In practice taxpayers often enter into arrangements in terms of which a company buys back its own shares held by certain shareholders, and immediately thereafter issues new shares to new shareholders. This practice has long caused tax avoidance concerns for the South African Revenue Service (SARS), as it could circumvent the payment of capital gains tax (CGT) by the shareholder whose shares are bought back.
For example, company A holds shares in company B. Company A wishes to sell these shares to company C. Rather than entering into a sale of shares agreement with company C, company A opts to enter into a share buy back agreement with company B. Immediately thereafter, company C enters into a subscription agreement with company B.
The benefits of entering into the latter arrangement is that company A receives an exempt dividend from company B, and is not liable for CGT on the disposal of the shares to company B to the extent of the dividend. Similarly, company C is not liable for any tax in respect of the subscription for shares in company B and company B is not liable for CGT in respect of the issue of shares. One is therefore dealing with a very tax efficient and favourable arrangement for all parties concerned - except for SARS.
The risk is that SARS may view the share buy back and subsequent issue of shares as a disguised sale between company A and company C.
On 16 March 2015, SARS issued Government Notice No 38569 (Notice), in terms of which the following arrangement has been identified as a 'reportable arrangement' for purposes of s35 and s36 of the Tax Administration Act, No 28 of 2011 (TAA):
Any arrangement in terms of which-
(a) a company buys back shares on or after the date of publication of this notice from one or more shareholders for an aggregate amount exceeding R10 million; and
(b) that company issued or is required to issue any shares within 12 months of entering into that arrangement or of the date of any buy back in terms of that arrangement.
The effect of the Notice is that any share buy back and issue arrangement which falls within the ambit of the Notice now places a disclosure obligation on any 'participant' of information in respect of the 'arrangement' for purposes of Part B of Chapter 4 of the TAA. The 'participant' must disclose certain information within 45 business days of the 'arrangement' qualifying as a 'reportable arrangement' for purposes of the TAA, or must disclose the information within 45 days from the date of becoming a 'participant' to that 'reportable arrangement'.
Section 38 of the TAA sets out the information that needs to be submitted to SARS in relation to the 'reportable arrangement', which information must be submitted in the prescribed form and manner, and by the date specified, and must be as follows:
- a detailed description of all the steps and key features of the 'arrangement', including, in the case of an 'arrangement' that is a step or part of a larger 'arrangement', all the steps and key features of the larger 'arrangement';
- a detailed description of the assumed 'tax benefits' for all 'participants', including tax deductions and deferred income;
- the names, registration numbers and registered addresses of all 'participants';
- a list of all agreements of the 'arrangement'; and
- any financial model that embodies the projected tax treatment of the 'arrangement'.
Section 212 of the TAA previously stated that a 'participant' who fails to disclose the information in respect of a 'reportable arrangement', as required by s37 of the TAA, is liable for a penalty for each month that the failure continues (limited to 12 months), in the amount of:
- R50,000 in the case of a 'participant', other than the 'promotor' (ie the person principally responsible for organising, designing, selling, financing or managing the 'arrangement'); or
- R100,000 in the case of the 'promotor'.
The section further stated that the amount of the penalty is double if the amount of the anticipated tax benefit for the 'participant' due to the 'arrangement' exceeds R5 million and tripled if the benefit exceeds R10 million. However, the Notice has now amended the TAA by causing any arrangement referred to in s35(1) of the TAA to be an excluded 'arrangement', as contemplated in s36 of the TAA, if the aggregate tax benefit which is or may be derived from that 'arrangement' by all 'participants' to that 'arrangement' does not exceed R5 million. Thus, the Notice does provide some relief in respect of share buy back and issue transactions.
Taxpayers should bear in mind that s234 of the TAA makes it a criminal offence to wilfully and without just cause fail or neglect to disclose to SARS any material facts which should have been disclosed under the TAA or to notify SARS of anything which the person is required to notify SARS of under a tax act. If a person is convicted of such criminal offence, the person is subject to a fine or imprisonment for a period not exceeding two years.