Good News For Corporate Raiders
25 June 2010
Posted by: Author: Wouter Scholtz and Dirk Kotzé
Good News For Corporate Raiders
Binding Private Ruling allows for the tax-deductibility of interest on loans to purchase shares—under certain conditions.Caution is however strongly advised
If you borrow money to buy shares, preparatory to a take-over of the ‘target’ company, you will ordinarily be denied a tax deduction for the interest paid on the loans.This flows from the fact that the income yielded by shares, in the form of dividends, is ordinarily exempt from tax in the hands of the shareholder.You should not be allowed a deduction for interest incurred in deriving exempt—as opposed to taxable income.
But what if your purpose in buying the shares is, in short order,to strip the assets out of the target company? Can it not then be argued that the purpose behind the loan was not to acquire the shares, but to lay your hands on the income-producing assets of the target? And if the assets of the target will produce taxable income,why should the interest incurred on your borrowings then not be deductible?
There is good news for corporate raiders in the form of a ‘Binding Private Ruling’—ruling number BPR 063—issued by SARS in November last year.The ruling serves to confirm that where a purchase of shares is a prelude to an ‘asset strip’, interest on money borrowed to acquire the shares may indeed be deductible.
However, the ruling must be approached with some caution.The BPR regime, set out in Section 76Q of the Income Tax Act, allows taxpayers to approach SARS for guidance (a ruling) in relation to the tax treatment of a particular transaction contemplated by the taxpayer.
The ruling is strictly only‘binding’ in relation to the particular transaction, and the taxpayer in whose favour it was issued. SARS is, in principle, not obliged to follow the same approach in relation to other (even similar) transactions and other taxpayers.BPR 063 nonetheless provides useful guidance in regard to SARS’ likely response to similar transactions.
We recommend that, where practicable, a preliminary offer should first be made for the assets of the company, with a share purchase to be resorted to only in the event that an offer for the assets is rejected. If the preliminary offer for the assets is accepted, it will take much of the anxiety and uncertainty out of the deal.If you buy shares, there are almost always concerns about contingent and or hidden liabilities of the company. If you buy the assets, these liabilities need not concern you.However, if the offer for the assets is rejected, having made the offer will serve as a clear signal that your fundamental intention was to acquire the assets,and not the shares. If, shortly after the take-over, you proceed to strip the assets out of the target company,you will have a clear case for the deductibility of interest.
If you are embarking on a transaction similar to that described here (or any other transaction, for that matter—especially if the amounts involved are substantial),it is highly recommended that you apply for an Advance Tax Ruling,even if you believe the facts of your particular case to be identical to those contained in a BPR that has already been issued.As the writers have already stated, while existing BPRs may well be persuasive in that they reflect the mind of SARS on a particular transaction, SARS is not obliged to follow an existing ruling in the case of taxpayers that are not party to such existing ruling.
Source: By Wouter Scholtz and Dirk Kotzé (Tax breaks)