Feedback from National Treasury workshop: Cross-issue of shares
01 April 2015
Posted by: Author: Lesedi Seforo
Author: Lesedi Seforo (SAIT)
National Treasury hosted a workshop on the 26th of March 2015 to discuss commentary received from industry regarding the cross-issue of shares dealt with in paragraph 11(2)(b) of the Eighth Schedule to the Income Tax Act No. 58 of 1962 (hereinafter ‘the Act’). SAIT attended the workshop and wishes to provide feedback to its members.
Prior to the amendment brought about by the Taxation Laws Amendment Act (No. 31 of 2013) ("TLAA”), paragraph 11(2)(b) stated that there was no disposal of an asset where a company issued shares. The amendment provided an exception to this rule in instances where a resident company issues shares in exchange for shares in a foreign company. This effectively subjects the issue of such shares to capital gains tax (‘CGT’). Although the main intention was to target the cross-issue of shares, the legislation hits any share-for-share exchange where any foreign shares are received in exchange for the issue of South African shares.
According to the Explanatory Memorandum on the Taxation Laws Amendment Bill, 2013:
The income tax framework seeks to strike a balance between permissible tax-free restructuring and the shifting of value offshore in order to effect an indirect corporate migration…
Many of the transactions of concern involve the dual cross-issue of shares between a resident and a non-resident. The purpose of the cross-issue is to shift control offshore free of tax. Many of these transactions also have the added benefit of the participation exemption, whereby the foreign shares received by the domestic transferor are also free of tax upon the subsequent disposal.
The anti-avoidance rules has subsequently come under heavy criticism as being overly broad. The new anti-avoidance rule essentially makes the creation of a section 9I headquarter company impossible without paying a heft entry tax. The new rule also ends the formation of most (if not all) other South African gateway structures.
A. Treasury position restated
At the workshop, National Treasury sought to clarify their concerns. In their view, the share issue concern is problematic when joined with the participation exemption. The idea here is that the tax-free acquisition via a share issue can be combined with a subsequent disposition of the foreign shares tax-free via the participation with special emphasis on a subsequent company migration from South Africa.
I particular, once a resident company is controlled by foreign shareholders (after the share issue), a decision may be taken for the company to migrate. Typically, when a company ceases to be a resident, section 9H will deem that company to have disposed of most of its assets at market value, thereby triggering CGT (the so-called "exit charge”). In such an instance, Treasury were concerned that the paragraph 64B participation exemption could exempt the migration from the section 9H exit charge depending on how the law was interpreted.
The other problem highlighted by Treasury was that government would still lose out on the exit charge if a resident company which acquired foreign shares through a cross-issue, subsequently sold off the shares prior to migration. However, this aspect of their concerns seemed somewhat muted.
B. Industry response
Industry representatives questioned whether the participation exemption truly applied in the abovementioned scenario. For the exemption to apply, the shares must be disposed of to a non-resident. Furthermore, there must be an actual disposal of shares, as opposed to a deemed one (in terms of section 9H). Finally, section 9H does not deem the shares to have been disposed of to a non-resident, which is a prerequisite for paragraph 64B to apply.
It was thus conceded by Treasury that the participation exemption may not result in a tax-free migration after all. However, wording should be inserted into the legislation to clarify that this is indeed the case.
C. Possible clawback?
To counter the above concerns, treasury suggested that a "claw-back” provision be inserted to provide for the recoupment of the previously disregarded capital gain. The claw-back would apply only where a "very short period of time” had passed between the sale of the foreign shares and the migration. Industry agreed to this condition. At issue was whether the time period should be 18 months versus 36 months (with government preferring the latter).
At the conclusion of the workshop, it appeared that National Treasury favoured a claw-back of 18-36 months if a company migration followed share-for-share involving the South African issue of shares for foreign shares. The big question was one of timing given that the current anti-avoidance amendment was holding number of commercial deals in suspense.
National Treasury expressed a willingness to resolve the problem when draft legislation is issued in June/July with the probable effective date being on the date of draft release. It is an open question whether SARS is willing to interpret paragraph 11(2)(b) anti-avoidance rule softly in the meantime.