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Possible Tax Implications on The Conversion of Par Value Shares to Non-Par Value Shares

10 September 2012   (0 Comments)
Posted by: Author: Lee-Ann Steenkamp
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Possible Tax Implications on The Conversion of Par Value Shares to Non-Par Value Shares

Under s 35(2) of the COA, a share does not have a par value,subject to item 6 of Schedule5 of the COA, which deals with transitional arrangements in respect of pre-existing companies.

1.A pre-existing company that has par value shares in issue immediately before 1 May 2011 may issue further par value shares of the same class up to its authorised limit of par value shares.It may not, however, increase the number of authorised par value shares [Reg 31(5)].

The company may apply to convert the class of shares to shares of no par value, but such a proposal must not be designed substantially or predominantly to evade the requirements of any applicable tax legislation [Reg 31(6)(a)].The abolition of par value shares gives rise to important tax issues as the tax law recognises the existing distinction.

Effect on share premium

Before 1 April 2012
Under the repealed Secondary Tax on Companies (STC) provisions, a distribution out of share capital and share premium was deemed not to be a dividend for tax purposes(and, accordingly, not subject to STC), but rather a capital distribution that gave rise to CGT implications.

2.After 1 April 2012
If, on the other hand, the distribution is a dividend, the new dividends tax and Contributed Tax Capital (CTC) provisions must be taken into account. Generally,the CTC of a company is the sum of all consideration the company has received for the issue of shares (per para (b) of the definition of ‘contributed tax capital’ in s 1of the ITA.)

Accordingly, one could expect distributions from the stated capital account (unless they constitute capitalised reserves) to be treated similarly, i.e. as a capital distribution.To the extent that par value shares are converted and compensation is paid, the relevant shareholders will be regarded as having disposed of the par value shares (for CGT purposes) for proceeds equal to the compensation received, and a CGT liability will arise in respect of the conversion.

3.With regard to the tax treatment of existing share premium after conversion, it appears that the share premium (in respect of shares issued under the Companies Act 1973) will continue to exist, even if capitalised.There are two instances where the repayment of share premium is treated as a dividend (in other words, it does not constitute CTC).One is where the share premium consists of capitalised reserves (due to a previous capitalisation issue) and the second is where an amalgamation occurred prior to 1 January 2011 and the share premium created by the acquiring company was deemed to be a reserve in terms of s 44(9A) of the ITA. S 44(9A) was deleted with effect 1 January 2011.

4.When shares are redeemed or share premium is repaid, this repayment of the CTC is not a dividend. The definition of CTC in s 1 of the ITA requires that the directors of the company must have determined, by the date of the transfer, that the transfer constitutes a transfer of CTC.Without this determination, the amount would consequently not be excluded from the definition of dividend and would therefore not be treated as a reduction in the CTC.It is understood that SARS envisages this determination to be evidenced by a directors’ resolution which must be communicated to each shareholder concerned.In addition,SARS requires the company to notify all parties to whom the transfer is paid, that the distribution stems from CTC and the extent of the distribution allocated to CTC, as opposed to a dividend.

5.This is also why the first exclusion to the definition of dividend in s 1 of the ITA deems a repayment of share premium (or CTC) not to be a dividend if the shareholder receives more than his pro-rata share (i.e. being a return of the shareholder’s original capital contribution).The company has to determine its CTC as at1 January 2011 for each class of shares and thereafter must keep record of any addition to or reduction of CTC after that date.Therefore,for each class of par and non-par value shares,a separate CTC record has to be maintained.

Effect on CGT

A value-shifting arrangement is defined in para 1 of the Eighth Schedule of the ITA. In very brief terms, it is an arrangement by which a person retains an interest in a company, trust or partnership, but the value of the interest reduces because the shareholder’s rights or entitlements change while a connected person’s interest simultaneously increases.

The decrease in value of a person’s interest is regarded as a deemed disposal by that person for CGT purposes (in terms of para 11(1)(g) of the Eighth Schedule of the ITA).The proceeds are equal to the amount by which the market value of that person’s interest has decreased as a result of the arrangement (para 35(2) of the Eighth Schedule of the ITA).The base cost is calculated in terms of a formula, found in para 23 of the Eighth Schedule of the ITA.

There appears to be concern among tax advisers in practice that the conversion of par value shares to non-par value shares constitutes a CGT disposal.However, unless the conversion leads to a change in the shareholder’s rights or entitlements, it is not a value-shifting arrangement and, accordingly, has no CGT consequences.

This viewpoint is confirmed by SARS’ Comprehensive Guide to CGT (Issue4) at 68: "Given that a share is a bundle of rights, there will be no disposal if those rights remain unchanged following a conversion from shares of par value to shares of no par value.However, if some of those rights are lost or diminished there will clearly be a disposal or part-disposal.”

The guide further explains that whether the reduction in rights will trigger a full or a part-disposal is a question of degree and will depend on the facts of the particular case.A part disposal is more likely to be triggered when the loss of rights is limited and clearly identifiable.The compensation received by a shareholder who has been adversely affected by such a conversion would usually comprise the proceeds for the disposal(although para 38 will substitute a market value consideration between connected persons).

In a recent binding class ruling regarding the conversion of ordinary par value shares to no par value shares, as directed under item 6 of Schedule 5 (read with Reg 31 of the COA), SARS ruled that there will be no disposal on conversion for the shareholders as contemplated in para 11(1)(a) of the Eighth Schedule to the ITA.SARS further ruled that there will be no receipt or accrual for the shareholders under the definition of gross income in s 1 of the ITA, provided the converted shares are held on revenue account.Finally, the ruling provided that the conversion will not be a transfer under s 1 of the Securities Transfer Tax Act, No 25 of 2007.

6.With the introduction of the COA, South African companies may convert their existing par value shares into non-par value shares.This article considered the potential tax implications of such a voluntary conversion, both from a dividends tax and a capital gains tax perspective.The draft Taxation Laws Amendment Bill (2012) also proposes to insert provisions regulating the mandatory conversion of par value shares to non-par value shares, which are to be inserted under s 43 of the ITA.The required conversion will fall under the definition of a ‘substitutive share-for-share transaction’ and will not be treated as a deemed disposal event (the base cost will remain the same).Should the draft provision be enacted, the tax consequences of share conversions will be regulated by s 43 of the ITA.

Source: By  Lee-Ann Steenkamp (TaxTALK)


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