Binding private ruling 185: Corporate rules – disposal of assets and liabilities
12 February 2015
Posted by: Author: BDO South Africa
Author: BDO South Africa
Binding private ruling 185: corporate rules – disposal of assets and liabilities as part of a group restructure
The above Ruling was issued on 11 December 2014. It is mainly concerned with the treatment of contingent liabilities to be transferred as part of the section 42 ‘asset-for-share' restructuring. The transfer of contingent liabilities in business restructuring arrangements is a particularly problematic area of Income Tax law in South Africa.
Unfortunately, as is the case with Binding Rulings, the reasoning behind the conclusion is not supplied, which therefore detracts from its usefulness. Nevertheless, the Ruling is interesting for a number of reasons.
The Applicant in the Ruling was a listed company incorporated in and a resident of South Africa and was the holding company of a number of wholly owned South African resident subsidiaries (‘SubCos'). To streamline the group's operations, the Applicant identified the need to restructure its South African operations with the objective of ‘becoming a true holding company'. To this end, the Applicant established a newly incorporated company, NewCo, as another one of its wholly owned subsidiaries.
The steps in the restructuring are the following:
- The Applicant will transfer to NewCo:
- All of its assets at book value (including the shares held in the SubCos but excluding a specified list of excluded assets) under sections 42 or 40CA, as the case may be, depending on the relative base cost and market value of each asset.
- All of its liabilities (other than a specified list of excluded liabilities). Included in the delegation of the liabilities are loans granted by financial institutions which are secured by specific assets that were acquired with the loans. The assets acquired are used in the Applicant's income-producing business and will also be transferred to NewCo. As a necessary consequence of the transfer of such assets, the financial institution loans will be assumed by NewCo.
- Contingent liabilities which include provision for the following:
- Leave pay
- Environmental rehabilitation
- Share incentive scheme
- Post-retirement medical aid benefits
- As consideration for the disposal of the assets by the Applicant to NewCo, NewCo will assume the liabilities (including contingent liabilities) and issue equity shares in the amount of the net asset value of the assets and liabilities transferred.'
Besides the Ruling that the disposal by the Applicant of its assets to Newco at net book value will constitute an ‘asset for share transaction' under section 42, a Ruling was made that expenditure incurred in relation to the contingent liabilities transferred (excluding expenditure related to environmental rehabilitation to which section 37A may apply) will be deductible in the hands of Newco, provided that the requirements of section 11(a) read with sections 7B and 23(g) are met at the time when the contingent liabilities materialise. In the case of environmental rehabilitation expenditure, the Ruling states that the expenditure incurred by Newco in making future payments to the rehabilitation trust will be deductible, provided that the requirements of section 37A are met at the time of making the payments.
What is particularly interesting is that the Ruling states that ‘in assessing whether or not the requirements of the above-mentioned sections are met, expenditure must be evaluated within the context of the nature of the going concern business as carried on by the Applicant prior to the transfer and by NewCo subsequent to the transfer, without regard to the fact that the assumption of that obligation by NewCo was part of the consideration for the acquisition of the assets. The circumstances under which the contingent liability arose in the hands of the Applicant are therefore relevant' (emphasis added).
In December 2013, SARS released a Discussion Paper dealing with the tax consequences for the seller and purchaser when contingent liabilities are assumed in part settlement of the purchase price of assets acquired as part of a going concern. This Discussion Paper indicates that in circumstances where fixed assets are acquired, expenditure incurred relating to so-called ‘free-standing' contingent liabilities, including bonus provisions, will be of a capital nature since it is incurred as a result of the acquisition of capital assets which are part of the purchaser's income-producing structure. The Ruling goes against this principle by stating that one should not have regard to the fact that the assumption of the obligation by NewCo was part of the consideration for the acquisition of the assets. One should instead evaluate the expenditure in the context of the nature of the business carried on by the Applicant before the transfer and NewCo subsequent to the transfer i.e. that such expenditure, even if related to the acquisition of fixed assets, may be of a revenue nature.
Regarding the provision for leave pay, it is not clear from the wording of the Ruling whether SARS is of the view that if and when expenditure is incurred by the purchaser relating to this provision, such expenditure may fall within the ambit of section 7B. It is submitted that the wording of the definition of ‘variable remuneration' in section 7B(1) poses a problem in this respect. The Ruling would, however, also be consistent with the view that such expenditure does not fall within the definition of ‘variable remuneration' and that it should therefore be deductible by the purchaser in terms of section 11(a) without regard to section 7B.
Of interest is also the fact that the Ruling does not deal with the reduced relief that applies where the transferor in a section 42 transaction becomes entitled to consideration other than equity shares received or certain debt assumed by the transferee, in terms of section 42(4). In these circumstances the transferor only obtains partial rollover relief and has to recognise income or a capital gain accordingly. It is submitted that a contingent liability is not a ‘debt' but that the assumption of a contingent liability by the transferee is ‘consideration' given and therefore that the assumption of a contingent liability by Newco in part settlement of the purchase price should give rise to this partial recognition treatment. Presumably, a ruling on this issue was not requested.
Then it is not clear why the Ruling is subject to the additional assumption that the disposal of the assets by the Applicant to NewCo will be structured in such a way that the only consideration given by NewCo in exchange for the assets will consist of the shares issued by NewCo and the assumption of the Applicant's liabilities, including the contingent liabilities. If consideration other than shares issued and the assumption by Newco of the Applicant's liabilities had accrued to the Applicant, the transaction would have been subject to partial relief treatment in terms of section 42(4) as, it is submitted, the transaction should in any event be insofar as the transfer of the contingent liabilities is concerned.
It is also not clear why the Ruling is subject to the additional assumption that the Applicant must transfer to Newco all the assets and liabilities (including contingent liabilities) that are attributable to and arose in the normal course of the business undertaking that is being disposed of and acquired by NewCo, as a going concern. This requirement appears to relate to sections 42(4) and 42(8), neither of which explicitly form part of the Ruling.
All in all, the Ruling unfortunately provides more questions than answers. In our view, an Interpretation Note dealing with the transfer of debts and contingent liabilities in sale of business arrangements would be very useful in providing insight into SARS's view on the numerous areas of uncertainty in relation to such transactions.
This article first appeared bdo.co.za.