Section 46 of the Income Tax Act, No 58 of 1962 (Act) provides tax relief where a company (Unbundling Co) wishes to unbundle its shareholding in a subsidiary (Unbundled Co), to the companys own shareholders. The Unbundling Cos shareholders indirect shareholding in the Unbundled Co is converted to a direct shareholding, in proportion to their shareholding in the Unbundling Co.
Where an unbundling takes place outside the scope of s46 of the Act, as set out above, several tax consequences would ordinarily apply:
- Shareholder A would receive the shares in SubCo as a dividend in specie, which may result in liability for dividends tax under Part VIII of the Act;
- The disposal of the shares in SubCo, would constitute a disposal under the Eighth Schedule to the Act, potentially leading to a capital gain for HoldCo; and
- Securities transfer tax (STT) would be payable on the transfer of all the shares under the Securities Transfer Tax Act, No 25 of 2007.
On 24 May 2019, the South African Revenue Service (SARS) published Binding Class Ruling 066 (BCR 066). BCR 066 provides the income tax consequences and applicability of s46 to the receipt of shares in a listed company by resident and non-resident shareholders, following an unbundling of that company by its listed parent company. It is binding only on the parties to the ruling.
- The ruling dealt, among other things, with the following aspects of s46:
- The definition of unbundling transaction in s46(1)(a); and
- The anti-avoidance provisions in s46(3)(a)(v).
The applicant in BCR 066 was a listed company with both listed and unlisted shares. A new company (NewCo) was to be formed and its single class of shares listed prior to the proposed unbundling. The shareholders in the applicant would upon the unbundling receive one NewCo share for each listed share they held in the applicant. In line with the participation rights attached to unlisted shares in the applicant, holders of these unlisted shares would receive one NewCo share for every five unlisted shares held in the applicant. In addition, some of the non-resident shareholders in the applicant were not able to take receipt of the unbundled shares, due to being restricted overseas shareholders in their jurisdiction.
BCR 066 explains that because of the distribution of unbundled shares to the applicants shareholders holding unlisted shares, it could result in such shareholders holding fractional entitlements. It was proposed that rather than transferring these fractional entitlements, they be rounded down to a whole number and the aggregated excess fractions to which a shareholder would otherwise have been entitled will not be transferred to the shareholder but will instead be sold on behalf of theshareholder.
A similar mechanism was proposed in relation to the non-resident shareholders who could not receive transfer of the NewCo shares, with the NewCo shares being sold on their behalf and the proceeds paid to them upon completion of the transaction.
Ruling and discussion
Ordinarily, under s46, shareholders of the Unbundling Co will receive transfer of a proportionate number of equity shares in the Unbundled Co. SARS decided on the facts of the ruling, that despite the shares being sold on behalf of the two types of shareholders, rather than the shares themselves being transferred, the transaction still fell within the definition of unbundling transaction in s46(1)(a). It is possible that SARS accepted this due to the specific facts of BCR066. For example, in BCR066, it is stated that the board resolution authorising and detailing the unbundling transaction provided that the entitlement to the NewCo shares would vest in the non-resident and unlisted shareholders and that ownership would transfer upon the unbundling.
Section 46(3)(a)(v) of the Act neutralises the tax value discrepancies which would occur where an indirect shareholding is unbundled into a direct shareholding. Essentially, it provides that the tax values market value and expenditure as defined of the unbundled shares, must be re-determined with reference to the market values of the unbundled and unbundling shares, at the end of the day that the distribution takes place.
In BCR 066, SARS ruled that s46(3)(a)(v) applied to both the holders of fractional entitlements and non-resident shareholders. This meant that the proportionate adjustment of the expenditure and market value of the shares to be sold on behalf of the abovementioned shareholders would be calculated at the record date. This would determine the amount they would be entitled to following the sale of the NewCo shares on their behalf.
BCR 066 is a good illustration of the underlying principles of the roll-over relief provided by s46 of the Act. To facilitate the restructuring of interests held within a group of companies, the indirect shareholding in a company can be unbundled to the shareholders of a parent company, without adverse tax consequences or significant economic distortion.