The Companies Act contains a long, detailed list of requirements for the conclusion of a merger transaction, including that each merged entity must comply with the solvency and liquidity tests after the implementation of the merger.Upon implementation of a merger agreement, the property of each merging company becomes the property of the surviving company, which is liable for all the obligations of every amalgamating or merging company.Again, this happens by operation of law, and no documentation other than a merger agreement and certain regulatory filing, is required.
These provisions in the Companies Act and the ITA do not specifically refer to one another.However, in our view, there appears to be no inconsistency between the two.Put differently, the Companies Act now allows for a transfer of assets either by way of a sale of assets shares, or a ‘merger’. We are of the view that both can be undertaken in terms of the roll-over relief rules contained in the ITA.Contracting parties must be careful to ensure that the procedural and anti-avoidance requirements in the various sets of rules are complied with when undertaking a merger or amalgamation, if it is intended that both the Companies Act and the roll-over relief rules from the ITA should apply.We are also of the view that parties seeking to ‘merge’ from a Companies Act perspective will be liable for CGT should they fail to ensure that their transaction falls within one of the roll-over relief rules.
Another area of interest arises in respect to company distributions.The corporate law rules regulating distributions by a company have been significantly relaxed under the Companies Act.While certain commentators suggest that the changes are not particularly significant, in our view the new regime, which holds liquidity and solvency of a distributing company as the major criteria for consideration in making a distribution, is a significant departure from the past.
Of primary concern to National Treasury, the body responsible for drafting fiscal laws, was that strict distinctions between the origin of funds of a company are no longer relevant in terms of the new Companies Act.Put differently, when assessing whether a company is competent to make a distribution to a shareholder, the key question is whether or not the company will be liquid and solvent as contemplated in section 46 of the Companies Act after that distribution, and not the type of funds being distributed, i.e. reserves, share premiums, etc.Because the ITA seeks to tax distributions of profits differently from distributions of capital, the Income Tax Act has assumed the obligation of defining the types of funds a company is distributing and, even, when such distributions may be made.
As was always the case, in terms of recent amendments to the ITA under the Taxation Laws Amendment Act, 2011 (the TLAA), a ‘return of capital’ remains a CGT event for a shareholder. No longer is the CGT payable calculated with reference to paragraph 33 of the Eighth Schedule to the ITA, but rather new rules have been drafted to specifically assist in calculating the capital gain of the shareholders in a capital distribution.These rules are encapsulated in paragraphs 76 to 74B of the Eighth Schedule.
Of particular interest, however, is that a ‘return of capital’ is essentially defined to be a distribution which reduces the contributed tax capital (CTC) of the distributing company.The problem with this is that CTC, which was formerly known as the capital of a company (i.e. capital and share premiums), is now defined to mean the share premium of the company as at 1 January 2011 or the amounts received by the company upon a subscription for shares by shareholders.CTC is also class specific, in that it appears from the ITA, CTC of one class of shares should not be distributed to shareholders of a different class, but should always be distributed pro rata to shareholding with a class.
Accepting for present purposes that CTC must be distributed pro-rata to shareholding in a class is competent (in our view it is not), interesting anomalies arise. Assume, for example, that a company has a foreign shareholder and a local BEE shareholder who cannot provide any funding to the company.It may well arise that all of the funding will be introduced by the foreign funder and, given that the foreign shareholder will be subject to thin capitalisation rules, a portion of the funding may need to be introduced as equity funding (i.e. CTC). Based on the rule enunciated above, that for the purpose of the ITA, CTC should be distributed pro-rata within a class, arguably a portion of the CTC contributed by the foreign shareholder must now be distributed only to the BEE shareholder.This would trigger an immediate capital gain for the BEE shareholder but one which the BEE shareholder will in all likelihood be happy to bear given that it is participating in funds that it did not introduce.
What the ITA is silent on, is what happens if the CTC prohibition is ignored? What will happen if all the funds are distributed to the foreign shareholder? Does the foreign shareholder realise the capital gain based on an excessive return of capital in terms of paragraphs 76 to 76B of the Eighth Schedule, or will the ‘excess portion’ constitute a dividend? All of these queries are yet to be answered and, hopefully, will shortly be dealt with by statutory amendments.
Source: By Andrew Wellsted and Trevor Baptiste (Tax Professional)