29 February 2008
Bradley Viljoen
Committee Secretary - Portfolio Committee on Finance
3rd Floor 90 Plein Street
Workstation W/S 3126
Parliament of RSA
Cape Town
8000
For attention of
the Portfolio Committee on Finance
Draft Taxation Laws
Amendment Bill, 2008
Submission on the
proposed changes to section 45 (intra-group transactions)
Introduction
My name
is George Negota and serve as a member of the Special Income Tax Court. I am also a
qualified attorney practising commercial law including tax law. Over and above
that I am also a transport economist and a businessman. I am an interested
party herein because of the impact that the Draft Taxation Laws Amendment Bill,
2008 will have on BEE transactions. If implemented there will be no
transformation of the economy as it is desired.
1. Background
1.1 In
terms of the Media Statement on ‘Taxation Laws Amendment Bills, 2008: Company
Restructuring Measures’, published on Thursday 21st February 2008
(‘the Media Statement’) certain methodologies whereby sellers of companies
could effectively exit their share investments in a tax free manner
(‘cashing-out’) through use of the section 45 intra-group transaction relief
have been identified, correctly we submit, as being at odds to the intent of
the rollover relief which, to quote the Media Statement,
“was never intended to apply in respect of this
cashing-out; it was merely intended to allow for the deferral of gain/
loss when assets are moved within a single group.”
1.2 The Media Statement goes through a
detailed example of one such scheme and outlines in summary a further two in
which cash is flowed through the group to achieve the same effect.
1.3 In
order to combat these schemes certain changes have been proposed to section 45
in the draft Taxation Laws Amendment Bill, 2008, published on Friday 22nd
February 2008 (‘the Bill’).
1.4 The
first of these changes (section 45(1)) limits the roll-over relief provided by
section 45 to instances where assets are transferred for:
(a)
no consideration; or
(b)
against the issue of a
debt instrument.
1.5 It is
proposed that transfers against cash consideration, currently within the scope
of the relief, are to be excluded.
1.6 Secondly
(section 45(3A)), where a debt instrument is issued, the seller’s tax basis in
that instrument is, in effect, limited to the tax basis of the assets
transferred in respect of which the instrument is issued. Subsequent repayment
of the loan thus triggers an additional taxable gain.
1.7 Whilst
we appreciate the anti-avoidance concern outlined in the Media Statement and
indeed fully support the closing of the loopholes identified we have grave
concerns that doing so in the manner currently proposed, as opposed to a
specific targeted anti-avoidance measure or indeed the use of the existing
general anti-avoidance rule which the Media Statement confirms the scheme
outlined is susceptible to, is extremely far reaching and has significant
detrimental effects on legitimate business transactions where no avoidance
(motive or effect) is present.
1.8 To
remove relief entirely simply by reason of an intra group purchase being
settled in cash (an entirely commercial and normal event) without there being
any change in the ownership in the shares of the seller of the assets (“the
transferor”) - as is contemplated in the Media Statement is clearly
illustrative of an avoidance measure going too far.
1.9 Indeed
the proposed changes would we suggest conflict with the position outlined in
the Media Statement that “the changes should eliminate the avoidance of concern
without undermining the effectiveness of the relief for intra-group
transactions”.
2. Summary of negative financial impact of
proposed changes on classes of legitimate business transactions
2.1 The
proposed redefining in section 45(1) as to what constitutes an intra-group
transaction for purposes of the roll-over relief precludes transactions whereby
the purchase price is settled in cash. In effect the roll-over relief is
denied, thus accelerating a tax cost and negating a relief explicitly provided
for in the legislation, by reference to a wholly normal transaction which is
not used to avoid tax. A simple example illustrating this effect is included at
Appendix I.
2.2 The
proposed section 45(3A) in turn effectively turns a roll-over relief section
into a taxing section. Instead of roll-over relief applying a taxpayer is in
effect hit with a double tax charge (with no means of avoiding the cascading
effect by means of a dividend) in respect of a single economic benefit.
Appendix II illustrated the cascading effect of CGT and the means by which this
is mitigated so that a group pays tax only once on its economic gains whilst
Appendix III illustrates why such mitigation is not possible under the proposed
changes and how double tax arises.
2.3 Both
of the above negative aspects of the proposed changes in legitimate business
transactions are we submit wholly unacceptable. It is worth noting that the
proposed changes in effect render the purported relief in section 45
meaningless – it is no longer a section which provides relief.
3. Impact of proposed changes on BEE
transactions
3.1 BEE
transaction are funded in a number of ways, two of the more common of which,
particularly where broad based empowerment is targeted are described in the
following sections.
3.2. BEE transactions (internally funded)
3.2.1 BEE deals under R100 million, where
external funding is particularly hard to obtain, are typically structured as follows;
·
A
Newco is set up with nominal capital which is held 75% by the existing group
and 25% by the BEE participants
·
The
existing group sells its business to the Newco on loan account using section 45
relief
·
The
existing group retains its 75% stake in Newco
3.2.2 This structure is commonly used where there
are no alternative means of funding sustainable empowerment, particularly on a
broad based empowerment platform.
3.2.3 The
advantages of structuring in this manner include;
·
Affordable access to BEE investors (in
particular facilitating the entry of broad based participants at little or no
cost);
·
Immediate transfer of full title ownership
to BEE parties;
·
BEE investors can be shielded from
historical business liabilities;
·
Group scores net equity value BEE
Scorecard points from outset thus obtaining competitive edge/ access to
contracts requiring given empowerment status
3.2.4 Internally funded deals already suffer from
a number of disadvantages when compared to externally financed transactions (in
respect of which see below) for a number of reasons, including the loan to
Newco failing to meet investment criteria as regards internal rate of return
(‘IRR’) performance criteria of the existing group. Where the interest rate on
the loan is set so as to ensure the IRR criteria is met this can lead to the
BEE deal being unsustainable as Newco is unable to cover the interest cost with
the result that no wealth opportunity is created for the black participants.
3.2.5 In addition a concern exists (based on
market experience) that the repayment of such loans (as opposed to external
bank funding) is seen as maybe quasi-equity as opposed to arm’s length debt by
the BEE partners with the result that the repayment thereof may be in question
where the BEE partners require cash for their own purposes.
3.2.6 The proposed changes further negatively
impact on such deals by giving rise to taxation in the existing group when the
loan is repaid by Newco. This is in addition to the tax that Newco will in any
event pay in respect of the disposal of the assets acquired from the existing
group.
3.2.7 Typically
the ‘cascading effect of CGT’ can be avoided by triggering the gain at the
lower level (Newco) and then (Newco) declaring a dividend of the resultant
profits. Such dividend does not then result in additional tax at the
shareholder level when the shareholder realizes its underlying investment which
has been stripped of the growth by the dividend.
3.2.8 The
changes proposed remove this flexibility with the result that double tax (in
Newco on sale of the assets and again in the existing company on repayment by
Newco of the loan) is unavoidable without the type of planning the changes are
proposed at combating.
3.3. BEE transactions (externally funded)
3.3.1 Commonly
larger BEE deals (where external funders are available) are structured as
follows;
·
A Newco is set
up with nominal capital which is held 75% by the existing group and 25% by the
BEE participants
·
Newco borrows funds from external lender
(bank) to acquire the business to be empowered for cash;
·
Business is sold from existing group
company using section 45 relief to Newco;
·
Existing group provides security to
Newco’s lender in support of the transaction;
·
Newco remains within the existing group
‘group of companies’
3.3.2 The
advantages of structuring in this manner are per the internally funded
alternative described above but without the negative connotations associated
therewith.
3.3.3 In mid
2007 we confirmed with the DTI that the benefits of this structure, as outlined
above, are indeed as envisaged by, and indeed required by, the Empowerment
Codes.
3.3.4 The
impact of the proposed changes is to deny the relief explicitly provided for in
the Act, solely by virtue that a purchase of a business is settled using cash without
there being a cashing out of the investment by the group as is contemplated in
the Media Statement. With all due respect we submit that this cannot be
supported.
3.3.5 Alternatively,
where the sale is on loan account from the existing group with the funds
borrowed from the external funder then used to settle that loan the position is
as set out for internally funded loans, i.e. double tax will result (once in
Newco on sale of the assets but also in the existing company on repayment by
Newco of the loan).
3.3.6 Again
the typical methodology of avoiding the ‘cascading effect of CGT’ by triggering
the gain at the lower level (Newco) and then (Newco) declaring a dividend of
the resultant profits is of no avail as the gain at the existing company level is
triggered by the repayment of the loan.
3.3.7 The
proposed change could we suggest also negatively impact on the requirements
imposed on the banks in terms of the Financial Services Charter to fund BEE
transactions as the proposed changes make deals more expensive in tax terms and
so raises the possibility that a lower number will be completed.
3.3.8 If the
changes proposed are effected deals will be less sustainable for BEE parties as
they will require to be structured in more expensive forms or the values at
which they are conducted will be raised to lessen the counter to negative tax
consequences.
4. Proposed
requirements for any solution
4.1 As
noted above we accept that measures are required to combat the mischief
identified and support that this be done.
4.2 However
we submit that the proposed change to the definition in s45(1)(a) should be
removed with the definition of intra-group transaction left as currently
stands, i.e. covering also cash transactions.
4.3 Whilst
we support the inclusion of an anti-avoidance measure such as that in the
proposed section 45(3A) we submit that the measure should satisfy the following
requirements, applying;
·
in instances of both
cash and debt instruments;
·
only in cases where a
tax free cashing out would otherwise result;
·
only to the extent that
a cashing out occurs (and not until such time as such cashing out is
unencumbered);
·
only for the same six
year period as the de-grouping charge covers;
·
so as to provide for the
tax basis in the loan (in effect determining the gain to be triggered to be
calculated) as follows;
o
the lower of;
§
the market value of the
assets transferred; and
§
the higher of;
·
the tax basis in the
assets and
·
the tax basis in the
shares in respect of which the cash out occurs
o
the portion detailing
the higher of is required as if the shares to be disposed of were previously
purchased it is possible that the price paid may include an amount in respect
of goodwill generated in the company acquired for which there is no tax basis.
In such instances it would be wholly inequitable to calculate the gain on
cashing out by reference to a figure lower than the amount paid by the selling
group on its original acquisition.
·
in such manner as full
base cost offset against initial payment (as opposed to part disposal concept
of partial use of base cost) similar to the approach we understand is adopted
by SARS on repayment of debt acquired at a discount
without impinging on
legitimate transactions.
4.4 Unfortunately
in the limited time available (as to which see also our comments below) and due
to the complexity of the area we have not yet come up with a formula that both
addresses the mischief targeted whilst leaving legitimate business transactions
unaffected.
4.5 Effective date
4.5.1 Whilst
we appreciate the need for anti-avoidance provisions to be included as early as
possible given the complexity of the area to be covered and the scope for
substantial negative impact on legitimate transactions we would suggest that in
order to have an adequate consultation period the effective date for the
proposed changes be deferred – in this regard we would suggest a date to be
determined by the Minister immediately following a consultation period.
4.5.2 Alternatively,
and very much as a poor second option due to the uncertainty it would create,
an effective date could be announced with the detailed legislation to follow.
5. Additional observations
5.1 Lack of alternative tax relief
5.1.1 The
commentary in the Media Statement that the alternative rollover relief found in
section 42 (assets for share transactions) may be utilized is not always the
case.
·
For example the
existence of minority shareholders in companies may prevent the commercial
transaction being effected as a transfer in return for shares (even prior to
considering what the tax effect thereof would be) as this would result in an
unacceptable dilution of minority shareholders.
·
Alternatively the cross
holdings which could result are undesirable from a corporate governance
perspective.
5.2 Taxation Laws Amendment Bill and period
for public comment
5.2.1 Due to
an error in placing the Second Taxation Laws Amendment Bill on Treasury’s
website twice (once in place of the Bill), the Bill, including the proposed
changes to section 45, was only available to the public on Friday 22nd
February. The date scheduled for public comment to the Portfolio Committee on
Finance is Wednesday 4th March, allowing only 8 working days for
public comment (and this 8 days includes the presentation by Treasury and SARS
to the Portfolio Committee on Finance.
5.2.2 Given
the magnitude of the proposed change as is evidenced by the transactions
detailed above we submit that this is wholly inadequate for a meaningful
consultative process.
5.2.3
In addition, we observe
that changes of this magnitude are generally only included in the Revenue Laws
Amendment Bills later in the year which thus does allow for a greater public
input.
6
Closing comments
6.1 We
would welcome the opportunity to present to the Portfolio Committee on Finance
in respect of the matters set out in this document.
Yours sincerely
[Name]
cc National
Treasury [email protected]
