ARTICLE
23 December 2011

Application Of Liquidation Rollover Provisions To A Transfer Of Business

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ENS

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ENS is an independent law firm with over 200 years of experience. The firm has over 600 practitioners in 14 offices on the continent, in Ghana, Mauritius, Namibia, Rwanda, South Africa, Tanzania and Uganda.
An interesting issue arises whether the provisions of section 47 of the Income Tax Act ("Act") may be used in circumstances where a company transfers a business including liabilities to its parent company.
South Africa Tax

An interesting issue arises whether the provisions of section 47 of the Income Tax Act ("Act") may be used in circumstances where a company transfers a business including liabilities to its parent company.

Section 47 of the Act forms part of the inter-group rollover provisions in terms of which assets may be transferred on a tax-free basis between companies which are related to each other.

In particular section 47 deals with transactions relating to liquidation, winding-up and de-registration. In essence the section is intended to cater for situations where a subsidiary is liquidated and its assets are therefore transferred to its holding company. In order for the provisions to apply, the holding company must form part of the same group of companies as the subsidiary. This generally requires at least a 70% shareholding in the subsidiary.

In terms of section 47, capital assets disposed of by the liquidating company in terms of a liquidation distribution to its parent are deemed to be disposed of at their base cost. The holding company is then deemed to acquire these assets at the same base cost. The capital gains tax consequences are therefore "rolled over" from the liquidating company to the holding company.

Similarly, trading stock transferred by way of a liquidation distribution from the liquidating company to its parent is deemed to be disposed of at its original cost by the liquidating company. The holding company is then deemed to acquire these assets at the same cost.

The question arises whether the provisions of section 47 of the Act may be used in circumstances where the liquidating company transfers its business including liabilities to its parent company. For example if the subsidiary has various trade debts which are owed by it to third parties or a shareholder loan owed to its parent, may it then transfer these liabilities in terms of section 47 of the Act? There is a school of thought that thinks this is possible. We analyse this proposition below.

The provisions of section 47(1) define the term "liquidation distribution" as meaning a transaction in terms of which a company distributes all its assets to its shareholders in anticipation of or in the course of the liquidation, winding up or de-registration of that company. This does not include assets which the liquidating company uses to settle any debts incurred by the liquidating company. However, all other assets must be distributed in order for the provision to apply.

Section 47 therefore only applies to assets which are distributed by a company to its shareholder. The concept of distribution is defined in the Eighth Schedule to the Act as meaning any amount transferred or applied by a company for the benefit of any shareholder in relation to that company by virtue of any share held by that shareholder in that company. This definition will be deleted with effect from 1 April 2012.

In addition, the definition of "dividend" in section 1 of the Act will be amended in terms of the Taxation Laws Amendment Bill to refer to any amount transferred or applied by a company for the benefit or on behalf of any person in respect of any share in that company whether the amount is transferred or applied by way of a distribution or as buy-back consideration in relation to those shares.

Therefore the concept of a distribution seems to require a transfer by a company of an amount (ie cash or an asset) in relation to shares issued by that company. It does not apply to or refer to liabilities of that company. In particular it may not be possible to distribute the "net assets" of a company. In the example set out above if the subsidiary purports to distribute its business to its parent company in anticipation of or during the course of its liquidation, the liabilities may not constitute "assets" distributed to its shareholder. The liabilities may therefore fall outside the provisions of section 47 of the Act since section 47 only deals with "assets" of the liquidating company. The consequence is, therefore, that the liabilities of the company are simply not dealt with in section 47 and does not fall within its ambit. If so, then the transfer of the liabilities of a company must be separately analysed in order to determine the tax effect thereof.

In particular, in the example set out above, if the liability constituting the shareholder loan owed by the subsidiary to its parent company does not fall within the ambit of section 47 of the Act it must be analysed whether any consideration was payable on the delegation of that liability to the parent company. If not, that is, if in terms of the new merger provisions of the Companies Act, the business of the subsidiary was simply merged with the business of the holding company and no consideration was payable for the shareholder loan then various adverse tax consequences may arise therefrom. In particular, the subsidiary may make an adjusted gain on transfer of that liability in terms of the provisions of section 24J of the Act. In addition, this delegation could have adverse donations tax and/or secondary tax consequences on companies.

It is, therefore, advisable to ensure that if the liquidation provisions contained in section 47 of the Act are applied in circumstances where the subsidiary has liabilities, such liabilities should be transferred at value to the holding company and their tax consequences should be separately analysed from the distribution by the subsidiary of its assets to its parent company. This is on the basis that only the assets distributed by a company fall within the provisions of section 47 of the Act and qualify for the rollover relief specified therein.

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.

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