Tax issue in new regime for mergers
SA tax legislation is not fully aligned with the Companies Act
THE Companies Act, 2008 introduced a new regime to South African corporate law whereby two or more companies can merge their respective assets and liabilities into one or more combined companies (we refer to this as a “statutory merger”).
The Companies Act defines an “amalgamation or merger” to include any transaction where:
Each of the merging companies is dissolved and the assets and liabilities of these merging companies are transferred to a newly formed company or companies; and
No new company is formed but at least one of the merging companies survives and the assets and liabilities of the non-surviving merging companies, which are subsequently dissolved, are transferred to the surviving company or companies.
The reform was aimed at providing a simple and uncomplicated framework within which companies can merge. However, our tax legislation is not fully aligned with the Companies Act. Some key issues are:
Application of rollover relief provisions A general misconception exists that a statutory merger necessarily qualifies for the corporate rollover relief offered to an “amalgamation transaction” in terms of section 44 of the Income Tax Act, 1962. The tax rollover provisions contained in sections 42, 44, 45, 46 and 47 of the Income Tax Act only apply to transactions meeting their specific requirements. In many instances these requirements differ from the statutory merger provisions.
For example, section 44 limits tax relief to certain types of transactions involving specific share issues and debt assumptions, whereas the statutory merger provisions envisage the transfer of all assets and liabilities to the acquiring company.
Although there is currently no automatic rollover of the tax position of the merging companies, certain changes have been introduced by the Taxation Laws Amendment Act of 2011 that improve the alignment of the tax and corporate regimes; however, risk areas remain.
Should an “amalgamation or merger” wholly or partly fall outside the ambit of the rollover relief provisions, the transaction may trigger unexpected income tax, capital gains tax, valueadded tax, transfer duty and/or securities transfer tax in the hands of any parties involved.
Transfer of tax liabilities An effect of the statutory merger rules is to transfer certain tax obligations to the merged entity. The commercial exposure may be intensified by the imminent Tax Administration Bill. Certain provisions of this bill will increase tax exposures and liabilities, not only for the merged entity but also for shareholders and financial management personally.
Underlying cause of the transaction A crucial issue is to determine the underlying cause of the fusion of assets and liabilities of parties entering into an “amalgamation or merger” transaction. Arguably, assets and liabilities of the target company transfer to the acquiring company by virtue of the underlying contract between the parties. Should this be the case, the traditional contractual mechanisms used (for example, the transfer of business agree-
The reform was aimed at providing a simple and uncomplicated framework within which companies can merge
ment) would govern the transaction.
The tax implications of the transaction would be dictated by the type of agreement used and should be in line with the usual tax implications arising from such agreements, possibly also by the tax rollover rules, if applicable.
Alternatively, it could be argued that the statutory merger provisions created a new method of transferring assets and liabilities between merging entities, namely the mere operation of law.
There are good legal arguments in favour of this interpretation and should they be correct the statutory merger provisions could have far-reaching tax implications. Firstly, it extends the ambit of the merger rules to contractual mechanisms not traditionally used to effect mergers (for example, an agreement for the sale of a business as a going concern, followed by the winding up of the seller).
These alternative mechanisms may become useful in effecting an amalgamation or merger. Secondly, assets will not be transferred in return for anything (such as cash, shares or the assumption of debt) and the transaction would arguably take place for no consideration.
Various anti-avoidance provisions in the Income Tax Act that are aimed at non-arm’s length transactions between connected persons may be triggered. Typically, these provisions deem a transaction to have taken place at market value. The acquisition of fixed or trading assets without a cost can also be problematic if the tax rollover rules do not apply to the specific case.
Going forward Minister Pravin Gordhan acknowledged in his 2012 Budget Review that the rewrite of the Companies Act gave rise to anomalies in relation to tax and announced that the nature of company mergers, acquisitions and other restructurings will be reviewed over a two-year period. In the meanwhile, companies intending merger transactions should pay special attention to the tax implications of their proposed transactions and not assume that the statutory merger regime has made it unnecessary to consider the tax effects of these transactions.
Further to this article, a more detailed technical analysis of the various tax consequences can be found on our website, www.ens.co.za/news.