The Income Tax Act contains various provisions in terms of which transactions can occur between specified parties without adverse tax consequences being incurred in respect of those transactions. These provisions are contained in sections 41 to 47 of the Income Tax Act and are generally known as the “group relief provisions”.
Apart from certain value-shifting and general anti-avoidance provisions, the group relief mechanisms override all other sections of the Income Tax Act to the extent that there are any inconsistencies. These transactions are asset-for-share transactions, amalgamations, intra-group transactions, and liquidation distributions. It is critical to know in which circumstances which transactions apply.
In what follows, we highlight one of the particular types of transactions with reference to its purpose, working and certain clawbacks which may apply in respect of this transaction.
SECTION 42 ASSET FOR SHARE TRANSACTION
In terms of section 42 a person (natural person, trust or company) can transfer an asset on a tax neutral basis to a South African tax residence company in exchange for shares in that company.
The person disposing of the asset to the company does not incur an immediate income tax or capital gains tax cost, since that person and the company to which it transferred the asset is deemed to be one and the same person with regards to the date of the acquisition of the asset and the cost incurred as part of the acquisition of the asset.
The person is no better or worse off from a value perspective since they merely replaced the value of the asset transferred with shares of an equivalent value in the company to which they transferred the asset. Importantly the person is required to hold a so-called qualifying interest in that company, being at least 10% of the equity shares in that company.
Some of the more relevant requirements for section 42 to apply are as follows:
- The market value of the asset must be equal to or exceed the base cost of the asset.
- The nature of the asset can be from trading stock to trading stock, capital asset to capital asset, or capital asset to trading stock. In other words, it is not allowed for a person to transfer an asset which they held as trading stock to a company which will forthwith hold that asset as a capital asset. The reason for this is clear in that SARS does not want to allow an asset that would have been subject to 28% tax to now be taxed at a lower effective capital gains tax rate when the asset is eventually disposed of.
Section 42 also contained a number of so-called clawbacks in that certain transactions in respect of either the asset acquired by the company or the shares that were obtained by the person who transferred the asset could have adverse tax consequences if transactions occur in respect of those shares or assets within 18 months after the transaction. There is not an absolute prohibition on transactions in respect of these assets or shares; it is merely the tax consequences which attach to them that should be considered.
Generally, any tax consequences that would have occurred in respect of that asset at the beginning of the 18-month period will attach to that transaction within the first 18 months following it. Essentially, the system does not allow a person to transfer a profit-making asset into a loss-making entity merely to avoid tax consequences.
The provisions of section 42 can become rather involved and technical, and it is advised that professional tax advice be received before entering such a transaction.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your adviser for specific and detailed advice. Errors and omissions excepted (E&OE).