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Tax threat to empowerment deals

Saturday, 11 June 2011   (0 Comments)
Posted by: Sanchia Temkin (Business Day)
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Cmpanies will be forced to return to the drawing board to consider their black economic empowerment (BEE) transactions to avoid facing adverse tax consequences in the wake of proposed draft tax laws, tax analysts have warned.

Stephan van der Walt, head of corporate finance at private equity group Bravura, says the proposed new tax laws place an immediate moratorium on the intragroup rollover relief provision contained in the Income Tax Act, which can also put a hold on many company acquisitions until further clarity is obtained from the government.Last week, the national Treasury issued the draft Taxation Laws Amendment Bill. 

The bill gives effect to many of the tax proposals contained in Finance Minister Pravin Gordhan’s February budget. The draft legislation is intended to broaden the tax base and close loopholes by introducing a number of new anti-avoidance measures, including the immediate suspension, until December next year , of section 45 of the Income Tax Act, which has allowed for the intergroup transfer of assets in a tax-neutral manner. However, the Treasury has indicated that some companies have taken advantage of the provision in creating excessive interest deductions. 

Keith Engel, chief director of legal tax design at the national Treasury, explains that the common use of the section involves "debt push-down structures" — the trigger for connecting excessive debt and funnel schemes.Mr van der Walt says the ability to transfer assets tax-free is fundamental in any tax system to enable corporate activity to take place. For example, section 45 is the key to the implementation of BEE transactions. 

It is the only provision of the Income Tax Act that allows for the conclusion of sustainable empowerment transactions that are not share-price dependent (unlike the typical share-funded models that were the cause of so many failed empowerment transactions ).

He says section 45 is also used in many internal restructurings and in the acquisition of businesses. "The immediate suspension will now force companies to revert to unsustainable forms of empowerment. Many companies, especially mining companies which have announced BEE transactions but await approval from the Department of Mineral Resources, will now need to go back to the drawing board or may face significant negative tax consequences.

"He also says it is likely that many companies will put acquisitions on hold until further clarity is obtained on the matter. "This is expected to have a significant impact on merger and acquisition activity in SA."

Dirk Kotze, a tax partner at audit, tax and advisory firm Mazars, says the hiatus on section 45 comes as a "surprise" to tax advisers and taxpayers alike as there was no mention in the finance minister’s speech that the provisions of section 45 would be substantially amended, let alone their use barred."What creates even more uncertainty is that many taxpayers and groups have planned restructures and transactions involving the use of section 45 and these will now have to be reconsidered in the light of the proposed amendment and its effective date," says Mr Kotze.

One of the reasons provided by the Treasury for the moratorium on the use of section 45 is the fact that taxpayers have apparently abused the provisions in order to reduce overall group taxable incomes. "Treasury indicated that the position is a suspension of section 45 as part of a larger investigation into the taxation of interconnected areas and that more legislation can be expected in 2012," says Mr Kotze.

Mr van der Walt points out that another amendment in the bill relates to preference shares. He says the use of preference share funding is in many instances the only form of viable funding. "We know that the South African Revenue Service is concerned about transactions generating tax-free dividends on the one hand and interest deductions on the other.

"Dividends on preference shares are generally not subject to income tax. The proposed amendments, effective from next April, will result in almost all preference share dividends now becoming taxable without a corresponding deduction."This will have a detrimental effect on the majority of BEE transactions, many of which are already distressed. The amendment will result in an approximate 40% increase in the cost of funding for BEE parties, leading to almost every share-funded BEE transaction being unsustainable with a limited to no prospect of realising any value," says Mr van der Walt.



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