General
1208. Deregistration of dormant companies
August 2004

Introduction

Section 73 of the Companies Act, Act 61 of 1973 allows for a company to be struck off the company register where it no longer trades and has no assets or liabilities. The deregistration route is often used in those cases where a company no longer serves any useful purpose and all its profits have been distributed to its shareholders. The question that arises from time to time is the manner in which a company that reflects an accumulated deficit and a significant loan payable to its shareholders and other creditors should be dealt with in order to bring the company’s existence to an end.

In such a case, the deregistration route is not available because of the fact that the company reflects amounts payable to its shareholders and thus has liabilities. If the shareholder chooses to waive the loan payable by the investee company, the company may face an unexpected tax liability. This is in accordance with the provisions paragraph 12(5) of the Eighth Schedule of the Income Tax Act, Act 58 of 1962, as amended ("the Act").

Waiver of loans

Prior to the introduction of capital gains tax, there was no difficulty facing a company that benefited as a result of its shareholder waiving a loan payable by the investee or subsidiary company. After 1 October 2001, the date upon which capital gains tax took effect in South Africa, it is not possible to waive a loan payable by one person to another without taking account of the capital gains tax consequences that can arise therefrom. This is by virtue of the provisions of paragraph 12(5) of the Eight Schedule of the Act which states as follows:

"

a) Subject to paragraph 67, this sub-paragraph applies where a debt owed by a person to a creditor has been reduced or discharged by that creditor -

i) for no consideration; or

ii) for a consideration which is less than the amount by which the face value of the debt is being so reduced or discharged,

but does not apply where:

aa) the amount of that reduction or discharge -

A) constituted a capital gain in terms of paragraph 3(b)(ii); or

B) has been taken into account in terms of section 8(4)(m) or 20(1)(a)(ii) or paragraph 20(3); or

bb) that person and that creditor are members of the same group of companies unless -

A) that debt (or any substituted debt) was acquired directly or indirectly from a person who is not a member of that group of companies; or

B) that person or another person became members of that group of companies after that debt (or any substituted debt) arose;

and these transactions were part of a scheme to avoid any tax otherwise imposed by virtue of this subparagraph."

Before considering the impact of paragraph 12(5) of the Eighth Schedule, it is necessary to be satisfied that the waiver of the loan concerned does not result in the company’s assessed loss being reduced in terms of section 20 of the Act or if not, whether income tax becomes payable as a result of the provisions contained in section 8(4)(m) of the Act.

If the debtor company reflects an assessed loss, the loss will firstly be reduced by the amount of the debt waived. This is by virtue of the fact that the company’s position is enhanced as a result of the waiver of the debt in question, in accordance with the provisions of section 20 of the Act.

In the event that the loan under consideration arose out of trading transactions concluded between two companies and comprises amounts of interest, management fees, or the consideration due for the purchase of goods by one company to another, the waiver of such a debt will be regarded as a recovery or recoupment of the expenditure previously claimed by the debtor company. This is in accordance with the provisions of section 8(4)(m) that deems the waiver of any debt to give rise to a recoupment of any expenditure previously claimed by the debtor company.

Where, however, neither section 8(4)(m) nor section 20 apply, the debtor company will become liable to capital gains tax unless it can be shown that the loan was payable to a company that is regarded as part of the same group as that term is defined in the Act.

Section 1 of the Act contains a definition of "group of companies" which means:

"two or more companies in which one company (hereinafter referred to as the "controlling group company") directly or indirectly holds shares in at least one other company (hereinafter referred to as the "controlled group company") to the extent that –

a) at least 75 per cent of the equity shares of each controlled group company are directly held by the controlling group company, one or more controlled group companies or any combination thereof; and

b) the controlling group company directly holds 75 per cent or more of the equity shares in at least one controlled group company;"

Thus, where company A owns all the shares in company B and company B has ceased trading and reflects an accumulated deficit and a loan payable to company A, it will be possible for company A to waive the loan payable by company B without company B facing any adverse tax consequences. Where, however, a natural person owns the shares in the company concerned, the waiver of the debt will give rise to capital gains tax payable by the investee company. The company in such a case is for all intent and purposes insolvent and it remains to be seen how SARS will ever recover the tax that arises under the provisions of paragraph 12(5) of the Act.

Concerns relating to this issue were considered in chapter IV of the 2003 Medium Term Budget Policy Statement where at page 55 the following was stated:

"During the comment process for the 2003 Revenue Laws Amendment Bill, the National Treasury identified growing concerns about the tax treatment of debt cancellations. Under current law, a debtor generally makes a capital gain if that debtor’s liabilities are cancelled. This stems from the notion that a debtor is enriched from the cancellation of the debt to the same extent as if that debtor received direct infusions of cash. On this view, tax principles demand comparable tax treatment. However, there are difficulties with this approach. The laws relating to insolvency are partly designed so that indebted businesses can restructure their debts and re-emerge as viable operations, thereby protecting productive capital and employment, for example. Any taxation of such debt cancellations works against this intent. Relief for debt cancellation was included in the 2003 Revenue Laws Amendment Bill in respect of intra-group debt. Other relief options will be reviewed in 2004."

It remains to be seen if the legislature will intervene to allow for those companies that are dormant to benefit from the waiver of debt by company shareholders who do not hold 75% or more of the company shares or by natural persons. Failure to address this issue will result in such companies lingering forever on both the companies and tax registers.

Such companies cannot be deregistered for the reason that they have liabilities payable and the only route available to terminate the company’s existence is to place the company into liquidation. However, this is an expensive process and if the shareholders waive the debt payable to the investee company, capital gains tax will become payable. It would be far preferable if the legislature intervened to allow for those companies that are no longer trading and did not derive any tax advantage at the time the loan arose, to be deregistered without capital gains tax becoming payable on the waiver of such loans.

Conclusion

Extreme caution must be exercised if the decision is made to waive a debt due by one company to another. The waiver of debt, as pointed out above, can either result in income tax becoming payable if the waiver falls into the rules contained in section 8(4)(m) of the Act or alternatively, capital gains tax in the event that the waiver of the debt falls within the rules contained in paragraph 12(5) of the Eighth Schedule of the Act.

Edward Nathan Friedland

IT Act:S 8(4)(m),

IT Act:S 20,

IT Act:8th Schedule par 12(5)

Companies Act: s73