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Tax consequences of waiver of contractual rights

Monday, 15 May 2017   (0 Comments)
Posted by: Author: Ben Strauss
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Author: Ben Strauss (CDH)

Capital gains tax (CGT) is levied on the disposal of an asset. The terms “disposal” and “asset” are defined widely in the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act). The term “disposal” includes “the forfeiture, termination, redemption, cancellation, surrender, discharge, relinquishment, release, waiver, renunciation, expiry or abandonment of an asset” (see paragraph 11(1)(b) of the Eighth Schedule to the Act (Eighth Schedule)).

Paragraph 38 of the Eighth Schedule applies when a person disposes of an asset by way of a donation, or to a person who is a connected person in relation to the person disposing of the asset for a consideration that is below an arm’s length price.  In such a case, the asset is deemed to have been disposed of for a market-related consideration.

The reduction of a debt for inadequate consideration can give rise to either income tax (under s19 of the Act), or to CGT (under paragraph 12A of the Eighth Schedule) in the hands of a creditor. The tax depends on the way that the debtor applied the debt funding.

Donations tax is levied on the value of property disposed of under a donation. The term “donation” includes “any gratuitouswaiver or renunciation of a right” (s55 of the Act – emphasis added).

The provisions above were the subject of Binding Private Ruling 273 (Ruling) issued by the South African Revenue Service (SARS) on 2 May 2017.  The facts were as follows: two companies (Co A and Co B) were both wholly-owned subsidiaries of another company. Co A had the right to receive from Co B “an annual quantity of produce” determined under a prescribed formula. Co A unilaterally waived the right against Co B.

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