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Section 42 of the Income Tax Act: Navigating the legislative maze of an asset-for-share transaction

The tax relief provided for in sections 41 through to 47 of the Income Tax Act, Act 58 of 1962 (herein the ”ITA”), or rather the ‘Corporate Rules’ allows for the tax implications, normally associated with a group company restructuring to be deferred.

A ‘group restructuring’ may constitute the altering or re-organising a group of companies to bring about a fundamental change in the group, usually in direct or indirect ownership of the group or management control.

There may be various commercial reasons and benefits, for restructuring a group of companies, whether it be for purposes of corporatisation of a business or portion of a business; the imposition of a company into an existing structure; or the acquisition of new business. The Corporate Rules may be an effective tool available to neutralise the possible tax consequences of a group restructuring.

One of the provisions contained in the Corporate Rules is the all-famous ‘Asset-for-Share’ transaction in terms of section 42 of the ITA. An ‘asset-for-share’ transaction can be described as any transaction in terms of which a person (natural or legal persona) disposes of an asset at market value to a resident company, in exchange for equity shares in that resident company.

Provided the transaction is in compliance with the legislative provisions and requirements of the ITA, the transfer and disposal of the assets will not subject the transaction to a capital gains tax liability (in respect of capital assets) or normal tax on the gain (in respect of trading stock).

The requirements of section 42 are as follows:

  • The consideration in exchange for the assets must be in the form of ‘equity shares’ or the Transferee Company must acquire a ‘qualifying debt’ from the Transferor.
  • The ‘equity shares’ issued by the Transferee Company to the Transferor must constitute at least 10% (ten percent) of the equity in the Transferee Company; or the transferor being a natural person, must be engaged on a full time basis in the business operations of the Transferee Company (or a controlled group company).
  • The market value of the assets transferred must be equal to or exceed the base cost thereof.
  • The assets transferred must retain their nature – in other words capital assets are acquired as capital and trading stock is acquired as such. Although, capital assets may be converted to trading stock.

Provided the transaction is in compliance with the aforementioned requirements, the transferor will not be liable for capital gains taxes (for capital assets) or normal tax on the gain (for trading stock). The Transferee Company will have acquired the base cost of the assets transferred, and inherit the transferor’s cost history in respect of the assets.

It should be reminded that transfer duty is not automatically exempt in terms of an ‘asset-for-share’ transaction. Although the Transfer Duty Act, Act 40 of 1949 states that no transfer duty will be levied in respect of the transfer of a property in terms of an ‘asset-for-share’ transaction where the transferor and recipient of the property are deemed one and the same person.

Finally, there are specific anti-avoidance rules to be considered (in addition to the general anti-avoidance provisions in the ITA). For one, should the transferor dispose of the equity shares (acquired as part of an ‘asset-for-share’ transaction), within 18 months of concluding the section 42 transaction, the proceeds realised, will be treated as ‘income’ in nature and the transferor will be liable for normal tax. However, should the shares be sold for more than they were worth at the start of the 18-month period, such excess will be treated as a capital gain.

Although the provisions of section 42 allow for a useful tool to transfer assets in a tax neutral manner, there are a number of compliance issues and requirements to consider. Consult with your legal advisor prior to entering into an ‘asset-for-share’ transaction or contact our firm for a detailed discussion.

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 legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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