Key Insights from Binding Private Ruling 410

Understanding the Legislative Context

The ruling referenced several critical sections of the Income Tax Act No. 58 of 1962 ("IT Act"). Specifically, it discussed the implications of section 9H(3)(b) and 9H(5), along with paragraph 64B of the Eighth Schedule, all of which played crucial roles in determining the tax outcomes of the transaction in question.

Parties Involved

The ruling involved multiple parties:

• The Applicant: A company incorporated outside South Africa but classified as a tax resident in South Africa.
• Company A: A CFC as defined in section 9D(1) of the IT Act, associated with the Applicant.
• Company B: A foreign company involved in the transaction.

Details of the Proposed Transaction

The proposed transaction involved Company A's participation in shares of Company B, which were considered "equity shares" under section 1(1) of the IT Act. Notably, the value of any assets in Company B was not linked to assets directly or indirectly located, issued, or registered in South Africa. As a result, the shares held by Company A did not constitute an interest as contemplated in paragraph 2(2) of the Eighth Schedule. The Applicant’s group intended to dispose of its interest in Company B.

Steps of the Proposed Transaction

The steps of the proposed transaction were complex, but essentially structured as a merger governed by foreign law. Company A, along with third-party shareholders, planned to dispose of their shares in Company B to a third-party purchaser (“the Purchaser”) in exchange for a combination of cash and shares. The Purchaser owned 100% of the shares in Merger Sub 1 (“MS1”) and Merger Sub 2 (“MS2”). Structuring the transaction as a merger provided the buyer with certainty regarding the acquisition of all issued shares in the target company.

The steps outlined in the ruling can be summarised as follows:

Step 1 – Merger 1: MS1 merged with Company B.

• Company B became the surviving entity, with MS1 being automatically terminated, thus becoming a wholly-owned subsidiary of the Purchaser.
• Company B shares held by Company A and the third parties were cancelled by Company B following their conversion to the right to receive the per-share merger consideration (a combination of cash and shares to be issued by the Purchaser).

Step 2 – Merger 2: Company B merged with MS2.

Company B merged with MS2, with MS2 as the surviving company, leading to the automatic termination of Company B. 

Step 3 – Payment of Consideration

The Purchaser paid the per-share merger consideration to Company A and the third parties (in the form of cash and shares in the Purchaser).

As a result of these steps, Company B (and its subsidiaries) ceased to be regarded as CFCs in relation to the Applicant.

SARS Ruling

SARS ruled as follows:

• Company A was regarded as having disposed of its shares in Company B to the Purchaser for the purposes of paragraph 64B(1)(b) of the Eighth Schedule.
• Immediately after the proposed transaction, the shareholders of the Purchaser and any company in Company A’s group were not “substantially the same” for purposes of paragraph 64B(1)(b)(iii) of the Eighth Schedule.
• The participation exemption in paragraph 64B(1) applied to Company A’s disposal of its shares held in Company B to the Purchaser, resulting in any capital gain (or loss) arising from the disposal to the Purchaser being disregarded.
• Section 9H(5) of the IT Act had the effect of section 9H(3)(b). This means that the deemed disposal of all Company B’s assets was not applicable when Company B ceased to be a CFC.

 It is clear that the cessation of CFC provisions and their interaction with various sections of the IT Act remains a complex area, which prompted the taxpayer to seek a ruling from SARS.

 The favourable stance taken by SARS is a positive sign for taxpayers entering into similar types of transactions, as there were no adverse tax consequences from a South African perspective.

Authors:

Jessica Brown & Tertius Troost