Tax Transition Measures
26 November 2010
Posted by: Author: Kazi Mbangeleli Goba
Tax Transition Measures
New Act introduces the concept of "contributed tax capital”
The much-anticipated new Companies Act 71 of 2008 will come into effect on 1 April 2011.It will introduce radical changes to existing company law principles.From a tax perspective, the Taxation Laws Amendment Bill 2010 introduces the definition of "contributed tax capital” to the Income Tax Act. This definition comes into operation from 1 January 2011.Once the Companies Act ("the Act”) has been passed,concepts of share capital, share premium and profits will become largely irrelevant in respect of company distributions.In general, all distributions will be treated as dividends unless those distributions come from the"contributed tax capital” account.
The definition of "contributed tax capital” is based on amounts received by or accrued to a company as consideration for shares. In this regard, it should be noted that the "contributed tax capital” concept will centre on tax principles and not shareholder contributions from company law or the Act. The Act will focus on value, whereas the "contributed tax capital” concept will focus on the tax cost of contributions by shareholders.
In determining the "contributed tax capital” balance, the starting point for a company is the sum of its share capital and share premium account on 1 January 2011.However, this does not include amounts of share capital or share premium which, if distributed,would have constituted a dividend before that date.
Once a company has established its starting "contributed tax capital” account on the aforementioned date, such account will thereafter be increased by amounts equal to the sum of the consideration received by or accrued to the company for the issuance of shares.
A company's "contributed tax capital” is then reduced by distributions made to shareholders where the directors have stated that such distribution constitutes a return of such "contributed tax capital”. Therefore, if a company makes a distribution to its shareholders and the directors state that such distribution is from the"contributed tax capital” of the company, then there is a prorata reduction of "contributed tax capital” for the company on a per shareholder class basis.To be noted in this regard, is that the amount of the distribution as determined in terms of the Act may not be the same as the amount by which the "contributed tax capital”account is reduced.
The concept of a "dividend” from a tax perspective will be the amount of a company distribution or the buy-back consideration which does not reduce the "contributed tax capital” of the distributing company.It is therefore important for every company to determine i t s"contributed tax capital” as at 1 January 2011.
A few relevant points in this regard are as follows.
• Firstly, the share capital and share premium of the company is not an accounting concept, but rather a company law concept.For example, from an accounting perspective ,redeemable preference shares are shown as a liability in the balance sheet of the company,whereas from a company law perspective such shares create share capital and share premium for the company.
• Secondly, it will also be necessary to determine whether the share capital and share premium accounts of the relevant entity reflect any capitalised reserves or amounts which would from a tax perspective be viewed as a dividend if distributed under current law.
• Thirdly, the "contributed tax capital” account should be established on a per shareholder class.
In terms of Section 40(5) of the Act, consideration for shares maybe in the form of an agreement for future services, future benefits, or future payment by the subscribing party.The consideration for such shares is regarded as having been received by the company to the extent that the instrument is negotiable by the company, or to the extent that the subscribing party to the agreement has fulfilled its obligations in terms of the relevant agreement.
In terms of the accrual principle,from a tax perspective, these amounts may accrue to the company prior to their receipt, and thus increase the "contributed tax capital” of the company, even though the relevant payments in respect of those shares have not yet been received by the company.It will also be necessary to determine the tax cost of the contribution made by the shareholder, e.g. where the shareholder makes a contribution other than in cash.
In determining the "contributed tax capital” balance of a company,the tax and legal issues must be considered. In particular, careful consideration is required in determining the "contributed tax capital” balance in respect of each relevant entity where the group relief provisions have been applied (i.e. asset for share, unbundling,and amalgamation transactions).
Source: By Kazi Mbangeleli Goba (Tax breaks)