Anti-corporate migration laws, equity and South Africa as a headquarter location
13 April 2015
Posted by: Authors: Justin Liebenberg and Charles Makola,
Authors: Justin Liebenberg and Charles Makola (EY)
A discussion on South Africa’s anti-corporate
migration laws and the ways in which they inhibit local equity raising efforts
and the use of the country as a headquarter location
anti-corporate migration amendment to paragraph 11 and 35 of the eighth
schedule to the Income Tax Act discourages the use of South Africa as a hub for
headquarter companies and makes it impossible to fund foreign acquisitions
through the issue of local shares. An international company that restructures
its business by moving offshore subsidiaries into a company headquartered in a
different region may do so on a cash-free basis or a combination of cash and
equity or scrip. A cash-free transaction would generally be undertaken where no
value exits the group. In the case of a foreign acquisition, a combination of
cash and debt would normally be used.
For example, a
foreign parent company ("ParentCo”) that owns shares in foreign subsidiaries
("ForeignSubs”) could decide to locate the shareholding of the ForeignSubs in
an intermediary holding company based in South Africa ("SACo”). The commercial reasons for choosing South
Africa as a base can vary – the location, size of economy, financial market
access, relative political stability, and so forth.
Before 2014, this
transaction could be undertaken wholly or partially on a cash-free basis,
through a cross-issue of shares. That is,
(i) ParentCo would establish a SACo and (ii) contribute its shares in ForeignSubs
to the SACo in exchange for the issue of the SACo’s shares. The transaction would not attract any South
African income tax implications because no South African economic value would
have actually changed hands. The issue
of shares by a company has long been tax-free (in other words, is not a
disposal for capital gains tax purposes).
Paragraph 11(2)(b) of the eighth schedule to the Income Tax Act
specifically excluded the issue of shares from the definition of disposal.
2013, an amendment was brought into paragraph 11(2)(b) that had the effect of
triggering a disposal in the case where the shares are issued in exchange for
foreign shares. The amendment came into effect on 1 January 2014. In terms of the revised paragraph, the issue
of a share by a company that is a resident to any person in exchange directly
or indirectly for shares in a foreign company constitutes a disposal for
capital gains tax purposes. Given that
there is no cost base on the issue of shares, the base cost of the shares will
be nil. However, the proceeds of sale
are deemed to be the fair market value of the shares in the foreign company.
Applied to the
facts under consideration, the effect of the amendment is that the SACo will be
liable for capital gains tax at an effective rate of 18.65 per cent on the fair
market value of the ForeignSubs shares.
This is the case even though the ForeignSubs were never under the direct
or indirect South African corporate tax base.
The Draft SARS
CGT guide (issue 5) provides that the amendment will also apply where a company
issues shares in exchange for cash and then uses the cash to acquire shares in
a foreign company. This is on the basis
that the amendment targets both ‘direct and indirect’ foreign share
acquisition. Thus in the example, SACo
will potentially suffer the same tax treatment if it was to fund the acquisition
of the ForeignSubs by raising local equity capital.
result arises because there seems to be a disparity between the wording of
paragraph 11(2)(b) and the intention of the legislature. The purpose of the revised paragraph, as
noted in the Explanatory Memorandum to the 2013 Taxation Laws Amendment Bill,
was arguably to prevent the indirect shifting of economic value that is already
attached to the South African tax base outside the direct South African tax reach. Through this shift, taxpayers were supposedly
able to exit the investment tax-free. The
argument is that:
- Had the resident
shareholder disposed of the shares in a South African company, the disposal
would be liable for capital gains tax.
- The issuing of shares
to a foreign shareholder instead of a direct disposal of the existing shares
represents the shifting of value from the direct to an indirect South African
capital gains tax framework. Considering
that non-residents are generally not subject to tax on disposal of domestic shares
(subject to exceptions), the shares issued to a non-resident may never be
subject to capital gains tax in South Africa.
Furthermore, to the extent that a substantial equity stake (more than 10%)
of the foreign entity is acquired by the resident, the ultimate disposal of
those foreign shares would be exempt from South African tax if exited to an
uncontrolled foreign third party.
that the targeted scenario is different from the ParentCo scenario described
above. In the scenario described, SACo clearly
has no intrinsic pre-transaction value to shift offshore. Taxing SACo under the circumstances also
appears to be contrary to the general thread of the Income Tax Act on taxing
incoming value. For example, had ParentCo
or the ForeignSubs simply assumed tax residency of SA no tax implications would
accrue. The companies under the
circumstances would rebase their assets; in recognition that the incoming value
was accrued outside the SA tax net.
There is also
a question of what is the asset being disposed of? The deeming provision in
paragraph 35(1A) assumes that it is a share. The CGT guide appears to be of the
view that the asset would be a personal right created pursuant to an agreement
to issue shares. That is, a personal
right to have the shares taken up is created and the actual issue of shares
constitutes the disposal of such right.
If this is so, there appears to be a conflict in the wording between
para 11(2)(b) and paragraph 35. If the asset is something other than a share,
then arguably paragraph 35 does not provide deemed proceeds. In the absence of
the deemed proceeds the proceeds in the current circumstance may arguably be
question relates to the base cost of the asset. Arguably, the base cost of the
‘personal right’ is the cost of creation of such right. The SARS CGT guide assumes that a company
would have paid nothing for the personal right, resulting in an almost zero
base cost (except for legal fees and other ancillary costs). A distinction is
made between the base cost of the foreign shares acquired (which is deemed to
be the market value in terms of section 40CA) and the base cost of the personal
creates significant uncertainty and has the effect of greatly hindering the
creation of South African regional holding companies. Foreign companies (including continental
African companies) cannot readily be placed under South African company control
without a significant tax charge. The line
between a legitimate local equity raising transaction to fund a foreign
acquisition and the targeted avoidance is also blurred.
It was encouraging
that the item was put at the top of the National Treasury/SARS workshop agenda
for possible inclusion in the 2015/16 budget cycle. During this workshop (held in December 2014),
National Treasury raised various concerns, including the economic implications
of the tax-free inversion of national champion companies (mainly listed
companies). Whilst arguably understandable,
it still remains unclear what options National Treasury would likely consider
if the item is adopted for legislative consideration. The inclination seems to be to refine the
anti-avoidance provision to make it more focused on the targeted tax ills.
This article first appeared on the March/April 2015 edition on Tax Talk.
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