ASSET FOR SHARES TRANSACTIONS

By Aimee Joubert

SECTION 42 OF THE INCOME TAX ACT PROVIDES TAX ROLL-OVER RELIEF IN RESPECT OF ASSET FOR SHARE TRANSACTIONS.

WHAT IS THE ROLL-OVER RELIEF? WHAT IS IT USED FOR? AND HOW DOES IT WORK?

An asset-for-shares transaction is, very broadly speaking, a transaction in terms of which a person disposes of an asset to a South African resident company in exchange for the issue of shares in that company, where the value of the issued shares is equal to the value of the asset disposed of.  Section 42 of the Income Tax Act provides for certain roll-over relief in respect of these transactions (provided that certain requirements are met).  This article does not deal with the specific requirements for the roll-over-relief to be available.  The purpose hereof is only to provide an explanation as to what the roll-over relief is and what the benefit is in making use thereof.

What is the roll-over relief provided in Section 42 of the Income Tax Act?

Ordinarily, where a person sells or disposes of an asset to another person, tax will be payable. This will either be in the form of Capital Gains Tax, where a capital asset is sold / disposed of, or in the form of Income Tax, where trading stock is sold / disposed of.  The roll-over relief provided for in Section 42 of the Income Tax Act effectively neutralises the tax effect of the transaction, meaning that the seller / disposer of the asset will not be liable for the Income or Capital Gains Tax which would ordinarily have been payable on the transaction.  (This does not mean that the tax liability will be escaped altogether – the fiscus will still claim its piece of the pie at some stage – it simply means that the immediate transaction can be carried out in a “tax neutral” way.  The payment of the tax is effectively deferred to some later date when the acquirer of the asset disposes thereof or when the initial disposer of the asset disposes of the shares which were issued as consideration for the asset acquired.)

What is it used for?

To state the obvious, no one wants to spend more money than is absolutely necessary to achieve a particular goal.  If money can be saved while still achieving what you need / want to achieve, then why not do so?  This is even more so when one thinks of savings of probably one of the biggest grudge payments known to man – TAXES.

The asset-for-share transaction ‘mechanism’ (for lack of a better word) enables companies to acquire (or take transfer of) other companies and/or businesses and/or individual assets in a way which is tax efficient for the transferor / seller.  This mechanism can be used to transfer assets from an individual, company, close corporation, trust or special trust to a South African resident company in a “tax neutral” way.  Although a value shift will occur (and the asset in question will change ownership), the transaction will have no immediate Income Tax, Capital Gains Tax, VAT (where otherwise ordinarily applicable), Transfer Duty (in the case of immovable property) or Securities Transfer Tax implications.

One way in which this mechanism is particularly useful (and which has been used by our own clients) is for the transfer of immovable property from a trust (where the effective Capital Gains Tax rate is a staggering 36%) to a company (where the effective Capital Gains Tax rate is a more palatable 22.4%).  (To put this in perspective, were a trust and a company both to realise a taxable Capital Gain of R 1 000 000.00, the trust will pay Capital Gains Tax of R 360 000.00, while a company would pay only R 224 000.00, R 136 000.00 less.)

A practical example:

ABC Trust (“ABC”), an ordinary trust, acquired an investment property (which it held as a capital asset) for an amount of R 5 000 000.00 in 2010.  (For purposes hereof it is assumed that no allowances were claimed in respect of the asset and that the base cost is equal to the purchase price.) The property now (in 2021) has a market value of R 10 000 000.00.  If ABC was to sell / dispose of this asset for R 10 000 000.00, it would realise a Capital Gain of R 5 000 000.00.  This Capital Gain would be taxed at an effective rate of 36% (ABC being a trust). In other words, the Capital Gains Tax payable would be an amount of R 1 800 000.00.  Transfer Duty of R 916 000.00 would also be payable on the transfer of the property.

If the asset is disposed of rather to XYZ (Pty) Ltd (“XYZ”) in terms of an asset-for-shares transaction (and XYZ issues shares to the value of R 10 000 000.00 to ABC), then ABC is deemed to have disposed of the asset for R 5 000 000.00 (being the base cost thereof).  Because the asset is disposed of for an amount equal to the base cost, there is no gain or loss and therefore no Capital Gains Tax payable (at this stage, at least).  The transaction is also exempt from Transfer Duty, thereby “saving” the total amount of over R 2 700 000.00 while still achieving the goal of transferring the asset from the trust to the company.

ABC is deemed to have acquired the shares in XYZ for an amount of R 5 000 000.00 and XYZ is deemed to have acquired the asset for R 5 000 000.00.

Conclusion:

The above represents an overly simplified explanation of an asset-for-shares transaction, prepared only for the purposes of giving you, the reader, a brief introduction into the benefits and potential use thereof.  Each individual transaction is unique and will need to be dealt with on a case for case basis in order to ensure that the requirements are met and the relief available.  Should this article have piqued your interest and you wish to know more about entering into a transaction like this, please do not hesitate to contact us.

(The content hereof does not constitute legal advice but rather information of a general nature. Should you want more information on any of the issues discussed herein, please do not hesitate to contact our office.)