Business Tax and Company Law Quarterly

Issue Number

Latest documents

• The Deferral of Unrealised Foreign Exchange Gains and Losses Rules, and the Applicability to Parties Other Than the Lender or Borrower

  This article considers the tax rules in relation to the deferral of unrealised foreign exchange gains and losses (referred to in tax terms as ‘exchange differences’) in respect of foreign loans between related parties and whether the deferral rules can be extended to include parties to the loan agreement other than the debtor and creditor. The rules applicable to foreign exchange gains and losses are dealt with in section 24I of the Income Tax Act, 1962 (‘the Act’). This provision subjects realised gains or losses to income tax, but defers the tax treatment of exchange differences on certain loans and debts to subsequent years in which the underlying asset is brought into use.\r\nUnrealised foreign exchange gains and losses (referred to as ‘exchange differences’) in respect of foreign currency loans (loans in foreign currency constitute ‘exchange items’) between related parties are deferred until the settlement or realised date of the loan, meaning that these gains and losses are not reflected in taxable income while the loan is not settled.\r\nThe deferral rules applicable to a ‘group of companies’ and ‘connected persons’ are found in section 24I(10A)(a) of the Act. The rules are comprehensive, but the particular issue for consideration in this article is the meaning of the words in the following extract:\r\n\r\n‘… [N]o exchange difference arising during any year of assessment in respect of an exchange item … shall be included in or deducted from the income of a person in terms of this section—\r\n\r\n\r\n(i) if, at the end of that year of assessment—\r\n\r\n\r\n(aa) that person and the other party to the contractual provisions of that exchange item—\r\n\r\n(A) form part of the same group of companies; or\r\n\r\n(B) are connected persons in relation to each other …’ (my emphasis).\r\nThe key question considered in this article is whether a guarantor to a loan agreement or any other party for that matter, being a party to a loan agreement, brings the agreement within the ambit of section 24I(10A)(a)(i)(aa), where such party or parties are either a ‘connected person’ in relation to the borrower or part of the same ‘group of companies. The hypothesis here is that these entities are party to the contractual provisions of the exchange item, namely the loan. The crisp issue is whether ‘the other party’ referred to in section 24I(10A)(a)(i)(aa) is intended to apply narrowly to a typical lender-borrower relationship or whether it should apply broadly to any party to the contractual provisions of an exchange item.\r\nThe article considers principles of statutory interpretation applicable to the definitive article ‘the’ in respect of ‘the other party’. It is submitted that the legislature could have used phrases such as ‘a party’, ‘any party’ or ‘another party’ but instead deliberately chose the phrase ‘the other party’. The article concludes that the provisions must have been intended to apply to an arrangement between the borrower and lender in the context of a loan arrangement and not any other party to the contractual provisions of the loan arrangement.\r\nAccordingly, it is submitted that the deferral of unrealised gains and losses in respect of a foreign loan or debt between parties within a ‘group of companies’, or who are ‘connected persons’, is restricted to the debtor and creditor in relation to the loan agreement and does not extend to other persons (such as a guarantor) that may be party to such an agreement.

• No Boardroom, No Debate: RESOLVING THE TENSION BETWEEN ROUND-ROBIN RESOLUTIONS AND COMPANY LAW DEMOCRATIC PRINCIPLES

  The primary decision-making organ of a company is its board of directors. The board functions based on majority rule, but only once the minority has had an opportunity of ventilating their views. This is the basic democratic principle of our company law. Board decisions are normally made at board meetings, where the minority has a forum to ventilate their view. But board decisions can also be made through round-robin resolutions, where there is no meeting. Without a meeting, the minority has no forum to ventilate their views. There is therefore a measure of tension between (non-unanimous) round-robin resolutions and the basic democratic principle. In this article, we consider — following a recent High Court judgment on the topic — how this tension is to be resolved. We describe the basic democratic principle and demonstrate that it is also reflected in the provisions of the Companies Act 71 of 2008. We then explore the tension between (non-unanimous) round-robin decision-making and the basic democratic principle. We conclude — as did the court in the aforementioned judgment — that any potential tension is reconciled through the requirement of proper notice. In this way, round-robin resolutions strike a balance — between pragmatism and efficiency, on the one hand, and adherence to the democratic principle, on the other.

• Editorial

  This issue features three articles, the first of which relates to an important issue of company law. The other two articles deal with topical issues of tax law.

• Asset-for-share Transactions: THE NUMBER-OF-SHARES CONUNDRUM*

  This article relates to asset-for-share transactions under section 42 of the Income Tax Act and addresses the question as to how many shares must be issued to the transferee company in exchange for the asset or assets transferred, so as to comply with the section.\r\nThe author gives examples to illustrate the operation of section 42 and the problems that can arise in asset-for-share transactions, particularly where assets have different values and more than one share is issued in exchange. It is suggested that if there are insufficient shares available to match the relative value of the assets being exchanged, the solution is to allocate the aggregate base cost of the assets to the shares issued. This solution will not, however work in the case of pre-valuation date assets, for which there are different methods prescribed for determining value. In such a case, the solution suggested is to allocate shares with distinctive certificate numbers to particular pre-valuation date assets based on their relative market value. The author suggests that, alternatively, it may be time for legislative intervention to simplify matters, by the introduction of a rule similar to that in paragraph 76B of the Eighth Schedule to the Act.\r\nThe article suggests that SARS should give comfort to taxpayers by adopting the suggested solution for post-valuation date assets in an Interpretation Note, or perhaps resorting to legislation to resolve the complexity.\r\nFinally, the article also considers the application and effect of the value-for-value rule in section 24BA of the Income Tax Act, which applies to section 42 asset-for-share transactions.

• Early Termination of a Lease: Tax Implications in the Hands of the Lessor

  It is not uncommon for a lessee to seek to exit a lease prior to termination date, for varied reasons. The lessor will usually only be amenable to such early termination in exchange for an early termination payment. The crisp issue is: is such termination payment a receipt of a capital or revenue nature. Intuitively, the answer is that the compensation is of a revenue nature as the compensation is to compensate the lessor for a loss of the rentals that would have been paid by the lessee had the lease run its course.\r\nHowever, the answer, as argued in this article, is not that straight forward. The answer is very dependent on the facts. The premise of this article is that where compensation is paid by a lessee to a lessor as compensation for the lessor agreeing to cancellation of a lease agreement, the compensation will be of a capital nature where the lease agreement constitutes the major, or the whole, business of the lessor. The fact that the lessor will in all probability be able to find a new tenant does not affect this conclusion. Nor is the conclusion different if the compensation is determined by reference to the loss of rentals that will arise in consequence of the termination of the lease agreement.\r\nBy contrast, where the lease arrangement is merely a part (i e not a major or the whole) of the lessor’s business, the compensation will in all likelihood be regarded as a receipt of a revenue nature.\r\nOn the basis that the compensation derived by the lessor for the early termination of the lease agreement is a receipt of a capital nature in these specific circumstances, the issue arises as to the capital gains tax (CGT) implications that arise in consequence of such receipt. The authors conclude that while the termination payment will constitute proceeds for CGT purposes, as the lessor will not have incurred any expenditure in respect of the acquisition or creation of the lease agreement qua asset, the base cost in such asset is nil.\r\nAs the termination of the lease agreement constitutes the surrender of a right, and accordingly the supply of a service for value-added tax (VAT) purposes, VAT will need to be accounted for by the lessor (if a VAT vendor) on receipt of the termination payment.

• Editorial

  This publication aims to engage with legal questions arising in modern commerce and tax. That being the case, it is something of a quirk of this edition — a pleasing one to my mind — that two of its three articles locate practical answers to modern-day questions in the works of the old Roman and Roman-Dutch writers (Voet and Pothier in particular).

• Hidden Complexities in the Right of Recourse Between Co-debtors and Co-sureties

  Does a co-debtor or co-surety who is called upon to pay, and does pay, more than his or her proportionate share of the principal debt enjoy an ex lege (i e automatic) right of recourse or contribution against his or her co-debtors or co-sureties? This is the question that the authors — sitting as an arbitration appeal panel of three — were called upon to answer in recent arbitration proceedings.\r\nThe common assumption, amongst lawyers and businesspeople alike, is that there is an ex lege or automatic right of recourse or contribution in these circumstances. However, as appears from the analysis below, that assumption oversimplifies the legal position — which, on an overview of the relevant authorities, has two central tenets.\r\nThe first is that the default or presumptive position is that co-debtors and co-sureties do enjoy a mutual right of recourse or contribution in the circumstances described above.\r\nThe second is that the default or presumptive position may be displaced by the nature of the underlying relationship between the individual co-debtors or co-sureties. It is their underlying relationship — not merely the existence of a relationship of co-debtorship or co-suretyship — that is ultimately determinative of whether or not a mutual right of recourse or contribution exists.\r\nAs an example, assume that budding entrepreneur A wishes to start a business. A seeks to borrow R100 as start-up finance from lending institution X. To satisfy X’s requirements in respect of security, A’s wealthy relative B agrees to assume personal liability, jointly and severally alongside A, for repayment of the loan. The position then is that Y, as creditor, is owed R100 by A and B as co-principal debtors.\r\nOn settling the loan in full, does A then enjoy a right to recover R50 (half of the total debt paid by A) from his co-debtor B?\r\nOn the common assumption referred to above, the answer would be yes. But the legal principles, properly understood and applied, yield the opposite answer. Unlike A, B (the wealthy relative) has no genuine interest in the advance of the loan. The law recognises that in these circumstances, the underlying relationship between A and B is inconsistent with the latter owing the former an obligation to relieve him or her of the full debt burden (i e by distributing it between the two of them).\r\nIn this example, the nature of the underlying relationship between the co-debtors A and B — which, again, is inconsistent with a mutual right of recourse or contribution between them — has the result that the default or presumptive position is displaced and does not apply.\r\nBut where the underlying relationship is unknown (because it is not established by the available evidence), or where the evidence otherwise falls short of establishing that the underlying relationship is inconsistent with such a mutual right of recourse or contribution, the default or presumptive position will hold; and the content of the right is based, in the absence of agreement to the contrary, on a presumed equality of burden amongst the co-debtors or co-sureties. The paying co-debtor or co-surety may thus recover an equal share of the debt from each of his or her co-debtors or co-sureties.\r\nThe article that follows, which is a modified extract from the authors’ arbitration appeal award, also engages with a particular question left open in the case law, viz ‘whether the mere fact that persons are bound together as co-debtors would, in the absence of agreement to the contrary, give rise to a right of contribution, or whether, as stated Voet, further elements are required’.1 The article concludes that no ‘further elements’ are required to trigger a presumptive right of contribution between co-debtors inter se. The mere fact that individuals are bound together as co-debtors is enough to trigger a presumptive right of contribution. The same holds for co-sureties.\r\nIn sum, the article analyses the various authorities — spanning Roman-Dutch writers to modern case law — and comprehensively sets out the authors’ reasoning for reaching the conclusions they do.

• Continuation Funds: The New Dawn in Private Equity Fund Formation

  This article explores the principal tax themes emanating from a new fund structure in the Private Equity industry referred to as a Continuation Fund.\r\nA Private Equity fund in South Africa is established in the form of a common law partnership, more specifically an en commandite partnership, meaning a distinction between so-called limited partners (limited in liability to their partnership contribution) and general partners (unlimited in terms of their liability to third parties, but share in profits disproportionate to their capital contribution).\r\nGiven the life expectancy of a PE Fund (typically a maximum of 10 years), the disposal of portfolio assets may be premature upon termination, given their inherent future value and poor market conditions. An appropriate investment remedy for investors wishing to further exploit the intrinsic value of PE portfolios is the establishment of a Continuation Fund.\r\nSimplistically, the Continuation Fund is a new partnership whereby partners of the existing fund contribute their interests from the old fund. Issues such as the term of the fund, establishing which partners are limited and general, and fees, are key aspects that required consideration.\r\nIn South Africa, a partnership under common law is not a legal person distinct from the partners, nor is a partnership a taxable person.\r\nAn important consideration relating to partners exiting partnerships is the theory that partners co-own, in an abstract sense, undivided shares in the underlying assets. Accordingly, a partner does not own a piece of the land or a portion of the shares in the object sense, but rather jointly owns an indefinite whole until action is taken to divide the common asset. So when a partnership dissolves, the partner’s interest becomes a divided interest in the assets.\r\nFor tax purposes, a partnership interest includes an undivided share in the assets of the partnership.\r\nA ‘disposal’ for Capital Gains Tax purposes is defined in paragraph 11 of the Eighth Schedule to the Income Tax Act 58 of 1962 (the Act), and includes ‘any event, act, forbearance or operation of law which results in the creation, variation, transfer, or extinction of an asset’ (my emphasis).\r\nIn terms of the common law, partners entering and leaving the partnership results in the extinction of the old partnership and the creation of a new partnership.\r\nFor tax purposes, the disposal of an interest in the underlying assets, will result in a disposal subject to CGT.\r\nIn the context of a re-investment in a Continuation Fund, it is submitted that the disposal must have resulted in a parting with the asset, in whole or in part. On dissolution of the old fund, the fund’s assets are distributed in accordance with the respective partners’ contractual interest, established upfront. An abstract interest in the assets is replaced with actual ownership of not parted with anything nor gained anything. A limited partner in the old fund which contributes its shares to the Continuation Fund, as a general partner, will not give up value on the date of entry to the new partnership. This is because the value of the contribution equals the value of the shares distributed from the old fund. A reconstitution of partner rights to profits does not result in the giving up of anything on the date of the contribution. The sharing of profits from that point on determines the profit allocation.\r\nAccordingly, a disposal for CGT purpose should not arise upon entry in the Continuation Fund.

• Editorial

  This edition has a decidedly un-tax feel to it as two of the three articles deal with non-tax issues.

• The Companies Second Amendment Act 17 of 2024: Ameliorating the Time-Barring Regime Under Sections 77 and 162 of the Companies Act

  A director owes duties to the company of which he or she is director. These include, in the main, a fiduciary duty and a duty to exercise reasonable care, skill and diligence. This is the position at common law, as well as under the Companies Act.\r\nSections 77 and 162 of the Companies Act contain the two principal remedies for breach of these duties. Section 77 provides for the director concerned to be liable for loss sustained by the company as a consequence of the breach. Section 162 provides for the director to be declared delinquent or under probation. Both sections have time-barring provisions. In terms of the existing section 77(7), proceedings by the company concerned to recover loss from the director may not be commenced more than three years after the act or omission that gave rise to the liability — i e irrespective of when the company did, or could have, acquired knowledge of the act or omission in question. In terms of the existing section 162(2)(a), stakeholders in a particular company wishing to bring delinquency proceedings against an individual who was, but no longer is, a director of the company, are required to do so within 24 months of the date on which the individual ceased to be a director — i e, even if the stakeholder concerned did not have knowledge of the delinquent conduct, and could not reasonably have acquired it, within the stipulated 24-month period.\r\nThese time-barring provisions have the potential to operate harshly — and so it has been contended, unconstitutionally. In light thereof, and following recommendations by the Zondo Commission, the time-periods have been revisited, and substantially ameliorated, in the recently enacted Companies Second Amendment Act. As part of these amendments, a discretion is now conferred on the court, in the context of both remedies, to extend the relevant time-period on good cause shown.\r\nThe article analyses the existing time-barring regime (i e, that are currently in place and which will remain in place until the Companies Second Amendment Act comes into operation); identifies the deficiencies in that regime and the likely rationale for amendment thereof; and explores the pros and cons of the more flexible time-barring regime introduced by the Companies Second Amendment Act.

Featured documents

• Interest-deduction limitation - Section 23M

  While recognising the need for debt capital, fiscal authorities throughout the world have been concerned for some time now that excessive debt funding could lead to tax avoidance. Such tax avoidance occurs where there is a mismatch between the tax treatment of interest incurred and interest...

• VAT and corporate transactions : the dragons slumber : part 2

  In the previous issue of this journal the provisions of section 11(1)(e) of the Value-Added Tax Act 89 of 1991 (the VAT Act), which applies where a vendor disposes of an enterprise or part thereof that is capable of separate operation as a going concern, were considered. This article...

• Leasehold improvements - the VAT implications

  The issue of how VAT must be accounted for under a leasehold-improvement arrangement remains topical. While SARS issued a Draft Interpretation Note in 2012 which was intended to bring very necessary clarity to this issue, it was never finalised. This article considers the VAT implications of such...

• VAT and corporate transactions : the dragons slumber : part 2

  In the previous issue of this journal the provisions of section 11(1)(e) of the Value-Added Tax Act 89 of 1991 (the VAT Act), which applies where a vendor disposes of an enterprise or part thereof that is capable of separate operation as a going concern, were considered. This article...

• The reduction of debt and taxation : some takeaways

  As most tax-orientated people will be aware, a new income-tax and capital gains tax (CGT) regime has been introduced that deals specifically with debt reduction, by whatever legal means the debt is reduced. Where any debt owed by a person is reduced and that debt was used to fund, whether directly...

• Covid-19 : desperate measures for desperate times : Covid tax relief

  2020 is a year many of us would like to forget, but it is also a year that will be imprinted on our minds for a long time. This article seeks to capture the key tax and related benefits provided by government in order to contain, to some extent, the economic bleed for many citizens. The ...

• The minefield of debt restructuring

  A debtor that benefits from a concession or compromise in respect of a debt could trigger a tax liability. The tax will not only add to the debtor’s financial woes, but it could be extremely difficult to accurately determine the amount of tax, seeing that the tax implications of the debtor depend...

• The Modified Section 23M

  Section 23M of the Income Tax Act 58 of 1962 seeks to limit the deduction of interest on debt arising between parties related to one another and in respect of which the interest is not subject to tax in the hands of the recipient of the interest.Section 23M was amended in 2021 by the Tax Laws...

• VAT and Remuneration : the devil is in the detail

  Complexities often arise when a provision in one tax Act is dependent on a provision in another tax Act. The treatment of employees and office holders in receipt of 'remuneration' as defined in paragraph 1 of the Fourth Schedule to the Income Tax Act 58 of 1962 (the IT Act) under the Value-Added...

• Sale of immovable property : selected transfer duty and value-added tax implications

  Sales of immovable property are a daily occurrence. While conventional wisdom seems to be that all sales of immovable property by persons registered as vendors for value-added tax (‘VAT ’) purposes are subject to VAT , and accordingly not transfer duty, the author explains that this is not the case ...