Asset-for-share transactions: Tax Free Restructure
09 Dec 2016
The Income Tax Act, 58 of 1962, contains several so-called ‘group relief’ provisions in terms whereof corporate restructures can take place on a tax neutral basis. One of these is if a transaction comprises an ‘asset-for-share transaction’, or put simply: where a company purchases an asset in exchange for which that company agrees to issue shares to the seller.
The term ‘group relief’ is somewhat of a misnomer in that not all of the group relief provisions necessarily involve groups of companies. The ‘asset-for-share transaction’ is one such an example where company groups are not necessarily involved. In fact, the concession (in section 42 of the Income Tax Act) is quite often used by individuals who are seeking to incorporate their businesses whereby they would transfer said business into a company in exchange for the latter issuing them with ordinary shares in that company. Such a transaction would not give rise to any immediate income tax costs, nor to any ancillary taxes such as VAT, Securities Transfer Tax, Transfer Duty, etc. (on condition that the relevant required formalities are observed).
The effect of an ‘asset-for-share transaction’ is effectively that the cost of the assets transferred is ‘inherited’ by the company. For example, assume Mr A has an asset with a base cost of R10 which is worth R100 today. He is able to transfer that asset to the company in exchange for shares without incurring any tax liability, but the company will be deemed to have acquired that asset at R10, and likewise Mr A acquires his shares at the same price. The effect therefore is that when one day Mr A should sell his shares, or the company the asset, the capital gain on the original R10 cost would still be realised and consequently taxed at that stage. The tax implications linked to the asset is therefore not avoided altogether, but merely postponed.
A few requirements to qualify for a section 42 transaction includes:
- The person to whom the shares are issued (i.e. the person selling the asset) must hold a ‘qualifying interest’ in the company subsequent to the transaction being concluded (being most often at least a 10% interest held in the company);
- The company and the person disposing of the asset must typically hold the asset with the same intent. In other words, if the company will hold the asset as - a capital asset, then so too must the person disposing thereof have held the asset as such; and
- The asset must be worth more than its base cost at time of the transaction being concluded.
Admittedly, this may be quite complex. To make matters worse, the provisions of section 42 apply automatically if its prerequisites are met and taxpayers are required to specifically elect out of its provisions if it does not want it to apply. All the more reason why any restructure would be incomplete without a review by a tax expert first before implementation thereof.