Do the homework before your company merger in South Africa

The Companies Act 71 of 2008 (Companies Act) introduced a new regime to South African corporate law whereby two or more companies can merge their respective assets and liabilities into one or more combined companies (we refer to this as a “statutory merger”).

The Companies Act defines an “amalgamation or merger” to essentially include any transaction where: (1) Each of the merging companies are dissolved and the assets and liabilities of these merging companies are transferred to a newly formed company or companies; (2) No new company is formed but at least one of the merging companies survives and the assets and liabilities of the non-surviving merging companies, which are subsequently dissolved, are transferred to the surviving company or companies.

The reform was aimed at providing an uncomplicated framework for company mergers. However, the tax legislation in South Africa is not fully aligned with the new Companies Act. Some of the key issues are below.

Rollover relief provisions

South Africa does not allow for taxation on a group or consolidated basis. However, in terms of the Income Tax Act 58 of 1962 (Income Tax Act), certain transactions undertaken within groups of companies may be implemented so that the tax consequences otherwise resulting from the transactions are deferred or rolled over until some later event. These transactions are: asset-for-share transactions (section 42); amalgamation transactions (section 44); intra-group transactions (section 45); unbundling transactions (section 46); liquidation distributions (section 47).

Traditionally, tax rollover relief was only available where the above transactions were entered into between the members of a group of companies. As from 1 January 2012 the asset-for-share, amalgamation, unbundling and liquidation rules have been extended to cover the restructuring of offshore companies under the control of South African multinational groups.

Tax rollover relief is subject to a transaction meeting the specific requirements of a rollover relief provision. In many instances these requirements differ from the statutory merger provisions. For example, a general misconception exists that a statutory merger necessarily qualifies as an “amalgamation transaction” under section 44 of the Income Tax Act. However, section 44 limits tax relief to certain types of transactions, involving specific share issues and debt assumptions, whereas the statutory merger provisions envisage the transfer of all assets and liabilities to the acquiring company. Although there is currently no automatic rollover of the tax position of the merging companies, certain changes have been introduced by the Taxation Laws Amendment Act of 2011 which do improve the alignment of the tax and corporate regimes.

However risk areas remain. Should an “amalgamation or merger” wholly or partly fall outside the ambit of the rollover relief provisions, the transaction may trigger unexpected income tax, capital gains tax, value-added tax, transfer duty, and/or securities transfer tax in the hands of any parties involved.

Transfer of liabilities

One effect of the statutory merger rules is to transfer certain tax obligations to the merged entity. Oddly, the statutory merger provisions fail to deal with the allocation of obligations in the case of multiple acquiring or merged companies. In such cases it may become unclear exactly by which of these companies the liability or obligation is owed.

The commercial exposure may be intensified by the imminent Tax Administration Bill. Certain provisions of this Bill will increase tax exposures and liabilities not only for the merged entity, but also for shareholders and financial management personally. It was recently announced in the 2012 Budget Review that the Bill will be promulgated and most of its provisions brought into force in 2012.

Cause of merger crucial

A crucial issue is to determine the underlying cause of the fusion of assets and liabilities of parties entering into an “amalgamation or merger” transaction.

Arguably, assets and liabilities of the target company transfer to the acquiring company by virtue of the underlying contract between the parties. Should this be the case, the traditional contractual mechanisms used (e.g. the transfer of business agreement) would govern the transaction.

The tax implications of the transaction would be dictated by the type of agreement used and should be in line with the usual tax implications arising from such agreements, possibly also by the tax rollover rules, if applicable. Alternatively, it could be argued that the statutory merger provisions created a new method of transferring assets and liabilities between merging entities, namely the mere operation of law (i.e. ex lege). There are good legal arguments in favour of this interpretation and, if correct, the statutory merger provisions may have far-reaching tax implications.

First, it arguably extends the ambit of the merger rules to contractual mechanisms not traditionally used to effect mergers (e.g. an agreement for the sale of a business as a going concern, followed by the winding up of the seller). These alternative mechanisms may become useful in effecting an amalgamation or merger.

Second, assets will not be transferred in return for anything (e.g. cash, shares or assumption of debt) and the transaction would arguably take place for no consideration. Various anti-avoidance provisions in the Income Tax Act that are aimed at non-arm’s length transactions between connected persons may be triggered. Typically, these provisions deem a transaction to have taken place at market value. The acquisition of fixed or trading assets without a cost can also be problematic if the tax rollover rules do not apply to the specific case.

Further changes

The statutory merger rules envisage the new merged company stepping into the shoes of the old merging company for commercial purposes. However, there are no explicit rules in the Income Tax Act treating or deeming these parties to be one and the same person for tax purposes. In his 2012 Budget Review, the Minister of Finance acknowledged that the rewrite of the Companies Act gave rise to anomalies in relation to tax and announced that the South African government is reviewing the nature of company mergers, acquisitions and restructurings with a view to possibly amending the Income Tax Act and/or Companies Act over a two-year period.

In the meanwhile, corporates intending merger transactions should pay special attention to the attendant tax implications of their proposed transactions and not assume that the statutory merger regime has made it unnecessary to consider the tax effects of these transactions.

Robert Gad is a director and Janel Strauss is an associate with Edward Nathan Sonnenbergs (ENS)

Johannesburg

150 West Street

Sandton

Johannesburg

South Africa

2196

Tel: +27 11 269 7400

Fax: +27 11 269 7899

E-mail: info@ens.co.za

www.ens.co.za