New limitation on asset-for-share transactions

A worrying inclusion in the Revenue Laws Amendment Bill 2008 ("RLAA") is an unwelcome limitation on asset-for-share transactions introduced into section 42 of the Income Tax Act, 1962. An asset-for-share transaction is one of the rollover relief transactions and applies where a person transfers an asset to a company and the consideration due by the company is settled by way of an issue of shares to the transferor.

Section 42(1)(b) of the Act sets out rules which stipulate the intention with which a transferee must be deemed to have acquired an asset under an asset-for-share transaction and, generally speaking, this will depend on the historical intention of the transferor in relation to that asset. The existing provision states that the acquiring company acquires the asset-

"…(i) as a capital asset or as trading stock, where that person holds it as a capital asset; or

(ii) as trading stock, where that person holds it as trading stock…"

As it stands, the provision makes sense as it prevents parties entering into an asset-for-share transaction from changing an asset held on revenue account into a capital asset, but allows assets which are held as capital assets by the transferor to be acquired by the transferee either as capital or revenue assets depending on the facts.

In terms of section 49 of the RLAA, section 42(1)(b) will be amended with effect from 1 January 2009 to read:

"…(b) as a result of which that company acquires that asset from that person –

(i) as trading stock, where that person holds it as trading stock;

(ii) as a capital asset, where that person holds it as a capital asset; or

(iii) as trading stock, where that person holds it as a capital asset, and that company and that person do not form part of the same group of companies."

We submit that the effect of this change is that, where an asset-for-share transaction is concluded between parties that are not group companies, the acquiring company will now be forced to acquire that asset as a revenue asset, notwithstanding how the transferor may have held the asset historically or how the transferee intends to hold the asset in the future.

In our view, this cannot have been the intention of the legislature as section 42 of the Act is one of two roll-over relief transactions that can be undertaken by parties not in the same group of companies. In its proposed form, however, the amendment makes it impractical for parties which are not group companies to utilise asset-for-share transactions because the transferee will be forced to acquire the asset as trading stock. Given that group companies would normally rely on the provisions of section 45 of the Act to transfer an asset intra-group, this amendment is all the more peculiar.

The Explanatory Memorandum to the RLAA does not give any clarification on this point as it suggests that what Treasury sought to achieve was that group companies transferring an asset in terms of section 42 would be forced to retain the intention of the transferor in relation to the asset transferred (which goal has been achieved). The amendment however goes much further than this stated goal for non-group companies.

We will raise this apparent anomaly with Treasury and hopefully iron it out. In the meantime any parties that are considering entering into an asset-for-share transaction after 1 January 2009 (which is just around the corner) should make sure that they –

• qualify for the roll-over relief contemplated (i.e. if they do not form part of the same group of companies, that the transferee intends to acquire the asset as trading stock); and/or
• do not unwittingly force a transferee into acquiring an asset as trading stock.