CORPORATE RESTRUCTURINGS (Part III of the Act)

1. CORPORATE RESTRUCTURINGS(Part III of the Act) National Treasury Tax Policy Chief Directorate 16 Oct 2001

2. List of Corporate Reforms 1. Corporate formations 2. Share-for-share acquisitions 3. Intra-group transfers 4. Unbundlings 5. Liquidations

3. Policy Goals 1. Corporate Restructuring Reform acts a standard measure to reduce the potential cascading impact of the capital gains tax on multi-tier groups. 2. Corporate Restructuring Reform is consistent with international practice, thereby keeping the South African tax system internationally competitive. 3. Corporate Restructuring Reform promotes onshore restructurings. 4. Corporate Restructuring Reform is comprehensive, going well beyond capital gains tax relief.

4. Common Policy Threads 1. Tax should not apply if taxpayers simply convert direct interests in assets into indirect share interests. 2. Tax should not apply if assets are transferred among corporate members within the same group because all these members are akin to divisions within the same corporate legal shell. 3. Yet, transactions must be taxed if parties are merely cashing-out their investments. 4. The tax system should ensure that transactions on the JSE are competitive with international stock exchanges, such as the New York and London exchanges. The tax system should accordingly cater to the ebbs (combinations) and flows (unbundlings) naturally occurring within the JSE.

5. Common Legal Threads (1) 1. Eligible Share Types. Tax-free exchanges for shares must involve shares that provide a full upside and downside stake in the recipient company. Tax-free treatment accordingly applies only to ordinary shares and participating preference shares. 2. Level of Share Ownership. Tax-free corporate restructurings require one of the three levels of share ownership: a) a 25 percent (i.e., a meaningful potentially blocking) interest in a company;

6. Common Legal Threads (2) b) a more than 50 percent interest for closely-held companies and an at least 35 percent interest for listed companies (representing controlling interests); and c) a 75 percent interest (representing a parent-subsidiary relationship whereby the subsidiary acts as division). 3. 18-Month Anti-Avoidance Rules. Corporate Restructuring Reform contains a series of 18 month anti-avoidance rules that require the parties to remain in place for an 18 month period. This 18 month delay period acts as a “rough-justice” substitute for previously used “intent” tests.

7. Common Legal Threads (3) 4. Anti-Financial Instrument Rules. Corporate Restructuring Reform contains a series of rules against the transfer of financial instruments (or financial instrument holding companies). Corporate Restructuring Reform is intended to promote the restructuring of active businesses, not the transfer of financial instruments which act as a hallmark of tax avoidance.

8. Company Formations (1)Nature of the Transaction INDIVIDUAL COMPANY X R25 Value R10 base cost Office building Office building R75 value base cost 12 R75 Ordinary shares R25 Ordinary shares NEWCO

9. Company Formations (2) Nature of the Transaction Facts: Individual transfers machinery for 25 ordinary shares, and Company X transfers an office building for 75 ordinary shares. The machinery has a R25 value and a R10 base cost (plus R30 of potential recoupment), and the building has a R75 value and a R12 base cost. Result:The transaction is tax-deferred in capital gains and income tax terms (but stamp duties, etc. apply). No tax applies to the transfer. Individual has a R10 base cost in the 25 shares, and Company X has a R12 base cost in the 75 shares. Newco receives a carryover base cost in both assets transferred plus the same potential recoupment.

10. Company Formations (3)Policy • 1. Tax should not apply if a taxpayer is merely transforming direct asset ownership into an indirect share interest. • 2. Tax must apply if a taxpayer is cashing-out. • 3. Tax policy should promote company formation (a hallmark of new business growth). • NOTE #1: These rules only have meaning for the transferor; the issuance of shares is always tax-free to the company transferee. • NOTE #2: These rules apply only to defer gains. Losses are triggered (subject to the clogged loss rules).

11. Corporate Formations (4)Basic Requirements 1. The transferor must receive at least 25 percent of the ordinary/participating preference shares. 2. The transferor receives tax-free treatment only to the extent of the ordinary/participating preference shares received. 3. The transferor may freely transfer property subject to debt (normally associated with the property). 4. The transferor must retain its 25 percent share interest for an 18 month period. 5. Requirements 1. Through 4. provide tax-free treatment on a transferor-by-transferor basis.

12. Corporate Formations (5)Basic Requirements 6. The transferee company can be newly formed or previously existing. 7. The transferee company must be a domestic (non-exempt) company. 8. The transaction does not apply to the transfer of financial instruments (other than trade receivables). 9. Special rules exist to promote tax-free formations of foreign-owned South African subsidiaries.

13. Corporate Formations (6)Anti-avoidance Rules 1. The transferee company must not retransfer the assets received in a second tax-free transfer for an 18 month period. 2. Hidden pre-transfer loss assets cannot offset transferee company gains for 18 months, and pre-transfer gain assets cannot be offset by transferee company losses for an 18 month period. (Note: Known losses within assets of a transferor cannot be transferred to a transferee company.) 3. The sale of shares will trigger ordinary income if the transferee company mostly contains ordinary assets.

14. Corporate Formations (7)Anti-avoidance Rules 4. Any reduction below the 25 per cent ownership level triggers gain on all shares held by the transferor, not just the shares sold. 5. Taxpayers generally do not receive tax-free treatment for indebted property if the debt was incurred in isolation within 18 months before the transfer. 6. Taxpayers cannot utilise the formation rules to avoid the clogged loss rules; all losses triggered within the 18 month period of the tax-free transfer are subject to special clogged loss rules.

15. Share-for-Share Combinations (1)Nature of the Transaction Acquiring Shares ACQUIRING Controlling Interest in the Target Shares TARGET

16. Share-for-Share Combinations (2)Nature of the Transaction Facts: Individual owns all the shares of Target with a R100 value and a R20 base cost. Individual transfers all the Target shares for newly issued shares in Acquiring equal to a 25 percent stake in Acquiring. Result:The transaction is tax-deferred in capital gains tax and income tax terms. Stamp duties (etc.) apply to the issuance of Acquiring shares (not the transfer of Target shares). Individual has a R20 base cost in the Acquiring shares, and Acquiring has a R20 base cost in the Target shares.

17. Share-for-Share Combinations (3)Policy • 1. Tax should not apply if a Target shareholder merely transforms a direct interest in Target into an indirect interest. • 2. Tax must apply if a taxpayer is merely cashing-out his or her investment. • 3. Tax policy should promote combinations on the JSE. • NOTE #1: These rules only have meaning for the Target shareholder; the issuance of shares is always tax-free to Acquiring. • NOTE #2: These rules apply only to defer gains. Losses are triggered (subject to the clogged loss rules).

18. Share-for-Share Combinations (4)Basic Requirements 1. Tax-free treatment applies to each target shareholder who acquires at least 25 percent of the ordinary/ participating preference shares in Acquiring. EXCEPTION: No percentage requirement applies if the Acquiring is a listed company.

19. Share-for-Share Combinations (5)Basic Requirements 2. Tax-free treatment applies only if Acquiring acquires a controlling interest in the Target: a) More than 50 per cent for closely-held Targets; or b) 35 per cent for listed Targets. 3. Both the Target and Acquiring companies must be domestic residents. 4. Target cannot be a financial instrument holding company.

20. Share-for-Share Combinations (6)Basic Requirements 5. Each Target shareholder must receive at least 25 percent of the ordinary/participating preference shares of a closely held Acquiring. This 25 per cent interest must be sustained for an 18 month period. 6. Each Target shareholder receives tax-free treatment only to the extent of the eligible shares received. 7. Requirements 4. & 5. provide tax-free treatment on a shareholder-by-shareholder basis. 8. The share-for-share rules contain similar anti-avoidance rules as the corporate formation rules.

21. Intra-Group Transfers (1)Nature of the Transaction Parent Sub 1 (selling) Sub 2 (buying)

22. Intra-Group Transfers (2)Nature of the Transaction • Facts: Parent owns all the shares of each of Sub 1 and Sub 2. Sub 1 sells a factory to Sub 2 in exchange for a R100 debenture from Sub 2. Factory has a R100 value, a R70 base cost, and R10 of potential recoupment. • Result: The transaction is tax-deferred in capital gains and income tax terms. Stamp duties, etc.. do not apply. Sub 2 receives a R70 base cost (along with the R10 of potential recoupment) in the factory.

23. Intra-Group Transfers (3)Policy • 1. Tax should not apply to transfers between corporate members that are akin to divisions. • 2. The tax attributes of the asset transferred (e.g., base cost and potential recoupment) should roll over to the transferee company like an inter-divisional transfer. • NOTE #1: These rules rollover gains and losses (intragroup losses outside these rules are clogged). • NOTE #2: Like most countries, South Africa does not have consolidated group rules that treat multiple members as a single entity. This rule is merely one step.

24. Intra-Group Transfers (4)Requirements • 1. Both the buying and selling member must be part of the same group (i.e., they both must be directly or indirectly controlled by the same common parent). • 2. The group relationship must have been in existence 18 months before the transfer. • 3. Both the selling and buying member must elect tax- deferred treatment. • 4. Tax-deferred treatment lasts until the buying member sells the asset outside the group, or until the buying and selling members are not part of the same group.

25. Intra-Group Transfers (5)Requirements • 5. Both the buying and selling members must be domestic residents. • 6. Tax-deferral does not apply to the transfer of financial instruments (but financial instruments such as shares and notes can be received in exchange). • 7. Anti-avoidance rules designed to prevent loss trafficking apply.

26. Intra-Group Transfers (6)Dividends • 1. The exemption from the secondary tax on companies is reduced from the current 100 per cent level down to the group 75 per cent level. • 2. The secondary tax on deemed dividends for connected party loans does not apply to intragroup loans.

27. Unbundling (1)Nature of the Transaction Unbundling Parent Subsidiary

28. Unbundlings (2)Nature of the Transaction • Facts: Parent is listed on the JSE. Parent owns all shares of Subsidiary. Parent has a R3 million value exclusive of Subsidiary, and Subsidiary has a R1 million value. Parent has a R200,000 base cost in the Subsidiary shares. Parent unbundles Subsidiary distributing 1 Subsidiary share for each party holding 1 share in Parent. Individual, a small holder of Parent shares, holds 10 shares in Parent with a R20 base cost. • Result: The capital gains tax, income tax, the secondary tax on companies, and stamp duties, etc.. do not apply. Individual has a R5 base cost in the Subsidiary shares, and a R15 base cost in the Parent shares.

29. Intra-Group Transfers (3)Policy • 1. The purpose of unbundlings is to promote the division of companies where the parental interest in the subsidiary is depressing the value of the subsidiary shares (i.e., the parts are worth more than the whole). • 2. Unbundlings should not be allowed as a general mechanism to disguise tax-free cash/property dividends. • 3. Tax policy should promote standard divisions on the JSE.

30. Unbundlings (4)Flexibility • 1. Subsidiaries can be distributed either to listed shareholders or company members within the same group. • 2. Unbundlings can be performed with divisions. Parent can transfer divisions into a newco subsidiary and then unbundle the newco subsidiary (stated differently, unbundling can act as a demerger).

31. Unbundlings (5)Requirements 1. Tax-free treatment applies only if Parent distributes a Subsidiary in which Parent has a controlling shareholder interest as follows: a) a more than 50 per cent level for closely-held subs; or b) a 35 per cent level for listed subs. NOTE: The 50+/35 per cent level is required for each sub distributed. 2. Both the parent and subsidiary companies must be domestic residents. In addition, distributions to non-residents holding more than 5 per cent trigger tax. 3. Sub cannot be a financial instrument holding company.

32. Unbundlings (6)Requirements • 4. The 50+/35 per cent level in the subsidiary must generally be held for an 18 month period before the unbundling. • 5. The unbundling distribution must reduce share premium before profits.

33. Liquidations (1)Nature of the Transaction Parent Liquidating Sub

34. Liquidations (2)Nature of the Transaction • Facts: Parent owns all the shares of Subsidiary. Parent has a base cost of R20 in Subsidiary. Subsidiary owns a factory with a R35 base cost and a R100 value. Subsidiary liquidates into Parent. • Result: The liquidation is tax-deferred in capital gains, income tax, and in secondary tax terms. The liquidation also avoids real estate transfer duties and stamp duties, etc.. Parent receives a R35 base cost in the factory (along with any potential recoupment).

35. Liquidations (3)Policy • 1. Liquidations of one corporation into a controlling parent are akin to the combination of divisions in single shell. • 2. The flexible format of the proposed liquidation regime promotes asset merger-type combinations.

36. Liquidations (4)Requirements • 1. Parent must own 75 per cent of the shares in the liquidating subsidiary. • 2. Parent need not hold the 75 per cent level for an 18 month period before the liquidation, thereby allowing for a share-for-share combination to follow a liquidation (to create the effective equivalent of an asset merger). • 3. Subsidiary must not act as a financial instrument holding company.

37. Liquidations (5)Requirements • 4. Both Parent and Subsidiary must be domestic residents. • 5. The liquidation rules contain anti-loss trafficking rules, including the loss of all regular and capital assessed losses in the subsidiary. • 6. Parent inherits the tax liability of liquidating Subsidiary.