Professor Emil Brincker, director and national practice head, tax, Cliffe Dekker Hofmeyr issued by www.moneywebtax.co.za
Does the conversion of par value shares by a company into no par value shares result in a tax liability, asks Professor Emil Brincker.
Since the introduction of the new Companies Act on May 1 2011, consultants have battled with the problem as to whether the conversion of par value shares by a company into no par value shares will result in a tax liability for purposes of the Eighth Schedule to the Income Tax Act, No 58 of 1962.
Even though Sars has indicated that no formal general ruling will be issued to this effect, some guidance has been given in the fourth edition of the Capital Gains Tax Guide (the Guide) that was published during December 2011.
It is important to note that existing companies do not automatically need to convert par value shares into no par value shares to the extent that existing authorised share capital is still available for this purpose. The shares only need to be converted if no sufficient authorised share capital is available so as to cater for the issue of the new shares. In particular, regulation 31(3) indicates that one cannot issue par value shares if no shares in that class have been issued out of the authorised shares in that class or, if they have been issued, they were all repurchased.
Any conversion into no par value shares may not be designed substantially or predominantly to evade the requirements of any applicable tax legislation in terms of regulation 31(6). It is not clear what the rationale is of this potential tax avoidance provision in the company laws, as it is submitted that there are more than sufficient protection mechanisms built into the Act. In fact, it seems that the avoidance provision in regulation 31(6) only has one requirement, ie any design substantially or predominantly to evade the requirements of any applicable tax legislation. Generally the concept of “substantially” can be interpreted to be significant as opposed to being more than 50%. In other words, it is a very wide anti-avoidance provision that has now been incorporated in a regulation, which is not even part of the substantive legislation. It is doubtful whether this provision will stand up to any attack from a constitutional or administrative perspective.
Should a decision be made to convert the par value shares into no par value shares, the board of directors of a company is required to prepare a report that sets out amongst others the following issues:
The material effects that the conversion will have on the rights of the holders of the securities; and
An evaluation of any material adverse effect of the conversion against the compensation that any of the shareholders may receive in terms of the conversion process.
Before any conversion takes place, a copy of the proposed resolution must be filed with the CIPC as well as Sars. Sars is then entitled to apply to the court for a declaratory order at any time before the shareholders meeting is called.
In the Guide, it is indicated that a share constitutes a bundle of rights. However, paragraph 11(1)(a) provides that any conversion of an asset constitutes a disposal for purposes of the Eighth Schedule. In the Guide, it is indicated that there will be no disposal if the rights of the shareholders remain unchanged following the conversion process. If some of the rights are lost or diminished, it is indicated that there will be a disposal or part disposal. Whether the reduction in rights triggers a disposal “is a question of degree and will depend on the facts of the particular case”. Should a shareholder receive compensation, that would clearly constitute proceeds.
Although the indication in the Guide can be welcomed, shareholders unfortunately have to continue dealing with a state of uncertainty given the absence of any specific guidance from Sars. Even though we agree with the views expressed in the Guide, the risk is always that an overzealous assessor can adopt a technical interpretation to the conversion of the par value shares into no par value shares, resulting in a company having to incur substantial costs so as to justify the argument that there is no disposal in circumstances where the conversion takes place from a company law perspective. It is also not clear to what extent taxpayers will have to embark on an administrative process to satisfy Sars each time that the conversion process is not subject to attack. Sars can expect to be swamped with reports as and when companies can no longer issue shares from existing authorised share capital.
A more controversial issue relates to whether any securities transfer tax is payable on the substitution of the par value shares with no par value shares. In the Securities Transfer Tax Act, reference is made to the fact that a transfer includes the transfer, sale, assignment or cession, or disposal in any other manner of a security, including the cancellation or redemption thereof. Given the fact that it is settled that any buyback of shares is subject to securities transfer tax (STT), it may well be that from a technical perspective STT will become payable on the conversion of par value shares into no par value shares given the fact that the existing shares are technically cancelled and substituted.