about the way that trusts are taxed and you should exercise caution when thinking about using a trust.

2. Keep accurate records of costs.

Put simply, CGT is levied on a capital gain realised on the disposal of property, that is, on the difference between the proceeds on disposal and the base cost. The base cost is essentially the sum of expenditure incurred to acquire, improve and dispose of the property.

Clearly, therefore, it is important to ensure that your base cost is determined correctly. To that end you should diligently store records of every amount you incur in relation to the property, notably, the costs of constructing or refurbishing the buildings on the property. Even small amounts add up over time.

3. Sell shares and claims.

Consider the following case: You formed a company to acquire commercial property. The company paid R1,000,000 to buy the property. You lent that amount to the company. Many years later a person offers you R5,000,000 for the property. The share capital in the company is a nominal amount of R1,000.

If the company sells the property and distributes the net profit to you, you will put R3,638,400 in your pocket determined as follows:

In other words, in the case where you sell the shares and loan in the company, as opposed to the case where the company sells the property and distributes the profit to you, you will pocket R705,764 more.

Now, an astute buyer may be disinclined to buy the shares and loan. First, the purchaser may think that they are taking over a company with skeletons in its closet. For example, the buyer may be nervous about the company’s VAT affairs. Second, the buyer would be taking over the “latent” CGT and dividends tax relating to the property. In other words, if the buyer bought the property from the company their base cost would be R5,000,000; if they bought the shares and loan then the company would still retain its base cost of R1,000,000 and the buyer would need to account for dividends tax when the company distributes the net gain to them.

One way of inducing the buyer to take the shares and loan is to reduce the price. In that case you may still pocket a higher amount after tax than would have been the case if the buyer bought the property. The benefit to the buyer is that they would pay less money now which they could use to fund the “latent” CGT and dividends tax in future, and possibly have money to spare.

You could also offer the buyer comprehensive warranties to cater for any hidden liabilities in the company. One could even place a part of the price in trust (escrow) for a period of time. The buyer would not need to go through the hassle of registering for VAT. As a final inducement to the buyer you could offer to restructure the property holding using the corporate relief provisions so that the buyer could hold the property in a new company with your company having been deregistered or wound up.


Tax and Exchange Control Alert
by Ben Strauss
This article forms part of Tax and Exchange Control Alert – 10 June 2016: Download PDF

Capital v Revenue: the taxpayer prevails – ommissioner for the South African Revenue Service v Capstone 556 (Pty) Ltd (20844/2014) [2016] ZASCA 2 (9 February 2016)

capetownThe question of whether an amount constitutes capital or revenue in a specific instance, is an issue that our courts have grappled with on many occasions.

In Commissioner for the South African Revenue Service v Capstone 556 (Pty) Ltd (20844/2014) [2016] ZASCA 2 (9 February 2016), the Supreme Court of Appeal (SCA) had to deal with this very issue. The SCA had to decide two questions:

  • whether the share sale of the taxpayer, Capstone, of approximately 17.5 million shares in JD Group Ltd (JDG), through which it made a profit of R400 million, constituted revenue or was capital in nature; and
  • whether an indemnity settlement paid by the taxpayer after it had sold the shares, formed part of the base cost of the shares for purposes of capital gains tax (CGT).

The matter was an appeal from the full bench of the High Court, Western Cape Division (Capstone 556 (Pty) Ltd v Commissioner for the South African Revenue Service 2014 (6) SA 195 (WCC); 77 SATC 1), on which we reported in our Tax Alert of August 2014.


When Profurn, a JSE listed company in the retail furniture industry, had run into serious financial difficulties by the end of 2001, it prompted two of its largest creditors, FirstRand and Steinhoff, to propose a financial rescue plan. Profurn’s imminent liquidation would threaten the stability of South Africa’s retail furniture industry. FirstRand ascertained that Profurn needed to reduce its debt by approximately R300 million and required a capital injection of approximately R600 million to survive. Subsequently, discussions took place between Lategan, Daun, Jooste and Sussman who agreed to carry out the rescue operation through the conclusion of a number of financing transactions which included the creation of a special purpose vehicle, the taxpayer. Daun, a wealthy German businessman and director of Steinhoff, was appointed as one of the taxpayer’s directors. A memorandum of understanding (MOU) signed by Daun on 26 June 2002, reflected what the parties had agreed on and the agreements that would be concluded to effect the rescue operation. The parties also agreed that this was the effective date on which the taxpayer acquired the risks and rewards attached to the JDG shares. All parties agreed that the rescue operation would be very risky and would probably require a period of three to five years.

The transactions envisaged in the MOU had to be amended to the following: FirstRand acquired a 78.8% shareholding in Profurn. JDG and Profurn then merged and FirstRand acquired approximately
42 million JDG shares. After Daun invited Jooste to take part in the transaction, the taxpayer was restructured and it purchased approximately 17.5 million shares. The taxpayer financed this purchase through a loan received from its holding company, BVI, which also led to the possible payment of an ‘equity kicker’ to BVI. The possible payment of the ‘equity kicker’ arose as the taxpayer’s loan from BVI was funded by a loan that BVI received from Gensec and which required BVI to pay the equity kicker in addition to the loan. The equity kicker represented a portion of the growth in the value of the JDG shares, calculated by means of a formula. The taxpayer had actually paid the equity kicker even though it was not party to the loan agreement between BVI and Gensec. The taxpayer also incurred a contingent liability in acquiring the shares, in the form of an indemnity to FirstRand in the amount of R62.5 million.

On 29 April 2004, the taxpayer sold its JDG shares and realised a profit of R400 million. The taxpayer’s liability in respect of the equity kicker amounted to R45,123,050. The contingent liability of R62.5 million was subsequently settled after another party who had acquired JDG shares, including a concomitant contingent liability to FirstRand, Daun et Cie, agreed to pay the taxpayer’s full contingent liability in return for the taxpayer paying it R55 million (indemnity settlement). The taxpayer incurred the liability to pay the R55 million in its 2005 year of assessment.

Issues to decide

The SCA had to decide whether the proceeds from the share sale was income of a revenue or capital nature, and whether the ‘equity kicker’ and indemnity settlement formed part of the base cost of the JDG share acquisition, in terms of paragraph 20 of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act). The parties agreed that the High Court was correct in finding that the equity kicker constituted borrowing costs and that a third thereof could be added to the base cost of the shares, in terms of an exception to paragraph 20(2) of the Eighth Schedule.

Was the income of a capital or revenue nature?

In essence, s1 of the Act defines ‘gross income’ as the total amount received by or accrued to a person, excluding receipts or accruals of a capital nature. In interpreting this definition, the SCA referred to a number of previous decisions on this issue and stated that the applicable principles in the current matter were as follows:

  • One must look at the intention of the taxpayer. Where the gain is made in the operation of business in carrying out a scheme of profit making, the profit will be revenue in nature. This would be ascertained by considering the purpose for which the taxpayer entered into the transaction. A company’s intention at a given time is determined by looking at the intention of the persons who were in effective control of the company at that time.
  • One must look at the nature of the taxpayer’s business activities.
  • The period for which the asset is held and the period for which it was anticipated to be held at the time of acquisition are relevant.
  • When dealing with an investment, the nature of the risk undertaken has a bearing on whether the transaction is aimed at building up the value of the taxpayer’s capital or directed at generating revenue and profit.
  • In many commercial situations there may be no clear intention at the outset and it may then be accepted that the taxpayer’s future intentions were indeterminate.

The SCA stated that the transaction must be considered in its entirety from a commercial perspective and not be broken into component parts or subjected to narrow legalistic scrutiny, when applying these principles.

In applying these principles to the facts, the SCA held that the purpose of the transaction should thus be determined as at 26 June 2002 when the MOU was concluded. The High Court also held that this was the case. On the question of who was in control of the taxpayer, the SCA agreed with the High Court and held that Daun was the ‘brain’ and ‘mind’ of the taxpayer and was in de facto control of the JDG shares from their effective acquisition to their disposal, as the decision when to sell was solely his. Daun, who the SCA found to be a credible witness, acquired the JDG shares as he believed that the rescue operation could be successful. The resale of the shares at a profit was one of several possibilities he initially considered. Daun’s investment was very risky as it was made in the hope that Sussman’s managerial skills would make the rescue successful by averting Profurn’s imminent liquidation. Daun committed himself to the investment without knowing how long his commitment would need to last.

The SCA rejected SARS’s argument that Daun’s intention became one of profit making when he decided to sell some of the shares to Steinhoff as part of a book-building exercise Steinhoff had undertaken. Daun testified that he only decided to sell after discussing it with Sussman and after his wife had convinced him that he was overexposed in South Africa. Steinhoff’s offer to sell pursuant to the book building exercise, was thus merely fortuitous. The SCA also rejected SARS’s argument that the short-term nature of the loan from BVI and the nature of the equity kicker indicated an intention to fund the loan repayments by selling the shares. This was because the loan agreement was entered into on 5 December 2003, long after the MOU and in any event, the equity kicker was payable irrespective of whether the shares were sold or not. Based on Daun’s evidence, which was corroborated by a number of other witnesses, the SCA held that the proceeds of the JDG shares were capital in nature.

Did the indemnity settlement form part of base cost?

This issue was heard by way of a cross-appeal brought by the taxpayer. The High Court had found that the indemnity settlement did not form part of the base cost of the shares as it was entirely separate from the acquisition of the JDG shares. With regard to the indemnity settlement, the SCA referred to paragraph 20(1)(a) of the Eighth Schedule of the Act, which states that the base cost includes “expenditure actually incurred in respect of the costs of acquisition” of an asset. The words ‘expenditure actually incurred’ refers to an unconditional legal obligation to pay and the words ‘in respect of’ connote a causal relationship. As the unconditional legal obligation to pay R55 million to Daun et Cie in terms of the indemnity settlement replaced the contingent obligation to FirstRand, the causal link between the acquisition of the shares and the indemnity settlement remained intact.


The SCA held that SARS had to pay all the taxpayer’s costs in opposing the appeal and the costs incurred by the taxpayer in the cross-appeal, including the costs of two counsel.


This case confirms the principle that to determine whether an amount constitutes capital or revenue will always be a question of fact and that courts will not follow a one-size-fits all approach. In light of the increase in the CGT rate to 80%, which applies as of 1 March 2016, as opposed to 50% at the time the shares were sold, the case raises an interesting practical issue, especially for companies who decide to embark on litigation of this nature in future. Based on the facts in this case, had the shares been disposed of after 1 March 2016, the taxpayer would have paid tax on the sale at an effective rate of 22.4%. On an amount of R400 million, this would trigger a tax liability of R89,600,000. Had the amount been classified as income in terms of s1, the taxpayer would have been liable to pay tax at the rate of 28%, which would amount to R112 million and amounts to a difference of R22.4 million. The SCA’s finding that the obligation to pay the indemnity settlement formed part of base cost, would have reduced the taxpayer’s tax liability by a further amount of R12,320,000. On the same facts, the successful litigation would have reduced the taxpayer’s tax liability by approximately R34,720,000 and would most likely have been worth the taxpayer’s while, from a business and financial perspective. However, considering the high cost of and risks attached to litigation, companies would be well advised to do the math and count the possible costs of litigation, before they decide to challenge SARS’s assessment on whether an amount constitutes capital or revenue.


This article forms part of Tax Alert – 11 March 2016:

Settlors beware: control over the assets of a trust

capetownThe establishment of an offshore discretionary trust (“the Trust”) by a South African tax resident person (“Settlor”) gives rise to various South African tax considerations.

In terms of current law (which may or may not be impacted upon by the various proposals set out in the Davis Tax Committee’s First Interim Report on Estate Duty), the following taxes may typically be triggered by the Settlor in respect of the disposal of assets to the Trust in settlement thereof:

  • capital gains tax at a maximum effective rate of approximately 13.65% of the capital gain realised;
  • donations tax at a rate of 20% of the amount or the market value of the assets donated; and
  • any income derived by the Trust in respect of any donation made by the Settlor may be attributed to the Settlor and accordingly subject to South African income tax in his/her hands.

The donations tax and income tax (attribution) implications which may arise in respect of the settlement of assets in a trust may be mitigated by the Settlor settling the Trust with a nominal donation and providing an interest-bearing loan to the trust. As any interest received by or accruing to the Settlor would be subject to South African income tax in his/her hands (subject to a possible tax credit being obtained for any foreign interest withholding taxes suffered), it is ordinarily advisable for the Trust to repay such loan to the Settlor as soon as possible.

In addition to the above, depending on the assets disposed of by the Settlor to the Trust, additional South African taxes may be triggered in this regard – albeit in the hands of the Trust, including:

  • securities transfer tax at a rate of, broadly speaking, 0.25% of the market value of any securities transferred to the Trust; and
  • transfer duty imposed on a sliding scale based on the market value of any immovable property transferred to the Trust.

Despite the above, South African tax residents pursue the establishment of foreign trusts for a variety of personal and/or commercial reasons, including for purposes of sheltering the assets of the trust from estate duty.

It is very important, however, for Settlors to be extremely cautious when establishing an offshore trust and to obtain the necessary South African legal and tax input in respect of any such trust to be established. Should the Trust be established in such a manner so as to detract from the independence of its trustees and/or provide for the control of the trust assets by the Settlor, the tax implications arising from such trust may differ significantly from the position as set out above.

In determining whether the Trust would be regarded as a trust in terms of South African law, there must, inter alia, be a genuine intention to create a trust. Should this intention be lacking, or if the real intention be to create something other than a trust, no trust will come into existence. In determining whether there was a genuine intention to create a trust (as opposed to a relationship of agency or partnership, for example), a court will have particular regard to the degree of control retained by the Settlor in regard to the affairs of the trust. The Supreme Court of Appeal in Land and Agricultural Bank of SA v Parker and Others 2005 (2) SA 77 (SCA) held that independence of judgment on the part of a trustee is “an indispensable requisite of office” and that, if there is no proper separation of ownership or control from beneficial enjoyment of trust property, the courts may disregard such trust.

Accordingly, should a Settlor be entitled (whether in terms of the applicable trust deed or otherwise) to, for example, appoint and replace the trustees of the Trust, instruct them as to the distribution of the trust capital and/or unilaterally revoke or amend the Trust Deed at will, these powers may be seen as undermining the independence of the trustees, as well as the vital separation between control and enjoyment of the trust property, and perhaps indicating an intention to create a relationship closer to agency than to a true trust.

Whether or not the existence of the Trust is called into question, should the Settlor retain control over the assets of the Trust, such assets may fall within his/her estate for estate duty purposes. In particular, in terms of section 3(3)(d) of the Estate Duty Act No. 45 of 1955, any property which the Settlor would be competent to dispose of immediately prior to his/her death may be subject to estate duty. In this regard, the deceased will be regarded as being competent to dispose of any property if:

  • he/she had such power as would have enabled him, if he/she were sui juris, to appropriate or dispose of such property as he/she saw fit whether exercisable by will, power of appointment or in any other manner; or
  • if under any deed of donation, settlement, trust or disposition made by him, he/she retained the power to revoke or vary the provisions thereof relating to such property.

Correspondingly, should a Settlor transfer of his/her assets to a trust (as some form of agent for the Settlor), but effectively retain ownership attributes in respect of such assets, such transfer of assets may not constitute a “disposal” for capital gains tax purposes or a donation for donations tax purposes.

It is evident on the basis of the above that a Settlor should have careful regard to the nature of the specific offshore trust to be established as the mere labelling of an entity or an arrangement as a trust does not, in itself, give rise to resultant trust tax and legal implications. It is always necessary to analyse the terms of the applicable founding documentation to obtain certainty in this regard. This is particularly important when applying South African tax and law to foreign “trusts” which are often governed by terms giving rise to different consequences.


Robert Gad

tax | corporate, indirect, disputes and share schemes | director
+27 82 567 9082

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Alexa Muller

tax | associate
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Asset-for-share transactions

taxation2Section 42 of the Income Tax Act of 1962 (the Act) provides for tax roll-over relief in respect of asset-for-share transactions as defined. Such a transaction generally entails the disposal by a person of an asset to a company, and the issue of new shares by that company to the person, as consideration.

One of the requirements is that the nature of the asset must be retained. In other words, if the person held the asset as trading stock, the company must acquire it as trading stock, and if the person held it as a capital asset, the company must acquire it as a capital asset. If the person held the asset as a capital asset, the company may acquire it as trading stock if the person (where the person is a company) and the company do not form part of the same group of companies.

However, asset-for-share transactions can create an opportunity for a person holding assets as trading stock, to dispose of such assets to a company by way of an asset-for-share transaction, and subsequently sell the shares as capital assets.

To prevent such an abuse of asset-for-share transactions, section 42(5) of the Act contains an anti-avoidance provision. If a person disposes of any share received in terms of an asset-for-share transaction within 18 months after the date of acquisition, and immediately prior to such disposal more than 50% of the market value of all the assets disposed of by that person to the company is attributable to allowance assets or trading stock, that person will be deemed to have disposed of the relevant shares as trading stock.

The deeming provision only operates to the extent that the amount received by the person for the disposal of the shares is less than or equal to the market value of the shares at the beginning of the 18 month period. In other words, the person disposing of the shares will be deemed to have disposed of the shares on revenue account, but only up to the amount of the market value of the shares at the beginning of the 18 month period. If the person receives more than that as consideration for the disposal of the shares, the normal rules will apply in respect of determining whether the disposal is on revenue or capital account.

The restriction does not apply to the disposal of a share by means of:

  • An intra-group transaction in terms of section 45 of the Act.
  • An unbundling transaction in terms of section 46 of the Act.
  • A liquidation distribution in terms of section 47 of the Act.
  • An involuntary disposal in terms of paragraph 65 of the Eighth Schedule to the Act.
  • The death of the person.

An amalgamation transaction in terms of section 44 is not excluded. However, see Binding Private Ruling No 159, in which the South African Revenue Service ruled that, based on the particular facts at hand, shares acquired in terms of a section 42 transaction could be disposed of by way of a section 44 amalgamation transaction and would not be deemed to be on revenue account but on capital account.

One of the amendments in the Taxation Laws Amendment Bill 2015 concerns the clarification of section 42(5) of the Act. There appears to be a concern that the current wording “creates unintended anomalies and potentially converts the nature of the equity shares to assets held as trading stock”.

It is proposed that, instead of formulating the anti-avoidance provisions as a deeming provision, whereby the person is deemed to dispose of shares as trading stock, the person must rather be directly obliged to include the relevant consideration in income. The inclusion in income will, therefore, not be as a result of the shares being deemed to be trading stock, which could have caused confusion considering accompanying transactions.

It is important to appreciate that the restriction contained in section 42(5) should be read together with the requirement that the person must retain a “qualifying interest”, as defined, in the company for a period of at least 18 months. The consequences for not doing so are described in section 42(6) of the Act. Even though it is possible for the person to dispose of the shares received within 18 months of the implementation of the transaction without section 42(5) necessarily applying (for example, if less than 50% of the value of the assets is
attributable to trading stock), the person should take care not to dispose of so many shares as would cause the person to no longer hold a qualifying interest in the company.

Cliffe Dekker Hofmeyr
ITA: Sections 6, 42, 44, 45, 46, 47 and paragraph 65 of the Eighth Schedule
BPR 159

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.

Capital Gails Tax – Disposal of sectional title units to shareholders

jungle12The South African Revenue Service (SARS) released Binding Private Ruling, No 206 (the Ruling) on 14 September 2015. The Ruling dealt with the disposal by a share block company of sectional title units to its share block holders.

A resident company (Applicant), and a resident trust (Trust), held shares in a resident share block company (Share Block Company).

The Share Block Company owned three sectional title units. It was proposed that the Share Block Company would dispose of the sectional title units to the Applicant and the Trust. The Applicant and the Trust would then surrender their share block certificates and rights of use to the Share Block Company. These would then be cancelled.

Effectively, after the completion of the transaction, the Applicant and the Trust would directly hold the sectional title units, and would no longer hold shares in the Share Block Company.

On the assumption that the Applicant and the Trust held their shares as capital assets, SARS ruled that paragraph 67B of the Eighth Schedule to the Income Tax Act of 1962 (the Act) would apply to the disposal of the sectional title units by the Share Block Company.

Paragraph 67B of the Eighth Schedule to the Act effectively provides that, where a person has a right of use of a part of the property of a share block company, conferred by reason of that person holding a share in that share block company, and that person subsequently acquires ownership of that part of the property upon disposal by the share block company:

  • The share block company must disregard any capital gain or loss resulting from the disposal.
  • The person must disregard any capital gain or loss resulting from the disposal of its shares in the share block company.

In addition SARS ruled that, to the extent that the disposal by the Share Block
Company of the sectional title units constitutes a dividend in specie, it would be exempt from dividends tax in terms of section 64FA(1)(d) of the Act. Presumably this would only be relevant to the Trust.

For purposes of Value-Added Tax (VAT), SARS ruled that the supply of the sectional title units by the Share Block Company would be deemed to have been made in the course and furtherance of an enterprise, as contemplated in section 8(19) of the Value-Added Tax Act  of 1991 (the VAT Act). The value of the supply would also be deemed to be nil in terms of section 10(27) of the VAT Act. Accordingly, the output VAT would be zero.

In terms of section 9(19) of the Transfer Duty Act of 1949, the transfer of the sectional title units would also be exempt from transfer duty.

Effectively, the provisions referred to above provide for roll-over relief where a share block company disposes of its property or parts thereof to a shareholder who has rights in respect of that property or part.

The Ruling illustrates the application of these provisions rather well, and also makes it clear that the provisions apply to undivided interests in sectional title units owned by share block companies.

Cliffe Dekker Hofmeyr
ITA: Section 64FA(1)(d) and paragraph 67B of the Eighth Schedule
VAT: Sections 8(19) and 10(27)
Transfer Duty Act: Section 9(19)
BPR 206

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.

Capital Gains Tax – Cross issue of shares and tax-free corporate migrations

capetownIn the 2015 Budget, the Minister of Finance indicated that paragraph 11(2)(b) of the Eighth Schedule to the Income Tax Act of 1962 (the Act), which deals with the issue of shares by a company, would be reviewed. The Taxation Laws Amendment Bill 2015 specifically addresses paragraph 11(2)(b).

The issue of shares by a company (whether for cash, shares or other assets) generally does not constitute a disposal for capital gains tax purposes, although there may be capital gains tax consequences in terms of section 24BA of the Act to the extent that there is a mismatch between the value of the shares issued and the cash or assets received.

In 2013, paragraph 11(2)(b) was amended to specifically provide that the issue of shares by a resident company in exchange for shares in a foreign company (whether directly or indirectly) would constitute a disposal.

This was a ‘blunt instrument’ approach to dealing with certain transactions that resulted in tax-free corporate migrations. These transactions involved the issue of shares by a resident company to a non-resident company, in exchange for shares in that or some other non-resident company. The resident company would then be stripped of its foreign assets in a tax effective manner by relying on paragraph 64B of the Eighth Schedule. Following a change in the place of effective management of the resident company, it would become a non-resident, and the exit charge would be minimal given the preceding disposal of foreign assets.

The 2013 amendments to paragraph 11(2)(b) halted these transactions because it would result in an immediate capital gain for the resident company equal to the market value of the foreign shares, the shares issued by the resident company having a zero base cost. However, the fact that paragraph 11(2)(b) applies to the direct or indirect exchange for shares in a foreign company had unintended consequences. Even if the resident company issued the shares for a cash amount, but the amount is ultimately settled by the acquisition of shares in any foreign company, or the resident company in any other manner ends up with foreign shares, there would be a disposal.

The economic consequence is that it hampers the acquisition by local companies of foreign entities and the growing of South African multinationals.
The 2015 amendments effectively reverse those made in 2013 in that the issue of shares by a resident company in exchange for shares in a non-resident company, no longer constitutes a disposal for purposes of capital gains tax.

Rather, paragraph 64B will be amended to provide that the disposal of shares in a foreign company by a resident company to a connected person would be subject to capital gains tax. In other words, the exemption in paragraph 64B would not apply if the foreign shares are disposed of to a connected person.

In addition, section 9H of the Act, which deals with changes in tax residence, will be amended to provide that any benefits that a resident company enjoyed under paragraph 64B and/or section 10B(2)(a) of the Act within three years prior to ceasing to be a resident, will be reversed upon ceasing to be a resident.

The amendments are proposed to apply retrospectively with effect from
5 June 2015.

Cliffe Dekker Hofmeyr
ITA: Sections 9H, 10B(2)(a), 24BA, and paragraphs 11(2)(b) and 64B of the Eighth Schedule

Assuming contingent liabilities in acquiring a going concern

taxation1Author: Erich Bell, Senior Tax Consultant at BDO South Africa

SARS issued a draft interpretation note (DIN) in September 2015 on the tax implications of the assumption of contingent liabilities where a business is sold as a going concern. This article sheds some light on the assumption of contingent liabilities which specifically formed part of the purchase price relating to the acquisition of the business as a going concern.1

A purchaser can settle the purchase price for the acquisition of a business as a going concern by employing a combination of: cash consideration, assuming the seller’s debts, assuming the seller’s contingent liabilities, loan funding, or share issues.

The DIN clarifies that a business disposed of as a going concern consists of individual assets and that the seller and the purchaser must allocate the purchase price to these assets using the same ratio. If the purchase price consists of a combination of cash and assumption of contingent liabilities, these elements will have to be allocated to the assets transferred in terms of the sale. Consider the following example:

A sells a manufacturing concern to B for R100 as a going concern. A and B agree that the R100 will be settled through a cash payment of R70 and the assumption by B of A’s bonus provision of R30. The bonus provision would only become payable to employees still in the employment of B after 2 months from date of transfer as a going concern. The assets transferred consist of premises of R60, machinery of R30 and trading stock of R10.

A and B would have to allocate the R100 to the assets transferred, which can be done in a manner they deem fit as long as it reflects the substance. Assume that R60 cash is allocated to premises and R10 to machinery, and that the R20 bonus provision is allocated to machinery and R10 to trading stock. The purchase price would then be allocated as follows:

Selling price Cash Bonus provision
Premises R60 R60 R0
Machinery R30 R10 R20
Trading stock R10 R0 R10
R100 R70 R30

1 The tax implications would differ where a purchaser assumes some of the seller’s contingent liabilities without it forming part of the purchase price.

The DIN defines a contingent liability as ‘an obligation whose existence will only be confirmed by the occurrence or non-occurrence of one or more uncertain future events and, if confirmed, will result in expenditure being incurred to settle the confirmed obligation’. The DIN draws a clear distinction between ’embedded obligations’, which constitute contingent obligations linked to a particular asset that reduces the value of the asset and which must be transferred with the asset under law, and ‘free-standing contingent obligations’, which constitute separately identifiable contingent liabilities not linked to and that do not affect the value of a particular asset. Free-standing contingent liabilities are most commonly encountered as employee provisions such as bonus and post-retirement medical aid provisions. An example of an embedded obligation is mining rehabilitation obligations associated with mining rights.

The DIN sets out the income tax implications for the seller and the purchaser on the assumption of the free-standing contingent liabilities by the purchaser and on the subsequent realisation thereof by the purchaser.

It is firmly established in our law that an ‘amount’ for ‘gross income’ and proceeds purposes (for CGT purposes) does not only include cash but also the value of property or the value of any other in kind benefit received by the taxpayer. The assumption by the purchaser of the seller’s free-standing contingent liabilities would benefit the seller as the seller would no longer be required to settle these liabilities if and when they become unconditional. The value of free-standing contingent liabilities must be determined and included in the seller’s gross income if they were allocated to an asset that is income in nature. Alternatively, the value would constitute proceeds for CGT purposes if the liabilities were allocated to an asset that is capital in nature. The DIN takes the view that the benefit amount is equal to the face value of the free-standing contingent liability.

From the above example, for CGT purposes, (i) the full cash payment of R60 would constitute proceeds for the seller for the disposal of the premises; and (ii) the R20 of the face value of the bonus provision plus the R10 cash payment would constitute proceeds for the seller on disposal of the machinery. R10 of the face value of the bonus provision allocated to the trading stock would have to be included in the seller’s gross income as trading stock is income in nature.

The seller must ‘actually incur’ an amount for it to qualify as a deduction. The courts have generally held that there must be a definite and absolute liability, or rather, a conditional legal obligation on a person to incur an amount for it to qualify as expenditure ‘actually incurred’ and be deductible. Provisions for anticipated expenditure would not qualify for a deduction. As the free-standing contingent liabilities are conditional at the date of transfer, the seller would not be deemed to have ‘actually incurred’ the free-standing contingent liabilities and would not qualify for a deduction, irrespective of whether the purchase price is reduced as a result of such transfer. The seller would also not be entitled to a deduction when the free-standing contingent liabilities subsequently realise in the purchaser’s hands, as the purchaser would then be the person who actually incurred the expenditure relating to the free-standing contingent liabilities and who should be entitled to the deduction (if applicable). From the example the seller would not be entitled to deduct the R30 bonus provision transferred to the purchaser.

The purchaser would not be entitled to a deduction of the value of the free-standing contingent liabilities assumed on the date of transfer of the going concern as the purchaser would not have actually incurred any expenditure with regard to the liabilities at such time (being conditional on events following date of transfer). The purchaser would only be entitled to claim a deduction of the liabilities when they realise and are actually incurred. Upon realisation of the free-standing contingent liabilities, the purchaser would need to investigate to which assets acquired in terms of the sales agreement the face value of the free-standing contingent liabilities were allocated. This determination is required as it considers the purpose for which the purchaser assumed the contingent liabilities and the nature of the expenditure resulting from the realisation of the free-standing contingent liabilities. The DIN clarifies that the expenditure resulting from the realisation of the free-standing contingent liabilities would follow the nature of the asset to which it was apportioned in terms of the purchase agreement. Therefore, when determining the deductibility of the expenditure resulting from the realisation of the free-standing contingent liabilities, the income or capital nature of the expense should not be considered, but instead the nature of the asset to which it was apportioned is relevant.

From the example above, the free-standing contingent liability is a bonus provision of R30 which would be deductible under normal circumstances upon realisation, being income in nature. In terms of the purchase price allocation, R20 of the bonus provision was apportioned to machinery which constituted capital assets, whilst R10 was allocated to trading stock which constituted revenue assets. Under the methodology applied in the DIN, the R20 bonus provision apportioned to the machinery would follow the capital nature of the machinery and would have to be capitalised to the cost of the machinery. This capitalised cost would qualify for a capital allowance over a number of years. The remaining R10 of the bonus provision apportioned to the trading stock would follow the income nature of the trading stock and would qualify for a full deduction on realisation.

This article summarises some of the main principles in the DIN relating to the transfer of contingent liabilities on disposal of a business as a going concern. These complexities should be considered in such transactions to manage any adverse tax implications.

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