South African residents are taxed on their worldwide income. Accordingly, a capital gain arising from the sale of shares in a foreign company will be subject to South African tax unless an exemption applies or a double tax agreement provides otherwise.
In particular, paragraph 64B of the Eighth Schedule to the Income Tax Act, 58 of 1962 ("the Act") provides, inter alia, that any capital gain or loss determined in respect of the disposal of any equity share in any foreign company (except certain shares where the value of the foreign company is largely derived from South African immovable property or immovable property rights and equity shares in certain foreign collective investment schemes) should be disregarded, provided certain requirements are met. This exemption is often referred to as the "participation exemption".
It should be noted that the participation exemption only applies to capital gains. If the proceeds from the disposal of shares in a foreign company are revenue in nature, the gain will be subject to income tax.
In terms of recent amendments to the Act in terms of the Taxation Laws Amendment Act, 22 of 2012 ("TLAA"), the participation exemption in paragraph 64B(1) now applies under the following circumstances:
- the seller (whether alone or together with any other person forming part of the same group of companies as that person) immediately before that disposal held at least 10% of the equity share capital and voting rights of the foreign company;
- such interest had been held for at least 18 months prior to that disposal, unless the seller is a company and that interest was acquired by the seller from any other company which forms part of the same group of companies and the seller and that other company in aggregate held that interest for more than 18 months; and
- that interest is disposed of to any person that is not a resident, other than a controlled foreign company ("CFC"), for an amount that is equal to or exceeds the market value of the interest.
Prior to the amendments in terms of the TLAA, the participation exemption applied, inter alia, to the disposal of equity shares in a foreign company to a CFC in relation to the seller or to a CFC that formed part of the same group of companies as the seller. Although the gain would have been disregarded in the seller's hands, the acquiring entity's "base cost" in respect of the shares would have been equal to the "proceeds" (usually the purchase consideration).The amendment to the participation exemption to exclude disposals to a CFC came into operation on 1 January 2013 and applies in respect of disposals on or after that date.
Although the sale of shares in a foreign company to a CFC no longer qualifies for the participation exemption, in the case of a disposal within a group, the "corporate rules" contained in sections 42 to 47 of the Act may provide roll-over relief.
In particular, in terms of section 42(1)(b), an "asset-for-share transaction" means any transaction in terms of which a company disposes of an equity share in a foreign company, held by that company as a capital asset, to another foreign company in exchange for the issue of an equity share in that other foreign company (provided further requirements are met). Similarly, the TLAA extended the scope of an "intra-group transaction" envisaged in section 45 to include any transaction in terms of which an equity share in a foreign company, held by a company as a capital asset, is disposed of by that company to another company ("transferee company") in exchange for the issue of debt or shares (other than equity shares) by that transferee company (provided further requirements are met). In both instances it is envisaged that the acquiring entity can/must be a CFC and that the seller and the acquiring entity must form part of the same "group of companies" as defined in section 1 of the Act, that is, including non-resident entities.
Generally, where the corporate rules apply, the transferor is deemed to have disposed of the asset in question for proceeds equal to its base cost (resulting in no capital gain) whilst the transferee is deemed to acquire the asset for expenditure equal to the transferor's base cost.
Accordingly, although the participation exemption will no longer apply to a disposal of shares to a CFC, in certain instances the roll-over provisions of sections 42 or 45 may apply, thereby resulting in no capital gain in the seller's hands. However, importantly, unlike instances where the participation exemption applies, the acquiring entity will not have a step up in its base cost in respect of the shares in the foreign company.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.