The interplay between the provisions in the Act pertaining to roll-over relief and those provisions regarding the imputation of tax to resident companies in respect of the income and capital gains of related foreign companies was recently considered in Binding Private Ruling 325 (Ruling), issued by the South African Revenue Services (SARS) on 23 August 2019. The Ruling examined both a liquidation distribution (in terms of s47 of the Act) and an amalgamation transaction (in terms of s44 of the Act) between non-resident companies. We discuss the liquidation distribution aspect of the Ruling below.
The Group Structure
The applicant in the Ruling is a company that is resident in South Africa (Applicant). The Applicant is a 100% limited partner in a foreign registered limited partnership (Partnership A), which in turn, is a 100% limited partner in a further foreign registered limited partnership (Partnership B).
Both partnerships constitute “foreign partnerships” as contemplated in paragraph (a) of the definition of “foreign partnership” in s1 of the Act. Therefore, they are fiscally transparent for South African tax purposes and any income received by or accruing to them is taxable in the hands of the Applicant.
Partnership B holds 100% of the shares in two non-resident companies, Company A and Company B, and Company A holds 100% of the shares in another non-resident company, Company C. Companies A, B and C are all controlled foreign companies (CFCs) in relation to the Applicant in terms of s9D of the Act.
The Proposed Liquidation Distribution Transaction
In an attempt to rationalise its offshore investments so as to have only one operating company in the foreign jurisdiction, the Applicant proposed a two-step transaction. The first of these steps involved a liquidation distribution.
It was proposed that Company A would dispose of its shareholding in Company C, as well as its business undertaking as a going concern, to Partnership B. All of Company A’s assets and liabilities would be transferred to Partnership B and no consideration would be paid in respect of the disposal.
Following the disposal, Company A would be wound-up and dissolved and its shares would be cancelled.
It was intended that the disposal qualified as a “liquidation distribution” as provided for in paragraph (b) of the definition contained in s47(1) of the Act.
Section 47(1)(b) of the Act defines a “liquidation distribution” in respect of a CFC, thereby providing the requirements that must be met in order to qualify for the roll-over relief contemplated in this section. These requirements can be summarised as follows –
- There must be a disposal of assets to the company’s shareholders in anticipation of, or in the course of, the liquidation of the company;
- The shareholders to whom the assets are disposed must constitute a holding company which is either –
(i) a resident company which forms part of the same group of companies; or
(ii) a CFC in relation to any resident company;
- Immediately before the transaction, each of the shares in the liquidating company that are held by the holding company must be held as capital assets;
- Immediately after the transaction, where the holding company is a CFC, more than 50% of the equity shares in the holding company must be directly or indirectly held by a resident; and
- The liquidating company must, within 36 months after the date of distribution, take the necessary steps to wind-up or deregister the company.
To the extent that the transaction pertains to a foreign company, two further provisions of the Act must be considered:
- Section 9D of the Act requires the imputation of the net income of a foreign company to a resident company to the extent that the foreign company is a CFC in relation to the resident company.
- Section 9H of the Act provides for the emigration of companies, including where a non-resident company constitutes a CFC prior to a transaction and subsequently is no longer a CFC. This section deems such company to have disposed of all of its assets on the date immediately prior to the day on which the CFC ceases to be a CFC and to have reacquired such assets the following day. This deemed disposal may result in CGT being payable by the resident company to whom the income of the now former CFC is imputed.
The Ruling that SARS issued was subject to the following conditions and assumptions –
1) The shares held in Companies A, B and C are all held as capital assets by the respective shareholders of these companies;
2) The shares in Company C that will be acquired in this step of the transaction will be acquired as capital assets;
3) The base cost and tax costs of the assets that will be transferred by Company A to Partnership B (other than the shares held in Company C) will not be less than the market values of the assets at the time of the implementation of the transaction;
4) The liabilities assumed by Partnership B will consist of qualifying debt only;
5) The deemed profit distribution that will arise under the foreign jurisdiction’s law between Company A and Partnership B will not be deductible by Company A in the determination of its tax on income; and
6) Company A will, within a period of 36 months after the date of the liquidation distribution, or such further period as the Commissioner may allow, take the steps as contemplated in s41(4) to liquidate, wind-up or deregister.
Based on the assumptions, SARS ruled that, in terms of step one of the proposed transaction, the roll-over relief provided for in terms of s47 of the Act applies and that no tax liability arises in terms of s9D and s9H of the Act.
Specifically, SARS found that neither Company A nor the Applicant will be subject to tax as a consequence of the implementation of step one of the proposed transaction and that the imputing provisions of s9D and the deeming provisions in s9H do not apply.
This Ruling illustrates how the roll-over relief provided for in s47 of the Act may apply to liquidation distributions involving non-resident companies, such as CFCs. The application of s47 to the disposals of the CFC and the fact that no CGT liability arises as a result of s9D and s9H of the Act, garners a significant benefit for the resident company that no longer holds shares in the non-resident company that was formerly a CFC in relation to it.