1625. Transfer of depreciable assets to connected persons
May 2008 – Issue 105
The taxing acts are scattered with provisions to prevent taxpayers from securing any unwarranted tax benefits apart from the new General Anti-Avoidance Rule. In particular, transactions between connected persons are extremely regulated.
In the context of a group of companies, the Income Tax Act No.58 of 1962 (the Act) defines a connected person as all companies within a group consisting of two or more companies in which the controlling group company directly holds more than 50% of the equity shares in at least one controlled group company, and more than 50% of the equity shares of each controlled group company are directly held by the controlling group company, one or more other controlled group companies, or any combination thereof.
The concept of equity shares means issued shares which do not carry any right to participate beyond a specific amount in a distribution with respect to dividends or capital, for example unrestricted ordinary shares as opposed to non-participating preference shares.
The restrictions imposed on transactions between connected persons are generally concerned with the pricing or the costing of such transactions. In this context, any disposal of an asset to a connected person (whether a depreciable asset or not) will be deemed to be made for consideration equal to the market value of that asset for purposes of calculating capital gains tax or taxable profits. The claiming of allowances or deductions on a depreciable asset acquired by a taxpayer from a connected person used to be limited to an amount not exceeding the lesser of the cost of such asset to such connected person or the market value thereof, as determined on the date on which the asset was brought into use by such person.
The latter type of connected party provision was scattered throughout the Act with little differences between them. Most of these provisions predated capital gains tax, which aimed to prevent connected parties from inflating prices on the transfer of assets from one party to another to gain higher capital allowances. The party transferring the asset needed to recoup the allowances previously claimed. Any gain in excess of the recoupment was considered to be a capital gain. Before capital gains tax, these gains were not subject to tax. Afterwards, they were taxed at 14.5% (now 14%) with respect to companies.
A cause for concern was that these anti-avoidance rules may have been overly harsh, especially where the market value of an asset was in excess of its original cost. Take for example the following situation –
Company A owns 60% of the shares of company B and also in company C. Company B sells depreciable equipment to company C. Company B initially purchased the equipment for R200 000 and depreciated the equipment by R60 000. Company B sells the equipment to company C for R240 000. Company B will trigger a R60 000 recoupment of allowances and a R40 000 capital gain which will be subject to tax. Company C’s future claimable allowances on the equipment used to be limited to R200 000, which for the group would have created a permanent economic tax loss of R5 800 (that is, the tax payable at 14,5% on the R40 000 capital gain).Up to now, the Act has not made any provision to recognise and adjust this permanent tax loss on the tax value of these assets. The Revenue Laws Amendment Act No. 35 of 2007 introduced a welcome new regime, effective from 1 January 2008, for the uniform treatment of all connected party transactions regarding depreciable assets. This Act deleted all of the scattered connected person provisions relating to depreciable assets and combined them into one single new section 23J.
While the old regime limited depreciable costs to the lower of the connected seller’s cost or the market value at the time of the connected person’s sale, the new regime gives credit for resulting taxation arising from the connected person’s sale.
More specifically, the depreciable tax cost for the connected purchaser is equal to the sum of –
· the cost (taking into account any subsequent tax allowances) of the depreciable asset to the connected person seller; plus · all ordinary revenue triggered upon the connected person’s sale as well as any inclusion stemming from the capital gain triggered on the sale.Using the same facts as in the above example, the new section 23J has the following effect –
The depreciable cost for the equipment purchased by company C is equal to R220 000 (R200 000 – R60 000 + R60 000 + R20 000), as opposed to the R200 000 previously mentioned, despite the fact that company C paid R240 000 for the equipment.Section 23J is applicable in all instances where a depreciable asset is acquired by a taxpayer and that depreciable asset was held by a connected person in relation to the taxpayer at any time within a period of two years before the acquisition by the taxpayer. It seems that the 2-year requirement was included to avoid schemes where an intermediate non-connected person is interposed before the asset is acquired by the taxpayer. If the depreciable asset was not held by a connected person in relation to the taxpayer within that period, section 23J is not applicable. Costs of acquisition by the taxpayer may then be used to determine future deductions or allowances. It is unclear whether the provisions of section 23J are applicable if the asset was not a depreciable asset, as defined, in the hands of the connected person.
VAT is generally chargeable on transactions between connected persons calculated with reference to the market value of the goods or services, unless zero-rating applies in cases where goods are transferred as a going concern and the requirements of section 11(1)(e) of the VAT Act are complied with, or the goods are transferred in terms of a transaction contemplated in sections 42 to 47 of the Act.
Notwithstanding these changes, readers should bear in mind that in a group of companies where the controlling group company holds directly or indirectly more than 70% of the shares in the controlled group companies, the parties may elect that section 45 of the Act is applicable to the transaction which deems the transaction to take place at tax value. The effect of that section on a depreciable asset is that no recoupment of previous allowances or any capital gain occur for the purpose of the seller and for the purpose of the purchaser, the parties are deemed to be one and the same person with respect to the date and cost of acquisition of the asset and to the allowances previously claimed. These provisions are efficient tax planning tools, widely used by taxpayers.
Edward Nathan Sonnenbergs Inc.
IT Act:S 1 definition of "connected person",
VAT Act:S 11(1)(e)
Editorial Comment: Refer item 1601.
