Cross-issue of shares and tax-free corporate migrations

In the 2015 Budget, the Minister of Finance indicated that paragraph 11(2)(b) of the Eighth Schedule to the Income Tax Act, No 58 of 1962 (Act), which deals with the issue of shares by a company, would be reviewed. National Treasury has now released the first batch of proposals forming part of the draft Taxation Laws Amendment Bill 2015, which specifically addresses paragraph 11(2)(b).

The issue of shares by a company (whether for cash, shares or other assets) generally does not constitute a disposal for capital gains tax purposes, although there may be capital gains tax consequences in terms of s24BA of the Act to the extent that there is a mismatch between the value of the shares issued and the cash or assets received.

In 2013 paragraph 11(2)(b) was amended to specifically provide that the issue of shares by a resident company in exchange for shares in a foreign company (whether directly or indirectly) would constitute a disposal.

This was a 'blunt instrument' approach to dealing with certain transactions that resulted in tax-free corporate migrations. These transactions involved the issue of shares by a resident company to a non-resident company, in exchange for shares in that or some other non-resident company. The resident company would then be stripped of its foreign assets in a tax effective manner by relying on paragraph 64B of the Eighth Schedule. Following a change in the place of effective management of the resident company, it would become a non-resident, and the exit charge would be minimal given the preceding disposal of foreign assets.

The 2013 amendments to paragraph 11(2)(b) halted these transactions because it would result in an immediate capital gain for the resident company equal to the market value of the foreign shares, the shares issued by the resident company having a zero base cost.

However, the fact that paragraph 11(2)(b) applies to the direct or indirect exchange for shares in a foreign company had unintended consequences.

Even if the resident company issued the shares for a cash amount, but the amount is ultimately settled by the acquisition of shares in any foreign company, or the resident company in any other manner ends up with foreign shares, there would be a disposal.

The economic consequence is that it hampers the acquisition by local companies of foreign entities and the growing of South African multinationals.

It is now proposed that the 2013 amendments to paragraph 11(2)(b) be reversed, and that the issue of shares by a resident company in exchange for shares in a non-resident company, no longer constitute a disposal for purposes of capital gains tax.

Rather, paragraph 64B will be amended to provide that the disposal of shares in a foreign company by a resident company to a connected person, would be subject to capital gains tax. In other words, the exemption in paragraph 64B would not apply if the foreign shares are disposed of to a connected person.

In addition, s9H of the Act, which deals with changes in tax residence, will be amended to provide that any benefits that a resident company enjoyed under paragraph 64B and/or s10B(2)(a) of the Act within three years prior to ceasing to be a resident, will be reversed upon ceasing to be a resident.

The amendments are proposed to apply retrospectively with effect from June 2015.