Would it be fair to describe 2020 as the most interesting year this century? It will certainly be mentioned in history books and, for those of us with an interest in tax, the year had some attention-grabbing moments.
It started on 26 February, the day on which Minister of Finance, Mr Tito Mboweni, delivered his budget speech. One of the announcements made by the Minister, relating to a proposal to amend section 46 of the Income Tax Act (ITA), caused a significant stir. The Minister had stated that:
'The Income Tax Act makes provision for rollover relief where shares of a resident company (referred to as an unbundled company) that are held by another resident company (referred to as an unbundling company) are distributed to the shareholders of that unbundling company in accordance with the effective interest of those shareholders. However, these unbundling transactions are subject to an antiavoidance rule that excludes the shareholders and the unbundling company from benefitting from the rollover relief if 20 per cent or more of the shares in the unbundled company are held by non-residents - either alone or together with individuals connected to those non-residents - after the transaction. This rule aims to limit the extent to which taxpayers can distribute tax-free shares in resident companies to non-residents. The current rule creates a loophole. To close this loophole, it is proposed that the legislation be amended to make provision for the 20 per cent rule to apply irrespective of whether non-resident shareholders are connected to each other.' (our emphasis)
It was not clear from the Minister's announcement when the proposed amendment was intended to take effect. Thus, there was uncertainty and a fear that it could take effect from the date of the announcement (i.e. 26 February 2020). It was only on 31 July 2020 that the intended date became known.
Publication of the Draft Taxation Laws Amendment Bill: 31 July 2020
The National Treasury Department (NT) published a Draft Taxation Laws Amendment Bill (Draft TLAB) on 31 July 2020, for public comment. In the Draft Bill, NT proposed that the amendments to section 46 of the ITA (specifically section 46(7), which are explained below, apply with effect from 31 July 2020.
The proposed amendments read as follows:
'. this section does not apply if immediately after any distribution of shares in terms of an unbundling transaction 20 per cent or more of the shares in the unbundled company are held in aggregate by disqualified persons.' (emphasis added)
The Draft Explanatory Memorandum which accompanied the Draft TLAB stated that:
'.Government has noticed the increased use of the unbundling transaction provisions to erode the tax base in structures that use unbundling transactions to distribute shares of unbundled companies tax free to non-resident investors. In particular, the current anti-avoidance measure in unbundling transactions creates a loophole in that the 20 per cent exclusionary rule may not apply as intended to limit such transactions where non-residents shareholders are not connected persons in relation to each other. This implies that non-residents may collectively hold 20 per cent or more of the shares in the unbundled company, but to the extent that they are not connected, the anti-avoidance rule in unbundling transactions may not apply. The result is that in aggregate, the shareholding of disqualified persons immediately after an unbundling transaction may exceed the 20 per cent threshold that aims to curb the erosion of the South African tax base.'
The proposal appeared to be directed at non-residents. However, if one looks at the definition of a 'disqualified person' in section 46, one will note that it encompasses a far wider group of persons which includes not only non-residents, but also retirement funds, among others. This was alarming particularly because according to a report published by NT in 2017, non-residents owned 38% of JSE listed companies and retirement funds 24.5% (well in excess of the proposed 20% threshold).
The general tone of the comments from the public made in response to the Draft Bill was that the proposed amendment would curtail the ability of South African listed companies to unlock value for their shareholders, particularly if one had regard to the 'all or nothing' effect of the section (i.e. disqualifying the entire unbundling (and not just the distribution to disqualified persons) by a company from tax relief.
Subsequent engagements with NT and submissions to Parliament
The comments on the Draft Bill were discussed during the public hearings hosted by NT in September. During the engagements, it was clear that NT was intent on continuing with the amendment regardless of the outcry it had elicited.
However, as the engagement proceeded, it became evident that NT was open to considering a softer stance than that represented by the Draft Bill; it gave an indication that it was amenable to the concept of pro rating (as opposed to the 'all or nothing' rule) and the idea of introducing a de minimus rule into the section. The impact of the de minimus rules would be that small shareholdings by disqualified persons would not be taken into account in determining whether the 20% threshold has been reached. The pro rating would mean that the exclusion would have a partial effect instead of disqualifying an entire distribution.
However, NT was not open to the idea of moving the effective date of the proposed amendment from 31 July 2020 to a later date (1 January 2021, for instance, which we had proposed in our submissions).
Publication of the Taxation Laws Amendment Bill: 28 October 2020
On 28 October 2020 the Minister tabled the Taxation Laws Amendment Bill (TLAB) in Parliament. The TLAB contains a revised version of the amendments to section 46. The revised amendments give effect to the pro rating and the de minimus rule. These are given effect to as follows:
- The 20% aggregate threshold referred to in the pre-amended legislation has been done away with. Instead, the exclusion in section 46(7) will apply in respect of each shareholder that is a 'disqualified person' and which holds at least 5% of the unbundling company immediately after the unbundling transaction. It is worth noting in this regard that no process is prescribed for identifying 'disqualified persons' (e.g. no requirement for shareholders to provide declarations) and their level of shareholding. We foresee practical challenges/teething problems with this and clarification from SARS would be welcome in this regard.
- The exclusion will no longer have an 'all-or-nothing' effect, meaning that an unbundling company which has disqualified persons among its shareholders can still rely on section 46 tax relief to the extent of a distribution of shares to qualified shareholders.
The definition of 'disqualified persons' remains unchanged and continues to include not only to non-residents, but also retirement funds and other exempt entities.
In addition, the exclusion from tax relief potentially triggers capital gains tax and dividends tax payable by the distributing company (not the disqualified shareholder). The company must be able to fund the tax in respect of that portion of the distribution which is made to a disqualified person which holds at least 5% of the shares in the unbundling company. Unfortunately, this tax burden affects all the shareholders of the company, irrespective of their status as disqualified persons. If the tax cost is significant, shareholders will be reluctant to allow the unbundling to take place. It remains to be seen to what extent the amendments stifle the ability of listed companies to unlock value for their shareholders through unbundlings without substantially generating the much needed tax revenue for the fiscus. Only time will tell.
The effective date of the amendments has been moved from 31 July
28 October 2020. Sadly, the drastic amendment will take immediate effect and impact transactions that may already be underway.
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