Merger of controlled foreign companies

On October 7 2015 the South African Revenue Service (SARS) released Binding Private Ruling 207, which dealt with the merger of two controlled foreign companies (CFCs) for purposes of Section 9D of the Income Tax Act (58/1962).

Facts

The applicant, a South African-incorporated and resident company, had two subsidiaries that were incorporated and resident in foreign countries and were classified as CFCs. The first subsidiary (CFC 1) was a listed passive holding company. The second subsidiary (CFC 2) was a privately held intermediate holding company.

In order to consolidate some of the group’s investments, it was proposed that all of CFC 1’s assets and liabilities be transferred to CFC 2 by way of a merger. As a result of the merger, the assets and liabilities of CFC 1 would become that of CFC 2 by operation of law, and CFC 1 would automatically cease to exist.

CFC 2 would issue a single ordinary share – at nominal value, ranking pari passu with all other issued ordinary shares – to the applicant, as consideration for the transfer of the assets and liabilities.

Decision

SARS ruled that the proposed transaction would constitute an amalgamation transaction under Paragraph (c) of the definition of ‘amalgamation transaction’ in Section 44(1) of the Income Tax Act.

The definition refers to a transaction:

“(c) (i) in terms of which an amalgamated company which is a foreign company disposes of all of its assets (other than assets it elects to use to settle any debts incurred by it in the ordinary course of its trade) to a resultant company which is a foreign company, by means of an amalgamation, conversion or merger;

(ii) if –

(aa) immediately before that transaction –

(A) that amalgamated company and that resultant company form part of the same group of companies (as defined in section 1);

(B) that resultant company is a controlled foreign company in relation to any resident that is part of the group of companies contemplated in subitem (A); and

(C) any shares in that amalgamated company that are directly or indirectly held by that resultant company are held as capital assets; and

(bb) immediately after that transaction, more than 50 per cent of the equity shares in that resultant company are directly or indirectly held by a resident (whether alone or together with any other person that is a resident and that forms part of the same group of companies as that resident); and

(iii) as a result of which the existence of that amalgamated company will be terminated.”

CFC 1, and therefore the applicant, would enjoy rollover relief in respect of the transfer of the assets and liabilities (Sections 44(2) and (3)).

The applicant would also enjoy rollover relief in respect of the disposal of its shares in CFC 1 and would establish a base cost in the consideration share issued by CFC 2 equal to the base cost it had in its shares in CFC 1. The issue of the consideration share would also not be treated as a dividend in respect of the shares in CFC 1 (Section (6)(c)).

Since the proposed transaction would constitute an ‘amalgamation transaction’ as defined, Section 9H(6)(a) would also apply to provide relief from any exit charge that could arise as a result of CFC 1 ceasing to be a CFC.

SARS also ruled that Section 24BA, which attempts to curb value mismatches in transactions where assets are transferred in return for the issue of shares, would not apply. Unfortunately it is not clear on what basis SARS ruled that Section 24BA would not apply – specifically, whether it was because there would be no value mismatch, the parties would transact at arm’s length or one of the exemptions in Section 24BA(4) would apply.