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Latest Tax Changes: Unintended Consequences?

30 August 2011   (0 Comments)
Posted by: Author: Stephan van der Walt
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Latest Tax Changes: Unintended Consequences?

BEE transactions and preference shares will be impacted

When the Taxation Laws Amendment Bill was announced at the beginning of June 2011, alarm bells started ringing regarding some of the unintended consequences of two of the proposed amendments. The most shocking amendment is the immediate suspension, until December 2012, of Section 45 of the Income Tax Act, which has allowed for the inter group transfer of assets in a tax neutral manner.

This ability to transfer assets tax free is fundamental in any tax system to enable corporate activity.As an example, Section 45 is key to the implementation of sustainable BEE transactions, as it is the only provision of the Income Tax Act which allows for the conclusion of sustainable BEE transactions which are not share price dependant (unlike the typical share funded BEE models which were the primary cause of so many failed BEE transactions to date).

Section 45 is also used in many internal restructurings and in the acquisition of businesses.The immediate suspension will now force companies to revert to unsustainable forms of empowerment. Many companies,especially mining companies which have announced BEE transactions but await approval from the Department of Minerals Resources,will now need to go back to the drawing board or may face significant negative tax consequences.It is likely that many acquisitions could now be put on hold until further clarity is obtained.This is expected to have a significant negative impact on merger and acquisition activity in South Africa.

The other amendment relates to preference shares.The use of preference share funding is, in many instances, the only form of viable funding.We know that SARS is concerned about transactions generating tax free dividends on the one hand and interest deductions on the other.Dividends on preference shares are in general not subject to income tax. The proposed amendments, effective from April 2012, will result in almost all preference share dividends now becoming taxable without a corresponding deduction.

This will have a detrimental effect on the majority of BEE transactions, many of which are already distressed.The amendment will result in an approximate 40% increase in the cost of funding for BEE parties, leading to almost every share-funded BEE transaction being unsustainable with limited to no prospect of realising any value.

A BEE transaction using Section 45 would have been the only viable alternative but that has also been removed, leaving the market with no economical or viable alternatives.In fact, this is probably the end of BEE deals until this unnecessary uncertainty has been removed.

The proposed amendments will also impact corporates who have funded themselves using preference shares, and will significantly increase their cost of funding and the viability of projects.The amendments contradict government policy of trying to grow and stimulate the economy,increase employment and encourage transformation.For example, I know of one transaction which will now need to be reassessed, and which would have created 400 jobs.I am also sure that the Treasury did not consider such unintended consequences, as by far the majority of the transactions have a neutral to positive impact on the fiscus.I accept some of the reasons behind the changes, but it is not appropriate to apply a broad brush approach here.

Above all, South Africa needs a tax system which is predictable and creates business confidence.This maverick approach with shocking surprises is not conducive to business development, and is scaring off foreign investment.Such drastic measures without consultation have a devastating impact on the ability of corporate financiers to structure and finance transactions which help to develop and grow the economy and lead to job creation.

The draft bill has been submitted for public comment, and it is sure that Treasury will be inundated with submissions and an outcry over these particular changes.

Source: By Stephan van der Walt (Tax breaks)


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