Buy­ing Peter to off­set Paul a tricky mat­ter

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW -

THE le­gal po­si­tion of a com­pany with an as­sessed loss ac­quir­ing a prof­itable busi­ness whereby the prof­its will be used to re­duce the as­sessed loss is im­por­tant to un­der­stand. Sec­tion 103(2) of the In­come Tax Act No 58 of 1962 deals with trans­ac­tions en­tered into for the sole or main pur­pose of avoid­ing or post­pon­ing li­a­bil­ity for, or re­duc­ing, amounts of tax on in­come.

In par­tic­u­lar, sec­tion 103(2) is an anti-tax avoid­ance pro­vi­sion al­low­ing the Com­mis­sioner of the South African Rev­enue Ser­vice to disal­low the set­ting off of an as­sessed loss or bal­ance of an as­sessed loss against the com­pany’s in­come if cer­tain re­quire­ments are met.

In cir­cum­stances where a com­pany with an as­sessed loss ac­quires a prof­itable busi­ness, two main re­quire­ments must be met in or­der for sec­tion 103(2) to ap­ply. In par­tic­u­lar, that:

An agree­ment has been en­tered into which di­rectly or in­di­rectly gave rise to in­come be­ing re­ceived by such com­pany; and

That such agree­ment has been ef­fected solely or mainly for the pur­pose of util­is­ing any as­sessed loss in­curred by the com­pany in or­der to avoid any tax li­a­bil­ity, or to re­duce any tax li­a­bil­ity.

In terms of the first point, there is no lim­i­ta­tion on the mean­ing of an “in­di­rect re­sult”, and the chain of cau­sa­tion may there­fore be long and in­volved, so long as it is not bro­ken. In the case of New Ur­ban Prop­er­ties Ltd v SIR 1966 (1) SA 215 (A), it was held that it will al­ways be a ques­tion of fact whether a com­pany has de­rived in­come “di­rectly or in­di­rectly” as a re­sult of the change of share­hold­ing.

In terms of the sec­ond point above, sec­tion 103(2) can only ap­ply if the agree­ment was en­tered into with the sole or main pur­pose of util­is­ing an as­sessed loss.

The word “pur­pose” is not de­fined in the In­come Tax Act, but is gen­er­ally un­der­stood to be “some­thing set up as an ob­ject or end to be ob­tained”, “the rea­son for which some­thing ex­ists or is done, made, used, etc”.

In ITC 1347 (1981) 44 SATC 33, a tax­payer ac­quired a com­pany with an as­sessed loss. Two of the fac­tors con­sid­ered by the court were that, although it was as­sumed that the com­pany had an as­sessed loss, no spe­cific en­quiries were made by the tax­payer to de­ter­mine the ex­tent of such loss and noth­ing was paid for the ac­qui­si­tion of the as­sessed loss.

In ITC 983 (1961) 25 SATC 55, the court found that, where a cloth­ing man­u­fac­tur­ing com­pany had ac­quired a sub­sidiary with a bal­ance of as­sessed loss and had then in­tro­duced in­come into that sub­sidiary, the sole or main pur­pose of the ac­qui­si­tion was not the ac­qui­si­tion of the as­sessed loss but rather to en­able the com­pany to ob­tain a pro­duc­tive man­u­fac­tur­ing unit that could go into im­me­di­ate op­er­a­tion to sup­ple­ment its own pro­duc­tive ca­pac­ity. Sec­tion 103(2) was there­fore not ap­pli­ca­ble.

In ITC 989 (1961) 25 SATC 122 the tax­payer com­pany had car­ried on busi­ness for a con­sid­er­able pe­riod as a tim­ber mer­chant and had in­curred trad­ing losses which re­sulted in an as­sessed loss. All the shares in the tax­payer com­pany were then of­fered to and ac­quired by another com­pany (ie the hold­ing com­pany) in the tim­ber busi­ness. This hold­ing com­pany pro­duced items made from wood such as doors which were mar­keted through a sub­sidiary com­pany. Prior to the ac­qui­si­tion of the share­hold­ing of tax­payer com­pany the hold­ing com­pany also utilised this sub­sidiary com­pany to sell tim­ber to builders and tried to utilise it to sell tim­ber to mer­chants also but ex­pe­ri­enced dif­fi­cul­ties in do­ing so be­cause the prac­tice of selling di­rect to builders led to the un­der­cut­ting of mer­chants, who con­se­quently re­fused to buy from the sub­sidiary.

Af­ter the ac­qui­si­tion, the hold­ing com­pany re­vised its selling ar­range­ments and ef­fected its sales to builders through the tax­payer com­pany. The tim­ber was sold to it at the nor­mal prices charged to mer­chants and was in turn resold by it to builders at re­tail prices.

In de­ter­min­ing the li­a­bil­ity for tax of the tax­payer com­pany for the first year af­ter the sale of its shares, the Com­mis­sioner ap­plied s 90(1)(b) of the Act 31 of 1941 (the equiv­a­lent of s 103(2)) and dis­al­lowed the setoff of the bal­ance of its as­sessed loss against its in­come.

The court held that, on the facts, the tax­payer com­pany had shown that nei­ther its sole nor its main pur­pose was the avoid­ance of li­a­bil­ity for tax. While there was some ad­van­tage de­rived by the hold­ing com­pany in pur­chas­ing the shares of the tax­payer com­pany and thus ac­quir­ing the ben­e­fit of its as­sessed loss, the hold­ing com­pany was able to show that ma­te­rial ben­e­fits ac­crued to it, for ex­am­ple, ben­e­fits flow­ing from the sep­a­ra­tion of the whole­sale and re­tail trades.

Ac­cord­ingly there ap­peared to be good rea­son to be­lieve that the pur­chase of the shares would in fact have been a prof­itable and ad­van­ta­geous pur­chase even if there had been no as­sessed loss. Sec­tion 103(2) was there­fore not ap­pli­ca­ble.

In light of the cases set out above, it is there­fore a sub­jec­tive and fac­tual en­quiry as to whether the ac­qui­si­tion of a prof­itable busi­ness by a com­pany with an as­sessed loss is en­tered into solely or mainly for the pur­pose of util­is­ing the as­sessed loss.

In terms of sec­tion 103(4) of the In­come Tax Act, the tax­payer bears the onus of prov­ing or show­ing that the trans­ac­tions were not en­tered into with the sole or main pur­pose of util­is­ing an as­sessed loss.

The rea­sons for a com­pany with an as­sessed loss in ac­quir­ing a prof­itable busi­ness should there­fore be doc­u­mented. It should be en­sured that there are suf­fi­cient busi­ness re­lated rea­sons for en­ter­ing into the trans­ac­tion, ie that these busi­ness rea­sons con­sti­tute the main rea­son for the trans­ac­tion.

As a fac­tual mat­ter, it should be en­sured that a com­pany with an as­sessed loss would ac­quire the prof­itable busi­ness even if it did not have such as­sessed loss.

Prof­itable busi­ness ac­quired in or­der to off­set as­sessed loss at the buyer has tax im­pli­ca­tions

Peter Dachs and Bernard du Plessis are di­rec­tors and joint heads of ENSafrica’s tax depart­ment.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.