SOUTH AFRICA: Proposed section 45 moratorium holds adverse tax implications for private equity

Issued by Meropa Communications on behalf of Lele Modise and Hannine Drake, Bowman Gilfillan

On 2 June 2011, the National Treasury (“Treasury”) released the Draft Taxation Laws Amendment Bill, 2011 (the “Draft Bill”) for public comment. The Draft Bill is intended to give effect to certain matters presented by the Minister of Finance, Pravin Gordhan, in the 2011 budget review tabled in Parliament earlier this year. Arguably the most controversial amendment in the Draft Bill is the proposed moratorium on the use of section 45 (“Section 45”) of the Income Tax Act 58 of 1962 (the “Income Tax Act”). Should the Draft Bill be passed in its current form, the moratorium will apply to all relevant asset disposals made on or after 3 June 2011 and before 1 January 2013.

The moratorium took the investment industry by surprise as there was no prior announcement in relation to the moratorium by the drafters of the Draft Bill prior to its release. Section 45 is one of the cornerstone tax provisions relied upon for many restructurings and mergers and acquisitions, including private equity transactions. Black economic empowerment (“BEE”) transactions, which comprise a significant portion of private equity transactions in South Africa, will also be adversely affected by the moratorium on the use of Section 45, as they are mostly highly leveraged.

Treasury has now taken the view that the use of Section 45 in the leveraged buyout and acquisition context has encouraged excessive debt financing and other aggressive funding structures. Section 45, according to Treasury, was originally intended to ensure that intra-group transfers of, for example, trading stock, between companies “historically operating together” may take place without significant tax hurdles. Industry lobby groups have since the release of the Draft Bill, argued that a more targeted approach is needed by Treasury as the moratorium would severely harm the private equity, restructuring and acquisition industry.

On 29 June 2011, Treasury and the South African Revenue Service (“SARS”) announced an accelerated consultation process whereby interested parties were encouraged to meet with Treasury and SARS between 30 June and 8 July 2011 to discuss the details of specific transactions contemplated or in progress. Treasury and SARS indicated that, should they find that the transaction not “erode the tax base and [be] purely commercial”, they will provide “assurance” to such interested parties. The exact extent of this assurance is unclear at this stage, but presumably Treasury and SARS contemplate providing interested parties with a red or green light on their proposed transaction structures. Treasury and SARS also indicated that they remain committed to use section 45 to enable BEE transactions, which provides a potential reprieve for the BEE industry.

Should assurance from Treasury and SARS not be sought, or should assurance be sought and not granted, the negative impact of the proposed moratorium will be at least two-fold: Firstly, the industries that typically rely on Section 45 will have to resort to untested alternative and possibly less tax-efficient methods to structure their transactions going forward. Secondly, the immediate effective date of the moratorium and lack of warning by Treasury will require that transactions that were in progress on 2 June 2011 (when the proposed moratorium was announced) be immediately restructured pending further clarity from Treasury. This may lead to significant increases in fees and potential share price losses. Transactions finalised on 2 June 2011, but subject to suspensive conditions such as regulatory approval, will be similarly affected by the moratorium.

As Treasury seems to be taking a conservative approach to the industry’s established use of roll-over tax relief, parties contemplating or intending to rely on other tax roll-over provisions such as sections 44 or 47 of the Income Tax Act, may wish to consider clarifying their intended use of any roll-over provisions with the tax authorities from the outset of their transactions.

The timeframe for public comments on the Draft Bill, at the time of publication of this article, will have expired by 5 July 2011. Proposed rules to the Draft Bill are expected to be released for public comment in mid-July and the Draft Bill is due to come before Parliament in August.

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