The importance of corporate agility to economic activity has been recognised in the corporate rollover relief provisions largely contained in Part III of Chapter Two of the Income Tax Act 58 of 1962 (Act). The roll over relief provisions allow corporate groups to reorganise without bearing the immediate income tax and capital gains consequences associated with certain intra-group transactions. This tax neutrality is, however, subject to certain prerequisite conditions and anti-avoidance rules.
The Draft Taxation Laws Amendment Bill, 2020 (Draft TLAB), proposes changes to the intra-group transaction provisions contained in section 45 of the Act. The Draft TLAB proposes inserting a new subsection into section 45, to avoid anomalous consequences which arise from the application of certain anti-avoidance rules, where an intra-group transaction is funded by debt or the issue of non-equity shares.
An intra-group transaction under section 45 allows one company to transfer an asset to another company forming part of the same group, on a tax neutral basis and to defer the tax liability that would have ordinarily been incurred. Section 45 however, contains anti-avoidance provisions aimed at preventing the abuse of the tax relief afforded to companies through intra-group transactions.
The proposed amendments in the Draft TLAB deal with the interaction between the “De-Grouping Charge” contained in section 45(4) of the Act and the “Zero Base Cost Rule” contained in section 45(3A) of the Act.
Intra-group anti-avoidance provisions
The De-Grouping Charge provides that if the transferor and the transferee companies cease to form part of the same group within six years of the implementation of the intra-group transaction, then any deferred tax benefit obtained from the transaction is triggered in the hands of the transferee. This is aimed at discouraging companies from implementing the intra-group transaction (thereby benefiting from the tax deferral) but then ceasing to form part of the same group soon thereafter.
The Zero Base Cost Rule applies, in summary and subject to further considerations, where an asset is transferred by the transferor to the transferee in exchange for debt or non-equity shares and deems the debt or non-equity shares to have been acquired by the holder for nil expenditure. The rule implies that debt and non-equity shares issued as consideration under an intra-group transaction are deemed to have a zero base cost in the hands of the transferor. Further, any repayment (capital repayment in respect of debt, or redemption of the non-equity shares) will not give rise to any income or gain in the hands of the holder of the shares or debt, provided the companies form part of the same group of companies when the repayments are made.
However, to the extent that the holder disposes of the debt or non-equity shares to a person outside of the group, tax must be accounted for on this disposal, having regard to the nil base cost of the debt and non-equity shares. This is aimed at adding a tax cost where companies engage in debt or non-equity share funded intra-group transactions, and then subsequently transfer the debt or non-equity shares outside of the group.
In certain instances, an intra-group transaction can be implemented in a manner where the transfer of an asset is funded by the issue of debt or non-equity shares by a group company, and a de-grouping subsequently occurs within a period of six years. Ordinarily, the De-Grouping Charge would apply and “reverse” the tax deferral benefit obtained. However, the Zero Base Cost Rule in this scenario has the effect that the holder still remains with a nil base cost in respect of the debt or non-equity shares. Essentially, this creates a “double whammy” in effect, namely the reversal of the tax benefit in terms of the De-Grouping Charge and a greater capital gain on the disposal of the debt or non-equity shares in terms of the Zero Base Cost Rule.
To address this issue, the Draft TLAB proposes inserting a subsection which applies where the De-Grouping Charge rule has been triggered in respect of an intra-group transaction where the Zero Base Cost rule was applied. The effect of the proposed subsection will be that the tax attributes of the debt or non-equity shares will be reinstated to reflect those that would have existed on the date of that de-grouping, had tax deferral not applied at all. This means that a debt or non-equity share in respect of which the Zero Base Cost Rule applied, should be deemed to have a base cost equal to its market value on the date of the intra-group transaction less any repayments made prior to the de-grouping.
The Draft TLAB containing the proposed amendments discussed here has been published by National Treasury and SARS for public comment until 31 August 2020. Once the Draft TLAB is tabled in Parliament, it will be subject to a further public participation process.
Taxpayers should welcome the resolution of the anomalous result brought about by the application of the two anti-avoidance rules discussed in this article. The amendments proposed in the Draft TLAB appear to be aimed at striking a fairer balance between the need to prevent abuse and the agility provided to corporate groups through the corporate roll over relief provisions, including intra-group transactions.