february 2015 issue 185 contents …saica.ensighthq.com/content/integritas-integritax...1 february...
TRANSCRIPT
1
FEBRUARY 2015 – ISSUE 185
CONTENTS
COMPANIES
2385. Asset for share transactions
The Income Tax Act No. 58 of 1962 (the Act) contains a number of provisions
in terms of which assets may be transferred from one taxpayer to another on a
tax-free basis, with the tax in relation to such an asset being deferred until the
transferee eventually disposes of the asset. One such provision is contained in
section 42, dealing with “asset-for-share transactions”.
COMPANIES
2385. Asset for share transactions
2386. Venture capital companies: the
investors
MINING
2389. Provision for mining
rehabilitation
DEDUCTIONS
2387. Improvements on Government
land
TRUSTS
2390. Pitfalls in dealing with trusts
GENERAL
2388. Conducting farming operations
SARS NEWS
2391. Interpretation notes, media
releases and other documents
2
An asset-for-share transaction is essentially a transaction in terms of which a
person (the Transferor) disposes of an asset to a company (the Company) in
exchange for the issue of shares by the Company, provided the Transferor holds
a qualifying interest in the Company at the end of the day of the transaction
(broadly speaking, 10% of the equity shares and voting rights in an unlisted
company, or any equity shares in a listed company). In addition, certain
qualifying debt may be assumed by the Company as part of the asset-for-share
transaction, without prejudicing the application of section 42.
Broadly speaking, in relation to capital assets, an asset-for-share transaction
results in no capital gain for the Transferor with the Company acquiring the
asset at the same base cost at which the Transferor held it. The base cost of the
asset accordingly “rolls over” to the Company and the deferred capital gain on
the asset is accordingly only triggered when the Company disposes of the asset,
unless any relief finds application at such time. In addition, the Transferor
acquires the shares in the Company at a base cost equal to the base cost at which
it held the asset disposed of to the Company.
Section 42(8) provides that a proportionate part of any qualifying debt that was
assumed by the Company as part of an asset-for-share transaction will constitute
an amount received by or accrued to the Transferor in respect of the disposal of
any of the shares in the Company acquired in terms of the asset-for-share
transaction, should such shares be disposed of by the Transferor. Essentially,
section 42(8) provides that the Transferor will have additional proceeds upon
the disposal of the shares equal to a proportional amount of the debt that was
assumed by the Company.
The reason for this provision appears to be to counteract the base cost allocated
to the shares in terms of section 42 where the assets disposed of are geared. For
example: Person A borrowed R100 from a bank and utilised the funding to
3
acquire an asset. The asset accordingly has a base cost of R100 in the hands of
Person A. Assume the asset grows in value to R150. Person A then disposes of
the asset to Company B in exchange for the assumption of the R100 debt and
the issue of shares in Company B. Simplistically speaking, the value of the
shares acquired by Person A in Company B will be R50 (being the net asset
value). However, in terms of section 42, the base cost at which Person A will
acquire the shares in Company B, will be deemed to be equal to the base cost at
which Person A held the asset, i.e. R100. But for the application of section
42(8), if Person A were to dispose of the shares in Company B at their market
value (R50), Person A will trigger a capital loss of R50 (R50 proceeds less
R100 base cost). However, in terms of section 42(8), Person A will be deemed
to have additional proceeds equal to the debt that was assumed by Company B
in terms of the asset-for-share transaction, in this case R100. This will result in
Person A triggering a capital gain of R50 upon a disposal of the shares (R50
real proceeds plus R100 deemed proceeds, less R100 base cost) which mimics
the commercial gain of Person A.
Generally, the application of section 42(8) does not place the Transferor in a
worse position than would have been the case had it retained the asset and was
taxed on the growth in value in the asset. However, the application of section
42(8) could have detrimental consequences in certain instances:
Firstly, most of the roll-over relief provisions in the Act do not contain
explicit roll-over relief in relation to the deemed additional proceeds
triggered in terms of section 42(8). Accordingly, should shares acquired
in terms of an asset-for-share transaction be disposed of in terms of
another transaction qualifying for corporate roll-over relief, such relief
may not cater for a gain which may arise as a result of the application of
section 42(8). Furthermore, the roll-over relief provisions may result in a
rolled-over base cost for the transferee, despite a capital gain being
4
triggered in the hands of the Transferor as a result of the application of
section 42(8);
Secondly, section 42(8) may give rise to detrimental consequences where
the debt that was assumed in terms of the asset-for-share transaction was
not applied in order to fund fixed assets (but, for example, to fund
working capital in the case of a sale of a business in terms of an asset-for-
share transaction). In such an instance, the base cost of the shares will not
equate to the debt that was assumed in terms of the asset-for-share
transaction, which may result in additional tax in the event of the disposal
of the shares.
Lastly, it is important to remember that there is no time limitation to the
application of section 42(8). In terms of current law, it will continue to find
application to a disposal of shares acquired in terms of an asset-for-share
transaction, irrespective of the time period that elapses between the asset-for-
share transaction and the future disposal of the shares. This is a further aspect
which should be borne in mind, inter alia, in determining whether an asset-for-
share transaction is an appropriate arrangement in terms of which to implement
a disposal.
ENSafrica
ITA: Section 42
2386. Venture capital companies: the investors
(Refer to article 2347 in the October 2014 – Issue 181)
Introduction
This is the second in a series of articles on venture capital companies. This
article looks at the conditions relating to the investors. In particular, it looks at
the way the investors are permitted to hold their investments in the venture
5
capital company (VCC) in order to qualify for the tax concessions available to
them and with transactions within the VCC.
Venture capital companies – the investment process
The tax treatment of the investors
Who are the investors?
Investors in VCCs may be individuals or corporate entities. Under certain
circumstances, individuals who subscribe for shares in VCCs may consider that
investment as part of their retirement planning, particularly in the light of
6
forthcoming retirement funding restrictions. Individuals may choose to invest
directly in VCCs or through intermediate passive investment holding companies
which will benefit from the dividends tax exemption and in certain cases lower
rates of corporate income tax at 28% compared to individuals where the highest
rate of personal income tax is 40%. However, companies suffer higher rates of
capital gains tax compared to individuals: 18.6% compared to 13.3%
respectively.
Operating companies which invest in VCCs should consider, apart from the tax
benefits, whether such investment qualifies for enterprise and social
development points in terms of the broad based black economic empowerment
codes.
Upfront income tax relief
VCC investors enjoy an immediate tax deduction equal to 100% of the amount
invested with no annual limit or lifetime limit (section 12J of the Income Tax
Act No. 58 of 1962 (the Act)). The tax relief is available provided that the VCC
investor subscribes for equity shares (as defined in section 1(1) of the Act), as
opposed to buying them second hand from other VCC investors.
The VCC scheme only applies to VCC shares acquired on or before
30 June 2021. The VCC investors must support their claim for a tax deduction
with a certificate issued by the VCC stating the amounts invested in the VCC
and that the Commissioner approved that VCC.
The table below compares the effect of the upfront income tax relief on an
individual, trust or company VCC investor. It assumes that the investor
subscribes for shares in the VCC in an amount of R100,000. Although
individuals are taxed at progressive rates of income tax it is assumed for the
purpose of this example that the individual is in the 40% income tax bracket.
7
Table 1. The effect of the upfront income tax relief
Individual /
Trust investor
Company
investor
Cost of the VCC investment
Subscription in VCC shares R100,000 R100,000
Income tax rate 40% 28%
(Less) tax relief (R40,000) (R28,000)
Net cost of the investment R60,000 R72,000
Initial value of the VCC
investment
Gross subscription by the investor R100,000 R100,000
Issue costs (say 5%) R5,000 R5,000
Initial net asset value R95,000 R95,000
Initial uplift: (Rand) R35,000 R23,000
Initial uplift ( As a percentage of
net cost)
58% 32%
Taxable recoupment
The Act specifically makes taxable any recoupment or recovery of an amount
which was allowed to be deducted under the provisions of section 12J.
According to the Taxation Laws Amendment Bill there will be no claw back of
the upfront income tax relief if the VCC shares are held by the VCC investor for
5 years.
VCC shares are not listed
Unlike shares in real estate investment trusts there is no statutory requirement
for VCC shares to be listed. Thus, VCC shares tend to be highly illiquid.
No capital gains tax (CGT) relief
8
The investor does not enjoy any VCC-specific CGT exemption on the disposal
of the VCC shares. Accordingly, CGT is payable upon the sale of the VCC
shares. For individuals the maximum rate of CGT is 13.3%; for companies,
18.6%, and for trusts, 26.6%. Where a VCC investor claims the section 12J tax
deduction on the subscription price for the VCC shares then the base cost of the
VCC shares will be reduced to zero. As a result the investor will not have any
base cost in the VCC shares to shield the subsequent proceeds from CGT. To
make the investment in a VCC more attractive, an exemption from CGT on the
disposal of the VCC shares would be welcomed.
Dividends tax
Investors will seek to make a return on their VCC investments either through
dividends arising from dividends paid by the underlying companies to the VCC
or dividends arising from the VCC disposing of the shares in the underlying
companies.
Dividends received by the VCC investors in respect of their VCC shares are
subject to the 15% dividends tax unless the investor qualifies for an existing
dividends tax exemption. SA resident company VCC investors will enjoy the
company-to-company dividends tax exemption. However, individual VCC
investors remain subject to the 15% dividends tax.
No CGT reinvestment relief
It is not possible for an investor to defer the gain on another investment by
applying the sale proceeds to subscribe for VCC shares. Thus, investors that sell
their, say, Sasol or MTN shares in order to reinvest the proceeds in VCC shares
will be subject to CGT on the sale of the Sasol or MTN shares. The after-tax
proceeds from the sale of those shares may then be invested in VCC shares.
No capital loss relief against income
9
Losses of a revenue nature can usually be set off against both income and
capital gains, while capital losses may only be set off against capital gains. An
investor in VCC shares that derives a capital loss (although very unlikely) will
not be able to set off that capital loss against its income gains.
The investment in the VCC must take the form of equity shares
Equity shares are defined more restrictively than shares
The section 12J deduction is limited to a subset of shares defined as ‘equity
shares’. The terms ‘shares’ and ‘equity shares’ are used frequently throughout
the Act. The ‘equity share’ incorporates the ‘share’ definition (equity share
means any share) with an important exclusion. Equity shares exclude so-called
fixed rate shares. Thus, where a share entitles an investor to a fixed rate
dividend it is excluded from the definition of equity share.
Debt instruments ineligible
Since the tax relief is limited to ‘equity shares’, it follows that VCC investors
will not qualify for the section 12J tax deduction if they subscribe for debt
instruments in the VCC.
Hybrid equity instruments and third party backed shares ineligible
The VCC scheme also excludes hybrid equity instruments and third-party
backed shares as these types of instruments have features in common with debt
instruments and are therefore considered safer forms of investment.
Can a VCC investor borrow to fund its investment?
Although there is no prohibition on VCC investors borrowing funds to acquire
VCC shares, the calculation of the section 12J deductible amount is subject to a
number of requirements and limiting factors. There are two basic requirements:
The first requirement: has the taxpayer used any loan or credit for the
payment or financing of the whole or any portion of the VCC shares?
10
The second requirement: does the taxpayer owe any portion of the loan or
credit at the end of the tax year?
If the answers to both requirements are ‘yes’, then the taxpayer has cleared the
first hurdle.
The second hurdle is a limiting factor. The amount which may be taken into
account as expenditure that qualifies for a deduction must be limited to the
amount for which the taxpayer is deemed to be ‘at risk’ on the last day of the
relevant tax year.
A taxpayer is deemed to be at risk to the extent that the incurral of the
expenditure to acquire the VCC shares (or the repayment of the loan or credit
used by the taxpayer for the payment or the financing of the expenditure to
acquire the VCC shares), may result in an economic loss to the taxpayer were
no income to be received by or accrue to the taxpayer in future years from the
disposal of any VCC shares.
A taxpayer is not deemed to be at risk to the extent that the loan or credit is not
repayable within a period of 5 years from the date on which the loan or credit
was advanced to the taxpayer.
A taxpayer is also not deemed to be at risk to the extent that the loan or credit is
granted directly or indirectly to the taxpayer by the VCC itself.
The exit mechanisms
Unlike a real estate investment trust (regulated by section 25BB of the Act), the
VCC shares do not have to be listed. This means that there is no ready market
for the secondary trade in these VCC shares. It also means that existing
investors cannot exit their investments by placing them for sale on the JSE.
11
The absence of a secondary market for the trade in VCC shares makes it
difficult to understand how the proposal in the 2014 National Budget Review
(proposing transferability of tax benefits when investors dispose of their
holdings) would be practically implemented. In reality, VCC shares will be
illiquid. The VCC will have to offer the investors an exit route. Existing
investors will in all likelihood realise value for their investments through:
trade sale of investments by the VCC followed by a distribution of cash
to the investors;
a repurchase of the investors’ VCC shares by the VCC; or
a consolidation and listing of underlying investments and distribution of
shares as dividends in specie to the investors.
Trade sale of investments by the VCC followed by a distribution of cash to
the investors
In a trade sale, the VCC sells all of its shares in an investee company to a trade
buyer, i.e. a third party often operating in the same industry as the company
itself. This method provides a complete and immediate exit from the
investment.
The VCC will be subject to capital gains tax at the rate of 18.6% on the sale of
the shares in the investee companies to the trade buyers. The VCC may
distribute the after-CGT cash proceeds it derives from the trade sale to the VCC
investors. These distributions may constitute a dividend or a return of capital or
a combination of the two. Dividends distributed by the VCC to the VCC
investors generally attract dividends tax at the rate of 15%. Certain VCC
investors such as resident companies are exempt from dividends tax.
Return of capital payments fall under a different system of tax compared to tax
on dividends. Return of capital payments are treated as proceeds subject to
12
capital gains tax. The main distinction between a dividends versus a return of
capital distribution is based on whether the distribution comes from Contributed
Tax Capital (CTC). Distributions from CTC qualify as a return of capital while
distributions from other sources qualify as dividends.
Repurchase of the investors’ VCC shares by the VCC
The investors will be subject to either dividends tax or capital gains tax or a
combination of the two on the repurchase of their VCC shares. SA resident
corporate investors will enjoy the dividends tax exemption. Thus, only
individual investors will be subject to the dividends tax. One method for
individual investors to defer the dividends tax is to hold their VCC shares
through a passive investment holding company. The dividends paid by the VCC
to the passive investment holding company will be exempt from dividends tax.
However, the eventual distribution of cash flow from the passive investment
holding company to the individual investor will be subject to dividends tax.
This structure allows the individual investor to defer - not avoid - dividends tax.
On the negative side the passive investment holding company is subject to
18.6% capital gains tax whereas the individual investor is subject to 13.3%
capital gains tax.
There is no capital gains tax exemption at the investor level on the disposal of
VCC shares. The VCC investor – whether an individual or juristic entity – will
be subject to capital gains tax on the repurchase of their shares by the VCC.
There is nothing in the present set of rules that prevents a VCC investor selling
its shares back to the VCC and using the proceeds to subscribe for another
shareholding in the VCC. Although there are no rules that prevent the
aforementioned repurchase-followed-by re-subscription scenario there are two
rules that lessen the tax benefit for the VCC investors.
13
The first is that the VCC legislation contains a rule that an investor that
becomes a ‘connected person’ in relation to the VCC after the subscription for
the VCC shares is not allowed the upfront income tax deduction. However, a
corporate investor only becomes a connected person in relation to the VCC if,
inter alia, it forms part of the same group of companies as the VCC or if it holds
at least 20% of the equity shares or voting rights in the VCC and no other
shareholder holds the majority voting rights in the VCC. If a corporate investor
keeps its shareholding below these limits and avoids the connected person
classification, then it may be able to benefit from this arrangement.
The second is that there is presently no capital gains tax exemption for the VCC
investor when it disposes of the VCC shares. The VCC investor will have to
reduce the base cost of the VCC shares by the amount claimed as an income tax
deduction in terms of section 12J. Thus, a VCC investor which subscribes for
VCC shares for R100 000 and claims that amount as a section 12J tax deduction
has a base cost of zero.
Consolidation and listing of underlying investments and distribution of
shares as dividends in specie to the investors
A distribution by the VCC that results in the disposal of shares in the investee
companies generates a capital gain or loss for the VCC at market value as if the
shares distributed to the VCC investors were sold to the VCC investors at
market value. This rule exists as a matter of tax parity within the corporate tax
system – a straight asset distribution should have the same tax impact as the
VCC selling the shares in the investee companies followed by a distribution of
after-tax cash proceeds. The tax considerations should accordingly be similar to
the tax consequences of the trade sale of investments by the VCC followed by a
distribution of cash to the investors which is discussed above.
ENSafrica
14
ITA: Sections 1(1) “definition of equity shares”, 12J and 25BB
Taxation Laws Amendment Bill 2014 (The Bill was promulgated as an Act
on Tuesday, 20 January 2015)
DEDUCTIONS
2387. Improvements on Government land
(Editorial note: Published SARS rulings are necessarily redacted summaries of
the facts and circumstances. Consequently, they (and articles discussing them)
should be treated with care and not simply relied on as they appear.)
On 1 October 2014, the South African Revenue Service (SARS) released
Binding Private Ruling 180 (BPR 180) dealing with the question of whether a
taxpayer, who is a party to a Public Private Partnership (PPP), would qualify for
a deduction under section 12N of the Income Tax Act No. 58 of 1962 (the Act)
in respect of improvements effected on land not owned by the taxpayer.
In respect of PPP’s, Government often undertakes to provide underlying land to
a private party for the construction of buildings or the improvement of the land,
without parting with ownership of such land.
Section 12N allows for private parties to a PPP to claim deductions in respect of
improvements effected on land or buildings owned by Government, even
though the private party only has a right of use or occupation of the land.
To qualify under section 12N, a private party must:
hold a right of use or occupation of the land or buildings;
effect improvements on the land or buildings in terms of a PPP;
15
incur expenditure to effect the improvements; and
use or occupy the land or buildings for the production of income, or
derive income from the land or buildings.
By way of background, a company incorporated in and a resident of South
Africa (applicant) and a department of the National Government (department)
entered into a PPP in terms of which it was agreed that under the proposed
transaction, the applicant would:
finance, design, construct, operate and maintain a new serviced head
office building for the Department that is to be constructed on land owned
by the Government; and
assume the financial, technical and operational risk for the project.
The applicant would be able to use subcontractors to carry out its obligations for
both the construction and the operational phases of the PPP. The PPP provided
for a unitary payment to be made by the department to the applicant of the
capital amount owed to the applicant, together with interest and service fees.
Furthermore, during the construction phase, the applicant would be granted
possession of and access to the project site to construct the serviced head office
building. The operational phase would commence thereafter.
It is important to note that the applicant would not hold any right of use or
occupation of the land or the serviced head office building by virtue of any term
of the PPP. The applicant would only be given access to the new building
exclusively for purposes of providing the services as described in the PPP.
The issue under consideration before SARS was whether the applicant qualified
for any of the deductions referred to in section 12N in respect of the
improvements effected on land not owned by the taxpayer.
16
SARS ruled that the applicant did not comply with the requirements of section
12N and therefore did not qualify for any deduction under any provision
referred to in section 12N.
The Taxation Laws Amendment Bill of 2014 (the Bill) was introduced to
Parliament on 22 October 2014. The Explanatory Memorandum on the Bill
notes that under certain PPP arrangements a private party is not able to meet the
criteria of section 12N. Specifically, the private party will not necessarily have
the right of use or occupation of the land or buildings. The private party could,
for example, only have a right to access the land or building in order to perform
under the PPP. As a result, the private party is not able to claim any deduction
under section 12N and this has an effect on the overall pricing of the project.
The Bill proposes the insertion of section 12NA into the Act, which addresses
the above problem and will essentially allow a private party to claim a special
capital allowance in respect of improvements to State-owned land and buildings
where the Government has the right to use or occupy the land or buildings, and
not the private party.
In order to claim this special allowance, the private party must:
be a party to a PPP agreement with Government; and
incur expenditure of a capital nature.
The proposed insertion of section 12NA to the Act will come into operation on
1 April 2015 and will apply in respect of expenditure incurred to effect
improvements during any year of assessment commencing on or after that date.
It is evident that the insertion of section 12NA to the Act will provide relief to
those private parties to PPPs, who find themselves in a position similar to the
17
applicant, where they do not have the right of use or occupation of land or
buildings owned by the Government and to which improvements have been
effected.
Cliffe Dekker Hofmeyr
BPR: 180
ITA: Sections 12N and 12NA
Taxation Laws Amendment Bill of 2014 (The Bill was promulgated as an
Act on Tuesday, 20 January 2015)
GENERAL
2388. Conducting farming operations
If only all judgments were formulated with the elegant reasoning and
perspicacity of the judgment delivered by Rogers J in the Western Cape
Division of the High Court in Kluh Investments (Pty) Ltd v Commissioner for
the South African Revenue Service (case number A48/2014, as yet unreported)
on 9 September 2014.
The appeal was against the dismissal of an appeal brought in the tax court
against an additional assessment levied by the South African Revenue Service
(SARS) in respect of the 2004 year of assessment. SARS added an amount of
R110 million to the appellant's taxable income on the basis that the gross
income giving rise to such taxable income had accrued to the appellant during
its 2004 year of assessment on disposal of a plantation as contemplated in
paragraph 14 of the First Schedule to the Income Tax Act No. 58 of 1962 (the
Act).
18
Section 26(1) of the Act provides that the taxable income of any person carrying
on pastoral, agricultural or other farming operations must, to the extent that it is
derived from such operations, be determined in accordance with the ordinary
provisions of the Act but subject to the special provisions set out in the First
Schedule to the Act. The relevant excerpt from paragraph 14 of the First
Schedule to the Act states that any amount that accrues to or is received by a
farmer (i.e. any person conducting pastoral, agricultural or other farming
operations) from the disposal of any plantation, irrespective of whether such
plantation is disposed of separately or with the land on which it is growing,
shall be deemed not to be capital in nature and shall constitute part of the
farmer's gross income.
The fact that the appellant had disposed of a plantation during its 2004 year of
assessment was undisputed. The nub of the appeal was whether the appellant
was conducting farming operations from whence the disposal proceeds
emanated – the prerequisite for applying the statutory provisions SARS had
applied in raising the additional assessment.
The facts of the case were as follows:
The appellant, a special purpose subsidiary of a Swiss company, had been
engaged by Steinhoff Southern Cape (Pty) Ltd (Steinhoff) to assume
Steinhoff's place as purchaser of certain land with a timber plantation on
it. The rationale behind the appellant's substitution as purchaser was
Steinhoff's aversion to owning fixed property in South Africa but still
wanting access to the plantation.
Steinhoff purchased all the machinery and equipment (including a
sawmill) while the appellant acquired the land, the timber plantation and
certain other assets. Both transactions were executed in writing in
October 2001, back-dated to 29 June 2001, and concluded as going
concern acquisitions, ostensibly qualifying for zero rating in terms of
19
section 11(1)(e) of the Value-Added Tax Act No.89 of 1991 ( the VAT
Act).
In May/June 2001 by virtue of the relationship of trust between them,
Steinhoff and the appellant agreed orally that Steinhoff would be entitled
to conduct the plantation business on the appellant's land for Steinhoff's
own profit and loss. Steinhoff was granted access to the land on which the
plantation stood and was entitled to harvest the timber for its own
account. Steinhoff used its own equipment to conduct the plantation
operations, employed employees to work on the plantation and contracted
with service providers in relation to the plantation operations. All
plantation operational income and expenditure was earned and incurred
by Steinhoff and reflected in its accounts. It was not obliged to render
reports to the appellant regarding the plantation operations.
The appellant owned no equipment and had no employees. It had no
expertise in operating plantations. It was common cause that the appellant
considered the acquisition of the land and plantation as a strategically
advantageous long-term investment. To protect its investment, the
appellant and Steinhoff agreed that upon termination of the oral
agreement, which was to subsist indefinitely, Steinhoff would ensure that
the plantation comprised trees of the same volume and quality as at
commencement.
The oral arrangement was terminated by agreement in June 2004 when
Steinhoff changed its policy, in light of escalating timber prices and the
scarcity of timber resources, and became amenable to purchasing fixed
property in South Africa.
The purchase price was determined by an independent valuer and heads
of agreement were concluded in terms of which 'the plantation business'
was to be sold by the appellant to Steinhoff as a going concern, zero-rated
in terms of section 11(1)(e) of the VAT Act.
20
Certain disputes arose between the parties which were duly settled and
recorded in a settlement agreement in terms of which the reference to the
sale of 'the plantation business' was altered to refer to the sale of
immovable property, standing timber, the plantation sale assets,
machinery and equipment and plantation contracts. In addition it was
recorded that VAT at the standard rate may be payable on the transaction
in respect of which the appellant was to issue invoices to Steinhoff.
Further it was agreed that the appellant was to pay Steinhoff a 'bonus
management fee' for the exemplary manner in which it had looked after
the appellant's investment.
In its 2004 tax return the appellant treated the disposal proceeds as capital
in nature. It declared a capital gain of R45,6 million being the difference
between the disposal proceeds of R144,7 million and the CGT valuation
of the plantation of R99,1 million as at 1 October 2001 (as opposed to the
lesser purchase consideration actually paid as at 29 June 2001). The
appellant also claimed a section 11(a) deduction of R12 million in respect
of the 'bonus management fee' due to Steinhoff.
SARS issued an additional assessment in August 2010 in terms of which
it rejected the appellant's treatment of the plantation disposal proceeds as
capital in nature. SARS averred that section 26(1) read with paragraph 14
of the First Schedule deemed the disposal proceeds to be part of the
appellant's gross income. The appellant objected to the additional
assessment. In its grounds of assessment SARS maintained its stance.
However, SARS contended in the alternative that if the appellant was
correct in treating the disposal proceeds as capital in nature, it had
calculated the gain incorrectly. The CGT issue was left over by
agreement pending the outcome of the main issue.
Before the tax court, SARS had argued that the mere disposal of a plantation
was sufficient to trigger the relevant statutory provisions. In effect SARS
21
submitted that it was not necessary to satisfy section 26(1) as a separate
jurisdictional fact before rendering the deeming provision of paragraph 14 of
the First Schedule applicable to the plantation disposal proceeds. Plainly put, it
was not necessary to first establish whether or not the appellant was conducting
farming operations. The mere fact that the appellant sold a plantation was
sufficient to render paragraph 14 applicable and deem the plantation disposal
proceeds to be part of the appellant's gross income.
In the alternative, SARS argued that even if Steinhoff had conducted the
plantation operations independently of the appellant, such operations had been
physically conducted on the appellant's land, the appellant retained a direct
interest in such operations and Steinhoff was required to restore the plantation
in the same condition upon termination of the oral agreement as it had stood at
commencement. As such SARS argued that there was a sufficiently close
connection between the disposal proceeds and the plantation operations during
the subsistence of the oral arrangement to render section 26(1) and paragraph 14
of the First Schedule applicable.
The tax court found it unnecessary to consider SARS' first argument as it found
in SARS' favour on strength of the alternative basis. In so finding, Rogers J
concludes that the tax court conflated two distinct issues:
"Section 26(1) does not apply merely because there has accrued to the taxpayer
income which has 'derived from' farming operations; the section applies to a
person carrying on farming operations to the extent that his income is derived
from such operations. Two questions must therefore be answered:
(i) Was the person whom SARS wishes to tax a person carrying on farming
operations during the year of assessment in question?
(ii) If so, did the particular item of income in dispute derive from those farming
operations?"
22
Rogers J then proceeds to review the relevant case law and concludes that a
number of tax court decisions1 have similarly conflated the two questions. In
rejecting SARS' first argument he states that the objective of "paragraph 14 is
not to define what constitutes the carrying on of farming operations, but to
characterise a particular type of accrual as gross income rather than capital."
The mere disposal of a plantation previously acquired by a taxpayer is
insufficient to constitute the carrying on of farming operations; and the conduct
of farming operations is the prerequisite for triggering the paragraph 14
deeming provision.
Rogers J concluded in favour of the appellant on the basis it was not conducting
farming operations. As section 26(1) was inapplicable, the characterisation of
the plantation disposal proceeds fell to be determined in accordance with the
normal provisions of the Act.
In upholding the appeal, he wryly observes that had SARS' contentions been
upheld, a Pandora's Box may have been opened for non-farming taxpayers
disposing of pastoral, agricultural or farming assets.
Cliffe Dekker Hofmeyr
ITA: Section 11(a) and 26(1) and paragraph 14 of the First Schedule
VAT Act: Section 11(1)(e)
MINING
2389. Provision for mining rehabilitation
Mining companies generally make financial provision for rehabilitation by way
of rehabilitation trusts or financial guarantees through a financial institution or
1 ITC 66 (1930) 5 SATC 85, ITC 1630 (1996) 60 SATC 59
23
with insurance policies. Although a deduction can be claimed for contributions
to a rehabilitation trust and the income derived by such rehabilitation trust is
exempt from tax, cash strapped mining companies in the current economic
environment are finding it tough to contribute the required amount of cash to
rehabilitation trusts. Insurance policies therefore have become a more lucrative
option as it enables mining companies to spread the premiums, and therefore
payment burden, over a longer period of time and even led to some mining
companies transferring the funds in rehabilitation trusts into the insurance
policies. The potential pitfalls of these methods are firstly, the adverse penalties
in excess of 200% of the value of the funds in the rehabilitation trust which
could be imposed by the South African Revenue Service (SARS) upon the
transfer out of rehabilitation trusts and the potential non-deductibility of the
premiums paid towards the insurance policies.
Mining companies in South Africa are required to make financial provision in
terms of the Mineral and Petroleum Resources Development Act No. 28 of
2002 (the MPRDA), read with the National Environmental Management Act
No. 107 of 1998 (NEMA), for the rehabilitation of the mining areas on which
mining activities are conducted (this will in future solely be governed by
NEMA). From an administrative and practical perspective, mining companies
are required to re-evaluate their rehabilitation liabilities and ensure that they
must be able to provide upfront for any shortfall in the provision for such
rehabilitation liabilities. In this regard, the Department of Mineral Resources
(the DMR) insists that mining companies must be able to provide upfront for
any shortfall in the provision for rehabilitation liabilities. For companies which
merely provide for rehabilitation through a rehabilitation trust, this would imply
that a cash contribution of the entire shortfall amount would need to be
contributed towards the rehabilitation trust. Commercially, many mining
companies (especially junior mining companies) are not in a position to make
24
such contributions as this would lead to cash flow constraints for the already
cash strapped mining companies.
As alluded to earlier, section 37A of the Income Tax Act No. 58 of 1962 (the
Act) provides for the deduction for income tax purposes of contributions made
to a qualifying rehabilitation trust. This deduction would not necessarily benefit
mining companies which are not in a tax paying position. Instead, additional
funding would need to be obtained to firstly fund the operations and secondly to
fund the rehabilitation trust. As a result, mining companies have opted to
provide for rehabilitation expenses through the various insurance products
which are currently in the market (and have been for quite some time) as this is
regarded by the mining companies as a more effective method to manage the
cash flow constraints and provide the DMR with the required guarantee(s) for
the future rehabilitation liabilities. The benefit of these insurance products is
that although the guarantee is received upfront, the mining companies have a
longer period during which the actual premiums can be paid as the insurance
policies typically extend over 3 years (which could be extended further),
thereby easing the cash flow constraints.
Due to the use of the funds contributed to a rehabilitation trust being restricted
and which can only be withdrawn for rehabilitation purposes (or used for
purposes set out in section 37A), many mining companies have opted to provide
for rehabilitation solely through insurance policies rather than to establish
rehabilitation trusts (i.e. mining companies regard insurance products to be a
more effective method to provide for future rehabilitation expenditure). In some
instances, mining companies have gone so far as to transfer funds out of already
established rehabilitation trusts into the aforementioned insurance policies.
SARS does not favour such transfers and has indicated that the application of
the penalty provisions provided for in section 37A (which would lead to a
penalty in excess of 200% of the value of the funds in the rehabilitation trust)
25
would be strictly applied to any transfer which contravenes the provisions of
section 37A.
From an insurance policy perspective, National Treasury has inserted section
23L into the Act which came into effect on 31 March 2014. In essence, the
purpose of section 23L is to disallow the deduction of any premiums incurred
by a taxpayer on short-term insurance policies, unless the required criteria are
met. The required criteria include, inter alia, recognising the insurance
premiums as an expense in the financial statements (and not capitalise the
expense as many mining companies would typically do). In this regard, the
question which should be considered by taxpayers is whether the specific
insurance policy which has been entered into to provide for future rehabilitation
expenditure would be regarded as a short-term insurance policy as envisaged in
section 23L of the Act and, if so, would the criteria be met so as not to fall
within the ambit of section 23L.
It is recommended that careful consideration be given and advice sought from
tax advisors who also understand and are knowledgeable as to the requirements
of the MPRDA and NEMA before a taxpayer opts to transfer any funds out of
an established rehabilitation trust into any other fund or policy not specifically
mentioned in section 37A. This is to ensure that the adverse (and arguably
draconian) penalty provisions contained in section 37A are not triggered. It is
further advisable that tax advice be sought before any mining rehabilitation
insurance policy is entered into by a mining company in order to ascertain
whether there is not a more efficient manner in which the policy could be
structured, thereby not falling within the ambit of section 23L.
It would be interesting to see how the Davis Committee will approach the
current tax incentives for mining rehabilitation and whether, going forward,
insurance policies of the nature discussed above would be recognised by the
26
Davis Committee and adequate provision be made in the Act for the treatment
of insurance premiums paid on such insurance policies.
ENSafrica
ITA: Sections 23L and 37A
Mineral and Petroleum Resources Development Act No. 28 of 2002
National Environmental Management Act No. 107 of 1998
TRUSTS
2390. Pitfalls in dealing with trusts
In two fairly recent cases, the Supreme Court of Appeal (SCA) has gone out of
its way to warn about some of the legal dangers facing people who transact with
trusts. These dangers relate mainly to the capacity of the trust to conclude the
transaction and the authority of a trustee to bind the trust.
In Nieuwoudt & Another NNO v Vrystaat Mielies (Edms) Bpk [2004] 3 SA 486
N and his wife W were the sole trustees of the family trust, through which they
conducted their farming business. Purporting to act on behalf of the trust, N
concluded a forward sale of the following year’s mealie crop at a price of R785
per ton. A year later, when the price of mealies had risen to R1 239 per ton, he
denied the validity of the sale on the grounds that his fellow trustee W had not
consented to or signed the deed of sale. The SCA accepted that the trustees had
to act jointly in order to bind the trust, but referred the matter for the hearing of
oral evidence on the question whether the trustees, acting jointly, had authorised
N to conclude the transaction on behalf of the trust, as their agent.
27
Similarly, in Land and Agricultural Bank of SA v Parker and Others [2005] (2)
SA 77 P and his wife W conducted their farming business through a family
trust, with themselves and their attorney as trustees. When the trust defaulted on
loan obligations (in excess of R16 million) owed to the Land Bank, the bank
successfully applied to the High Court for the sequestration of the trust and its
founder, P. On appeal, counsel for the trust argued that the loans were invalid
because at the time when they were entered into there were only two trustees in
office (the attorney having earlier resigned as trustee), and the trust deed
required a minimum of three trustees. The SCA agreed with this contention, but
dismissed the appeal nonetheless, on similar grounds: upon his sequestration P
was disqualified from acting as trustee, and there being a sub-minimum number
of trustees in office, the trust lacked the capacity to prosecute the appeal.
Legal capacity of a trust
Unlike a company, a trust is not a legal person. The assets of the trust vest in the
body of trustees whose powers to deal with the assets are determined by the
provisions of the trust deed – the ‘constitutive charter’ of the trust, as Cameron
JA described it in Parker’s case. Any action taken by the trustees outside the
scope of their powers is null and void. Thus it is vitally important for anybody
contracting with a trust to have sight of the relevant trust deed in order to
ascertain not only the identity of the trustees but also the limits of their powers,
and the minimum number of trustees required to enable the trust to act. As
Parker’s case shows, if the number falls below the minimum prescribed by the
trust deed, the remaining trustees will be incapable of binding the trust and the
trust will lack the capacity to act until further trustees are appointed.
Moreover, it is a fundamental rule of trust law, confirmed by the two cases
above, that unless the trust deed provides otherwise, the trustees must act jointly
if the trust is to be bound by their acts. Thus, even if a majority of trustees
agrees to and signs the contract, the contract will not be binding upon the trust.
28
This goes to trust capacity: the majority of trustees in question is not the body of
trustees empowered by the trust deed to act.
If the trust deed provides for decisions to be taken by majority vote, the
majority cannot act without consulting the minority; the trustees as a group must
consider the matter and if there is disagreement the majority view will then
prevail.
Authority of trustee to bind the trust
Even if a trustee has been properly appointed in terms of the trust deed, or by
the court in terms of general trust law, he or she may not act on behalf of the
trust until authorised to do so by the Master. Any such act performed by a
trustee prior to receiving Letters of Authority from the Master will be null and
void and incapable of ratification. Such authorisation by the Master must be
clearly distinguished from an authority granted to an individual trustee by the
board of trustees to perform some act on its behalf.
The fact that trustees have to act jointly does not preclude them from expressly
or impliedly authorising someone to act on their behalf, and that person may be
one of the trustees. Thus, acting jointly, they may delegate certain functions to
one of their number, or even to an outsider, whilst retaining responsibility for
the actions taken on their behalf. This brings the law of agency into play.
In accordance with general principles of agency, when a trustee purports to
contract on behalf of the trust, the trust will be bound only if the board of
trustees had conferred upon the trustee the requisite authority so to act. The
granting of such authority may be express or implied. If the contract fails
because the trustee lacked authority, an action for damages will lie against the
trustee for breach of warranty of authority, but this may be of little solace in the
circumstances.
29
The trust will be bound despite the trustee’s lack of authority if:
the board of trustees subsequently ratifies the actions taken on its behalf,
or
if the trustee had “ostensible authority” to bind the trust; that is, if the
board of trustees created the impression that the trustee had the necessary
authority to represent them, and the other party reasonably relied on that
representation. In such circumstances the board would be precluded (i.e.
“estopped”) from denying the existence of the authority.
Ratification is not possible in circumstances where the agent is required by
statute to obtain authorisation from the principal before entering into the
transaction. On this ground a sale of land was declared invalid in Thorpe and
Others v Trittenwein and Another [2007] 2 SA 172 SCA. The deed of sale had
been signed on behalf of a trust by a single trustee whose conduct was thereafter
ratified by the remaining trustees. The court held that such ratification could not
save the transaction because section 2(1) of the Alienation of Land Act No.68 of
1981 requires prior written authorisation of the agent.
What if it is clear from the trust deed that an individual trustee can be authorised
to represent the trust provided that certain internal formal or procedural
requirements have been met, for example, that the body of trustees has resolved
to delegate to the trustee the power to sign contracts on its behalf? In those
circumstances, must a third party dealing with the trustee check that the
requirements have been met, or is it entitled to assume that all is regular? That
depends on whether or not the so-called “Turquand Rule” of company law
applies to trusts too.
The Turquand Rule: applicable to trusts?
30
The Turquand Rule is part of the common law relating to companies, and
derives from the famous English case of Royal British Bank v Turquand [1856]
6 E&B 327, where it was held that –
“Persons contracting with a company and dealing in good faith may assume
that acts within its constitution and powers have been properly and duly
performed, and are not bound to enquire whether acts of internal management
have been regular.”
A statutory version of the rule is now to be found in section 20(7) of the
Companies Act No. 71 of 2008:
“A person dealing with a company in good faith … is entitled to presume that
the company, in making any decision in the exercise of its powers, has complied
with all of the formal and procedural requirements in terms of this Act, its
Memorandum of Incorporation and any rules of the company, unless, in the
circumstances, the person knew or ought reasonably to have known of any
failure by the company to comply with any such requirement.”
Thus, for example, if a company’s Memorandum of Incorporation provides that
the managing director can conclude contracts on behalf of the company,
provided the board has delegated such power to the director, a third person
dealing with the company would generally be entitled to presume, when its
managing director signs the contract on behalf of the company, that the
necessary delegation has occurred. The effect of the rule is that the company
will be bound even if the director lacked authority because the internal
requirement of delegation had not been met.
Whether the Turquand Rule should be made applicable also to trusts is
somewhat controversial, and the issue was expressly left open by the Supreme
31
Court of Appeal in the two cases discussed above. In Nieuwoudt, Harms JA was
rather sceptical, because in company law the rule is closely associated with the
doctrine of constructive notice (third parties dealing with a company were, and
to some extent still are, deemed to have knowledge of the contents of the
company’s constitutional documents), and he doubted whether the general
public could similarly be deemed to have knowledge of the contents of trust
deeds, which are essentially private documents. However, in Parker’s case,
Cameron JA expressed the view that “[w]ithin its scope the rule may well in
suitable cases have a useful role to play in securing the position of outsiders
who deal in good faith with trusts that conclude business transactions.”
Clearly, in the present state of the law, it would be prudent for those dealing
with trusts to assume that the rule does not apply to trusts.
Conclusion
Persons who contemplate contracting with a trust should, before committing
themselves to the deal, take the following elementary precautions:
insist on seeing Letters of Authority from the Master authorising the
trustees to act as such;
insist on seeing the trust deed itself, to make sure that the board of
trustees is properly constituted and has the capacity to enter into the type
of contract in question; and
check that all internal formal or procedural requirements have been met,
particularly as regards the granting of authority to a particular trustee to
enter into and sign the contract on behalf of the trust. An assurance from
the co-trustees that the contracting trustee has the necessary authority will
usually suffice, since that will preclude the board from subsequently
denying his or her authority.
32
By the same token, trustees who conclude contracts on behalf of the trust should
ensure not only that they have the necessary authority to do so, but also that
there is strict compliance with all the provisions of the trust deed.
ENSafrica
Alienation of Land Act: Section 2(1)
Companies Act: Section 20(7)
Trust Property Control Act: Section 6
SARS NEWS
2391. Interpretation notes, media releases and other documents
Readers are reminded that the latest developments at SARS can be accessed on
their website http://www.sars.gov.za.
Editor: Mr P Nel
Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan,
Prof KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC
Foster
The Integritax Newsletter is published as a service to members and associates of
The South African Institute of Chartered Accountants (SAICA) and includes
items selected from the newsletters of firms in public practice and commerce
and industry, as well as other contributors. The information contained herein is
for general guidance only and should not be used as a basis for action without
further research or specialist advice. The views of the authors are not
necessarily the views of SAICA.