A Hidden CGT Time Bomb?
20 December 2012
Posted by: Author: Andrew Knight
A Hidden CGT Time Bomb?
New legislation contains a significant (and potentially expensive) change
South African residents and controlled foreign companies are exposed to tax on foreign currency movements under two principal provisions of the Income Tax Act (ITA), namely Section 24I (income tax) and Paragraph 43 of the Eighth Schedule (Capital Gains Tax).
The proposed amendments contained in the 2012 Taxation Laws Amendment Bill (TLAB2012), tabled in Parliament on 25 October 2012, contain a significant and potentially expensive change to the tax treatment of currency movements in relation to assets that are acquired by a South African resident or controlled foreign company in a currency other than rand, and are disposed of (or deemed to be disposed of) in the same currency. For purposes of this article, the foreign currency in question is assumed to be the United States dollar (USD).
Under current rules (Paragraph 43(1) of the Eighth Schedule), the capital gain or loss arising from the disposal is not affected by any Rand/USD currency movements between the date of acquisition and disposal. The capital gain or loss is determined in USD, and is then translated to Rand at either the spot rate on the date of disposal or the average rate for the year of assessment in which the disposal occurs.
Paragraph 43(1) is currently subject to Paragraph 43(4), which requires that in certain situations:
•the USD base cost be translated to rand at either the spot rate on the date of acquisition or the average rate for the year of assessment in which the acquisition occurs; and
•the USD proceeds be translated into rand in the same way as for paragraph 43(1), i.e. by reference to the time of disposal. However, such situations are limited to disposals of:
•foreign equity instruments(including foreign-listed shares,interests in a collective investment scheme, and certain contractual rights linked to a foreign index);
•assets whose gain or loss is from a South African source, which would in turn include:
•South African immovable property;
•any asset of a South African resident not attributable to a foreign permanent establishment(PE) if the proceeds are not subject to tax elsewhere; or
•any asset of a non-South African resident that is attributable to a South African PE; and
•assets that are exchange items to which Section 24I applies.
The new position under TLAB2012
Under TLAB 2012, Paragraph 43(1) is to remain largely unaffected in so far as the disposing person is an individual or a non-trading trust,and indeed their position is no longer subject to Paragraph 43(4) (or its equivalent).
However, companies and trading trusts are to be covered by a new Paragraph 43(1A), which in effect uses the currency treatment previously limited to the situations specifically provided for by Paragraph 43(4), which is to be deleted. Therefore, the starting principle now is that an asset disposed of in a foreign currency by a company or trading trust after 1 January 2013 having been acquired at any time (i.e. including before 1 January 2013) in that same currency will be exposed to gains due to currency movements.
Certain assets are specifically excluded from Paragraph 43(1A),notably:
•a unit of currency;
•a debt (which is not defined);and
•contractual rights whose value is determined by reference to a unit of currency or a debt.
These exclusions were only introduced in the July draft of TLAB 2012, and are welcome in preserving the tax neutrality of financing activities of non-South African residents. Residents would still be exposed, at least in relation to debts, to an income tax charge on exchange differences under Section 24I. Controlled Foreign Companies should be protected, provided that their debts are in their local (functional) currency.
Where a capital gain arising on the disposal of an equity share in a foreign company attracts exemption from tax under Paragraph 64B, any additional gain arising from the application of Paragraph 43(1A) should also be exempt.
However, any other asset will be subject to potentially punishing tax exposure where the Rand depreciates between the time of acquisition and disposal (unless within the same year of assessment). And ‘any other asset’ would (in particular) include equity interests in foreign companies of less than 10%, preference shares, and intangible assets. There is no general exemption for transactions as between group companies, and there is no particular let-out for a controlled foreign company under Section 9D(9). Perhaps more worrying is the technical possibility that disposals that qualify for rollover relief under Sections 42, 44, 45, and 47 may be caught by Section 43(1A). This would presumably not have been intended, and requires further analysis.
The bottom line
If multinationals are currently intending to do any restructuring, they would be well advised to consider the impact of the above changes and, if appropriate, do the restructuring before 1 January 2013. More generally, any asset disposal, whether or not in the context of a group re-organisation, is going to need to be considered with additional care from 1 January 2013 onwards.
Source: By Andrew Knight (Taxbreaks)