Exclusion of certain companies and shares from “group of companies”

Article by: IBFD

On 11 February 2020, the South African Revenue Service (SARS) published an Interpretation Note 75 (Issue 3) (the Note)on the exclusion of certain companies and shares from a “group of companies” as defined in section 41(1) of the Income Tax Act 58 of 1962 (the ITA). The purpose of the Note is to provide guidance on the application of the proviso to the definition of “group of companies” in section 41(1) of the ITA, which contains a narrower definition, which is generally applicable for the purposes of corporate rules.

Under specific circumstances, corporate rules provide relief from income tax if assets are disposed of among companies forming part of the same group of companies as defined in section 41(1) of the ITA. These relief measures defer the income tax payable on income and capital gains until the asset is disposed of to a third party or until a degrouping occurs.
The definition of “group of companies” in section 41(1) begins with the definition in section 1(1) (wider definition) and subsequently excludes specified companies and shares by way of a proviso (paragraphs (i) and (ii) of the proviso).

The main issue considered by the Note is whether, after excluding the companies and shares listed in the proviso, the remaining companies meet the requirements of the definition of “group of companies” in section 41(1). In addressing the above issue, the Note states that, based on the definition of “group of companies” in section 41(1), for a group of companies to exist as such, it must have a “controlling group company” and one or more “controlled group companies”. It concludes that a group that does not have a “controlling group company” after applying the proviso cannot comprise a “group of companies” for the purposes of the definition of that term in section 41(1). Similarly, a company whose equity shares are deemed not to be equity shares under paragraph (ii) of the proviso cannot have a “controlling group company” and, accordingly, is excluded from forming part of a “group of companies” as defined in section 41(1).

The Note also considers the question of whether the exclusion of specified companies may be considered tax discrimination under tax treaties. In this regard, the Note states that, in deciding this issue, it is necessary to determine whether two resident subsidiaries of a resident parent company which are in a similar position would be denied group relief. The Note provides that the proviso does not discriminate against resident companies because they are wholly or partially owned or controlled, directly or indirectly, by one or more non-resident parent companies; instead, it does so because the parent companies are not liable to taxation in South Africa, except on South African-source income and capital gains on South African immovable property and assets of a permanent establishment in South Africa. The Note further states that the relief is also denied to resident subsidiaries of a resident parent company if the parent company is exempt or partially exempt from normal tax in South Africa.

In conclusion, the Note states that article 24(5) of the OECD Model (2017) does not apply if paragraph (i) of the proviso (to section 41(1) of the ITA) excludes a non-resident controlling company from the definition of a “group of companies” because resident companies that are similarly exempt from income tax in South Africa are also excluded from relief under the corporate rules; therefore, the exclusion of non-resident companies by the proviso does not constitute discrimination under South Africa’s tax treaties.

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