Ruling on issue of capitalisation shares
18 August 2015
Posted by: Author: Heinrich Louw
Author: Heinrich Louw (DLA Cliffe Dekker Hofmeyr)
The South African Revenue Service (SARS) issued Binding Private Ruling No 201 (Ruling) on 13 August 2015.
The Applicant, being a natural person, held 100% of the equity shares in a resident operating company (OpCo). OpCo, in turn, owned 100% of the shares in a dormant resident company (Co-Applicant). The parties wished to introduce a black-owned company (BEECo) as a shareholder in OpCo in order to improve its Black Economic Empowerment (BEE) credentials.
In order to achieve this, it was proposed that:
- OpCo would dispose of its shares in the Co-Applicant to the Applicant for nominal value;
- The Applicant would dispose of its ordinary shares in OpCo to the Co-Applicant in exchange for ordinary shares in the Co-Applicant (ie an asset-for-share transaction in terms of s42 of the Income Tax Act, No 58 of 1962 (Act));
- The Applicant would then hold 100% of the equity shares in the Co-Applicant and the Co-Applicant would hold 100% of the equity shares in OpCo;
- The Co-Applicant would issue 10 000 capitalisation shares to the Applicant for no consideration; and
- The Co-Applicant would issue 25.1% ordinary shares to BEECo for a negligible subscription price.
The 10 000 capitalisation shares would:
- be participating, cumulative, redeemable preference shares;
- be redeemable at the option of the Co-Applicant at 100% of the current equity value of OpCo;
- only have to be redeemed by the Co-Applicant if a default is triggered by the Co-Applicant falling into financial distress;
- entitle the Applicant to a cumulative preference dividend equal to the unredeemed balance of the redemption price of the shares, plus arrears, times 72% of the prime rate; and
- entitle the Applicant to 1% of all distributions made in respect of the ordinary shares.
SARS ruled that:
- The receipt by the Applicant of the capitalisation shares would not be seen as a disposal of the Applicant’s ordinary shares in the Co-Applicant (presumably as a result of dilution), and the anti-avoidance provisions contained in s42(5) of the Act would not be triggered (Please refer to our Tax Alert dated 31 July 2015 for the latest developments regarding s42(5) of the Act);
- The Applicant will continue to hold a "qualifying interest" in the Co-Applicant subsequent to the issue of the capitalisation shares, and s42(6) of the Act will not be triggered;
- The receipt of the capitalisation shares would not constitute "gross income" in the hands of the Applicant, presumably because it is a capital receipt as opposed to a dividend, and would also not have to be included as an amount in respect of services rendered;
- The capitalisation shares would also not be subject to s8C of the Act;The capitalisation shares would not constitute a "dividend" or a "return of capital" as defined in s1 of the Act;
- The exchange of the Applicant’s personal right to receive the capitalisation shares, for the actual capitalisation shares upon receipt will constitute a "disposal" by the Applicant, but will be disregarded for capital gains tax purposes (presumably because the base cost of the right would equal the proceeds, but this is unfortunately not made clear);
- The expenditure incurred by the Applicant in respect of the capitalisation shares will be deemed to be nil in terms of s40C of the Act; and
- No "contributed tax capital" will be created by the issuing of the capitalisation shares.
SARS did not make this ruling subject to any conditions or assumptions, but it did clearly indicate that the Ruling does not extend to any issues regarding company law, accounting treatment, or BEE accreditation.
This article first appeared on cliffedekkerhofmeyr.com.