The Income Tax Act contains various provisions in terms of which transactions can occur between specified parties without adverse tax consequences being incurred in respect of those transactions. These provisions are contained in sections 41 to 47 of the Income Tax Act and are generally known as the “group relief provisions”.
Apart from certain value-shifting and general anti-avoidance provisions, the group relief mechanisms override all other sections of the Income Tax Act to the extent that there are any inconsistencies. These transactions are asset-for-share transactions, amalgamations, intra-group transactions, and liquidation distributions. It is critical to know in which circumstances which transactions apply.
In what follows, we highlight one of the particular types of transactions with reference to its purpose, working, and certain clawbacks which may apply in respect of this transaction.
SECTION 47 LIQUIDATION DISTRIBUTION
In terms of a liquidation distribution, a company can wind-down, liquidate, or deregister in a tax neutral manner.
Usually, a company will incur a tax cost on the assets transferred to shareholders as part of liquidation, as well as that distribution being subject to dividends tax at a rate of 20%. Section 47, however, allows that a tax neutral liquidation can occur where the shareholder (of the company that is being liquidated) is a South African resident company, and those companies form part of the same group of companies.
In other words, a holding company should hold at least 70% of the shares in the liquidating company for the relief in terms of section 47 to apply. It is important to note that the relief will only apply to the extent that the holding company cancels the shares held in the subsidiary company and that the holding company only assumes so-called “qualifying debts” of the subsidiary company being liquidated. In general terms, such qualifying debts would be debts incurred in the ordinary course of business (trading dates) or debts that are older than 18 months.
Where there are outside shareholders involved in a transaction (i.e. up to 30% shareholders who are not the direct holding company), ordinary tax consequences would be incurred in respect of this portion of the liquidation distribution. Importantly, once a transaction has been triggered, the liquidating company has 36 months in which to initiate the process of liquidation, deregistration or winding down (all of which have different requirements – a liquidation, for example, is in terms of a court process, which is not the same as for deregistration). Otherwise, any relief in terms of this provision would not apply, and adverse tax consequences can ensue because of this.
We recommend that if such a tax neutral liquidation is pursued, that professional assistance be obtained to navigate through the process.
This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your legal adviser for specific and detailed advice. Errors and omissions excepted (E&OE)