28 January 2010
Posted by: Author: Nicola Hunter
What’s meant to be a concession can trigger a nasty CGT surprise
Under normal circumstances,the disposal of an asset for more than its base cost will result in capital gains tax being triggered.The tax system, however,recognises that an exception needs to be made where a group of companies moves assets between its group companies, to improve economic efficiency. Sections 41 to 47 of the Income Tax Act commonly referred to as ‘the corporate rules’, are intended to permit a tax-neutral transfer of assets within the same group of companies, such that any capital gain (tax liability) is deferred to a future date when the asset is disposed of to a party outside the group.
There are, however, instances when a tax liability may be triggered prior to the asset being disposed of to a non-group company, one such instance being dubbed ‘de-grouping’. The purpose of this article is to understand the concept of ‘de-grouping’ and the impact of the ‘de-grouping charge’ on the affected group companies.
The first step in the process is to determine whether the group has under taken any intra-group transactions (part of the ‘corporate rules’) in terms of Section 45 of the Act. An intra-group transaction is one in which an asset (excluding shares in the transfered/buyer) is disposed of by one company (transferor or seller) to another resident company (transferee or buyer)—and both companies form part of the same group of companies—remembering that for Income Tax purposes at least 70% of the equity shares of a company must be held by another company to form a "group”.
In addition to the disposal requirement, Section 45 requires that the asset which is transferred from the seller to the buyer retains its nature, i.e. capital assets remain capital while trading stock remains trading stock. If these requirements are met, Section 45 has the effect of creating a tax-neutral event on transfer of the asset (not taking STC into account) which deems the buyer to step into the shoes of the seller and assume the cost history of the asset.
All supporting documentation for the asset should be transferred from the seller to the buyer on transfer.The section has the effect of removing tax considerations from business decisions, by deferring the tax implications of asset disposals to such a time as the asset is disposed of to a party external to the group.
Prior to 1 January 2009, Section45 was an elective section, allowing group companies to elect whether to defer the tax implications of intra-group transactions.As of 1 January 2009 the Section, and hence the deferral, applies automatically. However, it does allow the seller and buyer to jointly elect for the deferral not to apply,for example, if they wish to utilise a capital loss or scrapping allowance.
The group needs to consider the following questions: Did it elect for the Section 45 deferral to apply prior to 1 January 2009, or has it entered into any such transactions subsequent to that date for which no election has been made? If the answer to either of these questions is yes, and the transactions took place after 2002, the companies must be aware of the potential ‘de-grouping charge’ and its implications.
The ‘de-grouping charge’ can be triggered in one of two ways, the first of which occurs if, within six years of the Section 45 transaction,the buyer is still holding the asset but ceases to form part of the same group as the seller or any of the direct or indirect holding companies sitting above the seller company (i.e. the holding dips below 70%).
Only after the six year limit can the group reduce the relevant shareholdings in order to be ‘safe’ in this regard.An exception to this rule occurs if the seller or buyer is liquidated,wound up or deregistered and the resident holding company of said company holds at least 70% of its equity share capital.In this instance, the holding company is regarded as having stepped into the shoes of the liquidated, wound up or de-registered company and no de-grouping occurs.
The second de-grouping trigger is if, within two years of the Section 45 transaction, the amount received by the seller for the asset is transferred out of the group for no or inadequate consideration, or as a distribution, e.g. dividend.Additionally, this two year distribution rule applies to any amount derived from the original amount i.e. if that amount is invested and earns interest income,of which more than 10% is distributed.
Practically, the tracking and allocation of specific funds to a specific transaction may prove problematic as proceeds start to lose their specific identity overtime, and this should be considered when structuring any Section 45 transaction.
The final step is to determine the income tax implication if de-grouping does occur. Although commonly referred to as a charge,the 'de-grouping charge’ is not a penalty in the traditional sense but rather a normal income tax charge resulting from a deemed disposal of an asset (an event which is treated as a disposal for tax purposes). The date of de-grouping is the date on which the asset is deemed to have been disposed of and immediately reacquired by the buyer (transferee).
The amount to be included as gross income, taxable income or a capital gain of the buyer, on the deemed disposal, depends on the type of asset concerned i.e. tax depreciable or non-depreciable asset or trading stock, and Section45(b) is prescriptive on this point.
In addition to the income tax implications in the year of assessment in which the defairly grouping occurs, the base cost of the immediately reacquired asset is increased in accordance with Section 45(b). In these challenging economic times, as companies may be more prone to restructuring and asset disposals, it is important for a group to carefully consider these issues.‘De-grouping’ may be unwittingly triggered and the transferee disadvantaged by cash outflows for a tax liability which should only be incurred in the future.
Although the charge is really more a timing issue than an actual penalty, an understanding of the ‘de-grouping charge’ is important from a tax planning and cash flow perspective, and also to ensure no penalties are incurred in the future on incorrect submissions to SARS.
Source: By Nicola Hunter (Tax breaks)