Determining a 'group of companies' for purposes of the corporate rules
28 January 2014
Posted by: Autthor: Andrew Lewis
Author: Andrew Lewis (DLA Piper)
The Income Tax Act (58/1962) contains a definition of a 'group of companies' in Section 1 . However, a narrower definition of the term is contained in Section 41 which applies to certain corporate tax roll-over rules and other provisions contained in the act. It is important to identify which companies fall within the different definitions in order to determine whether one qualifies for the applicable tax relief.
The South African Revenue Service (SARS) released Interpretation Note 75 on October 24 2013 to provide guidance on the interaction of the definitions of group of companies as found in Sections 1(1) and 41(1) of the act. To obtain a better understanding of SARS's interpretation of the proviso to the definition in Section 41 of the act and the definition in Section 1 it is helpful to consider the following basic example of a foreign tax resident holding company (USCo) that directly holds 100% of the equity shares in two South Africa tax resident companies (SACo 1 and SACo 2).
In determining whether USCo, SACo 1 and SACo 2 form part of the same group of companies for purposes of Section 41(1) of the act, the interpretation note submitted that:
- the first requirement of Section 41(1) of the act would be satisfied in that there is a group of companies as defined in Section 1(1). USCo holds at least 70% of the equity shares in SACo 1 and SACo 2. SACo 1 and SACo 2 are therefore the 'controlled group companies' of USCo;
- Paragraph (i)(ee) of the proviso to the group of companies definition in Section 41 of the act excludes a company incorporated under the law of any other country other than the Republic of South Africa (unless that company has its place of effective management in South Africa). USCo, being a non-resident, should be excluded from consideration as being part of the group of companies; and
- the definition contained in Section 1(1) of the act should be re-applied to assess whether the remaining companies fall within the group of companies definition in Section 1 of the act. If this approach is applied, USCo would be excluded from the consideration of the group of companies definition in Section 1 of the act and there would be no controlling group company in relation to SACo1 and SACo 2. As a result, SACo 1 and SACo 2 would not form part of the same group of companies for purposes of Section 41 of the act.
The interpretation note concluded that it was not permissible to interpret the proviso as an independent enacting clause and its provisions must be read as if they form part of the opening words of the definition in Section 41(1) (ie, the group of companies definition in Section 1). The exclusion by the proviso of, for example, a controlling company from a group of companies will affect whether its controlled companies remain part of a group of companies under the corporate rules.
The South African Institute of Chartered Accountants (SAICA) submitted comments on the draft interpretation note. In particular, SAICA submitted that:
"[w]hat section 41 definition requires is that a group of companies must be determined in accordance with the section 1 definition. Paragraph (i) of the proviso then requires that the specified companies are excluded from that group of companies for purposes of section 41. Nowhere does it suggest that the section 1 definition must be reapplied without having regard to the specified companies."
If interpretation were adopted and applied to the aforementioned example, for purposes of Section 41 of the act :
- USCo would not form part of the same group of companies as SACo 1 or SACo 2 (excluded by the provision in Paragraph (i)(ee) of the group of companies definition in Section 41 of the act); and
- SACo 1 and SACo 2 would still form part of the same group of companies on the basis that they fall within the group of companies as defined in Section 1 and do not fall within in any of the proviso's to the group of companies in Section 41 of the act.
With the release of the interpretation note it is clear that SARS does not accept the above interpretation. It is critical that taxpayers carefully analyse whether their transactions fall within the relevant group of companies definitions, otherwise the anticipated tax implications of the transaction may be queried.
This article first appeared on lexology.com.