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South Africa's Company Tax Law On Its Way

by Robert Lee,,

19 October 2001

South Africa's corporations are hoping that the government will make an announcement on the timetable for introducing new tax provisions on unbundling and restructuring any day now, and when it does it is expected that there will be heated debates in Parliament.

At the time of his February budget presentation, Finance Minister Trevor Manuel said: 'Unbundling provisions were introduced to facilitate the dismantling of SA corporate structures. The internationalisation of the SA economy means that non-SA residents are benefiting from these provisions. SA Revenue Services and the national treasury will therefore review the unbundling provisions to ensure that they are still appropriate in the current business environment.' The need for a review was also accentuated by the introduction of capital gains tax this year.

The Second Revenue Laws Amendment Bill will be debated when Parliament's finance committee holds public hearings on the bill. As regards domestic companies, five types of transaction are dealt with: company formations, share-for-share combinations, intra-group transfers, unbundling and liquidations.

For company formations, the bill recommends that tax should not be imposed if the taxpayer is transforming direct asset ownership into an indirect share interest, or is not cashing out. While the transferee company can be newly formed or previously existing, both it and the transferor company must be domestically incorporated. Separate rules exist to promote the tax-free formation of foreign-owned SA subsidiaries. To qualify for the tax-free basis, the transferor must acquire a minimum of 25 per cent of the ordinary or participating preference shares and hold the interest for at least 18 months. Property subject to debt may be freely transferred. The transfer of financial instruments will not qualify.

Tax-free exchanges for shares will be limited to ordinary shares and participating preference shares. The principle behind the share-for-share rules is that deferred capital gains made on the transformation of a direct interest into an indirect interest should be tax free, but only if both companies are domestic. There should be no capital gains tax if the investor is not cashing out the investment. A minimum 25% acquisition of ordinary or participating preference shares applies to the shareholder of the target company, but only for non-listed companies, and to qualify for tax-free treatment the acquiring company must acquire more than 50% of closely-held target companies and 35% of listed ones. In the exchange of shares, the shareholders in the target company must receive at least 25% of the shares of a closely-held acquiring company.

As for intra-group transfers, the two subsidiaries must have been South African domestic companies for the last 18 months, then capital gains tax won't have to be paid until the asset is sold externally to the group or until the buyers and vendors cease to be part of the same group. In addition the threshold for exemption from secondary tax on companies will be lowered from 100 per cent to the 75 per cent level.

Unbundling takes place to promote the division of companies where the parental interest in the subsidiary is depressing the value of the subsidiary shares. SA Revenue Service's general manager of tax law administration, Kosie Louw, says unbundling should not be seen as a general mechanism to disguise tax-free cash or property dividends. Relief from capital gains tax will apply only if the parent distributes a subsidiary in which the parent controls more than 50% for closely-held subsidiaries or 35% for listed subsidiaries. Parent and subsidiaries companies must be domestic, the shareholding must have been held for 18 months and the unbundling distribution must reduce share premium before revenue reserves. Where domestic companies are liquidated into a controlling parent, tax relief will only be granted if the parent owns 75% of the shares in the liquidating subsidiary. The bill's liquidation rules incorporate anti-loss trafficking rules, including the loss of all regular and capital assessed losses in the subsidiary.

The Second Revenue Laws Amendment Bill also addresses the tax treatment of international shareholdings and share transactions.

Under what is known as a participating share exemption, the sale of ordinary or participating preference shares in an active foreign company will be exempt if sold by a controlled foreign entity that owns more than 25% of the active company's shares sold. A comparable exemption will also apply to dividends from active foreign companies' shareholdings. However, portfolio income including the sale of foreign shares and income from diversionary transactions will be taxed.

National treasury director Keith Engel told the finance committee this week that it had been decided not to follow the UK in exempting all share transactions as this would encourage share portfolios to be lodged in controlled foreign entities in order to sell them free of capital gains tax.

The sale of foreign non-currency assets would exclude currency gains and losses, but these would be accounted for if they arose from foreign equity instruments such as listed foreign shares, listed unit portfolio interests and commodities listed on an index. This would apply to all taxpayers. The amendments also stipulate that all companies, trusts with a trade and any individual who trades in currency assets - actual foreign currency, foreign currency loans and forwards - would be subject to income tax under section 24I of the Income Tax Act on an annual mark-to-market basis (that is deemed annual sales to determine income gains or losses) with respect to all their foreign currency assets.

All other individual taxpayers would be subject to the capital gains tax regime with respect to all their foreign currency assets when they convert into and out of a foreign currency. Engel said this approach would introduce a simple regime which would deal with about 95% of all cases. The 24I regime is also amended to prevent tax avoidance through hedging mechanisms.

The list of foreign currency items covered by the tax may be expanded to include commodity forward contracts and commodity option contracts denominated in a foreign currency.

The proposed legislation also narrows the exemption for financial institutions to prevent disguised passive treasury operations and more subtle forms of round-tripping, by, for example, shifts of interest offshore followed by the repatriation of dividends. Technical amendments are also made to the foreign dividend tax legislation, mostly in favour of the taxpayer.

Engel said these latter amendments would be backdated to the introduction of the residence based and foreign dividend tax system last year and the SA Revenue Service would undertake to make refunds to taxpayers where necessary.

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