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FEBRUARY 2015 – ISSUE 185

CONTENTS

COMPANIES

2385. Asset for share transactions

The Income Tax Act No. 58 of 1962 (the Act) contains a number of provisions

in terms of which assets may be transferred from one taxpayer to another on a

tax-free basis, with the tax in relation to such an asset being deferred until the

transferee eventually disposes of the asset. One such provision is contained in

section 42, dealing with “asset-for-share transactions”.

COMPANIES

2385. Asset for share transactions

2386. Venture capital companies: the

investors

MINING

2389. Provision for mining

rehabilitation

DEDUCTIONS

2387. Improvements on Government

land

TRUSTS

2390. Pitfalls in dealing with trusts

GENERAL

2388. Conducting farming operations

SARS NEWS

2391. Interpretation notes, media

releases and other documents

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An asset-for-share transaction is essentially a transaction in terms of which a

person (the Transferor) disposes of an asset to a company (the Company) in

exchange for the issue of shares by the Company, provided the Transferor holds

a qualifying interest in the Company at the end of the day of the transaction

(broadly speaking, 10% of the equity shares and voting rights in an unlisted

company, or any equity shares in a listed company). In addition, certain

qualifying debt may be assumed by the Company as part of the asset-for-share

transaction, without prejudicing the application of section 42.

Broadly speaking, in relation to capital assets, an asset-for-share transaction

results in no capital gain for the Transferor with the Company acquiring the

asset at the same base cost at which the Transferor held it. The base cost of the

asset accordingly “rolls over” to the Company and the deferred capital gain on

the asset is accordingly only triggered when the Company disposes of the asset,

unless any relief finds application at such time. In addition, the Transferor

acquires the shares in the Company at a base cost equal to the base cost at which

it held the asset disposed of to the Company.

Section 42(8) provides that a proportionate part of any qualifying debt that was

assumed by the Company as part of an asset-for-share transaction will constitute

an amount received by or accrued to the Transferor in respect of the disposal of

any of the shares in the Company acquired in terms of the asset-for-share

transaction, should such shares be disposed of by the Transferor. Essentially,

section 42(8) provides that the Transferor will have additional proceeds upon

the disposal of the shares equal to a proportional amount of the debt that was

assumed by the Company.

The reason for this provision appears to be to counteract the base cost allocated

to the shares in terms of section 42 where the assets disposed of are geared. For

example: Person A borrowed R100 from a bank and utilised the funding to

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acquire an asset. The asset accordingly has a base cost of R100 in the hands of

Person A. Assume the asset grows in value to R150. Person A then disposes of

the asset to Company B in exchange for the assumption of the R100 debt and

the issue of shares in Company B. Simplistically speaking, the value of the

shares acquired by Person A in Company B will be R50 (being the net asset

value). However, in terms of section 42, the base cost at which Person A will

acquire the shares in Company B, will be deemed to be equal to the base cost at

which Person A held the asset, i.e. R100. But for the application of section

42(8), if Person A were to dispose of the shares in Company B at their market

value (R50), Person A will trigger a capital loss of R50 (R50 proceeds less

R100 base cost). However, in terms of section 42(8), Person A will be deemed

to have additional proceeds equal to the debt that was assumed by Company B

in terms of the asset-for-share transaction, in this case R100. This will result in

Person A triggering a capital gain of R50 upon a disposal of the shares (R50

real proceeds plus R100 deemed proceeds, less R100 base cost) which mimics

the commercial gain of Person A.

Generally, the application of section 42(8) does not place the Transferor in a

worse position than would have been the case had it retained the asset and was

taxed on the growth in value in the asset. However, the application of section

42(8) could have detrimental consequences in certain instances:

Firstly, most of the roll-over relief provisions in the Act do not contain

explicit roll-over relief in relation to the deemed additional proceeds

triggered in terms of section 42(8). Accordingly, should shares acquired

in terms of an asset-for-share transaction be disposed of in terms of

another transaction qualifying for corporate roll-over relief, such relief

may not cater for a gain which may arise as a result of the application of

section 42(8). Furthermore, the roll-over relief provisions may result in a

rolled-over base cost for the transferee, despite a capital gain being

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triggered in the hands of the Transferor as a result of the application of

section 42(8);

Secondly, section 42(8) may give rise to detrimental consequences where

the debt that was assumed in terms of the asset-for-share transaction was

not applied in order to fund fixed assets (but, for example, to fund

working capital in the case of a sale of a business in terms of an asset-for-

share transaction). In such an instance, the base cost of the shares will not

equate to the debt that was assumed in terms of the asset-for-share

transaction, which may result in additional tax in the event of the disposal

of the shares.

Lastly, it is important to remember that there is no time limitation to the

application of section 42(8). In terms of current law, it will continue to find

application to a disposal of shares acquired in terms of an asset-for-share

transaction, irrespective of the time period that elapses between the asset-for-

share transaction and the future disposal of the shares. This is a further aspect

which should be borne in mind, inter alia, in determining whether an asset-for-

share transaction is an appropriate arrangement in terms of which to implement

a disposal.

ENSafrica

ITA: Section 42

2386. Venture capital companies: the investors

(Refer to article 2347 in the October 2014 – Issue 181)

Introduction

This is the second in a series of articles on venture capital companies. This

article looks at the conditions relating to the investors. In particular, it looks at

the way the investors are permitted to hold their investments in the venture

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capital company (VCC) in order to qualify for the tax concessions available to

them and with transactions within the VCC.

Venture capital companies – the investment process

The tax treatment of the investors

Who are the investors?

Investors in VCCs may be individuals or corporate entities. Under certain

circumstances, individuals who subscribe for shares in VCCs may consider that

investment as part of their retirement planning, particularly in the light of

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forthcoming retirement funding restrictions. Individuals may choose to invest

directly in VCCs or through intermediate passive investment holding companies

which will benefit from the dividends tax exemption and in certain cases lower

rates of corporate income tax at 28% compared to individuals where the highest

rate of personal income tax is 40%. However, companies suffer higher rates of

capital gains tax compared to individuals: 18.6% compared to 13.3%

respectively.

Operating companies which invest in VCCs should consider, apart from the tax

benefits, whether such investment qualifies for enterprise and social

development points in terms of the broad based black economic empowerment

codes.

Upfront income tax relief

VCC investors enjoy an immediate tax deduction equal to 100% of the amount

invested with no annual limit or lifetime limit (section 12J of the Income Tax

Act No. 58 of 1962 (the Act)). The tax relief is available provided that the VCC

investor subscribes for equity shares (as defined in section 1(1) of the Act), as

opposed to buying them second hand from other VCC investors.

The VCC scheme only applies to VCC shares acquired on or before

30 June 2021. The VCC investors must support their claim for a tax deduction

with a certificate issued by the VCC stating the amounts invested in the VCC

and that the Commissioner approved that VCC.

The table below compares the effect of the upfront income tax relief on an

individual, trust or company VCC investor. It assumes that the investor

subscribes for shares in the VCC in an amount of R100,000. Although

individuals are taxed at progressive rates of income tax it is assumed for the

purpose of this example that the individual is in the 40% income tax bracket.

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Table 1. The effect of the upfront income tax relief

Individual /

Trust investor

Company

investor

Cost of the VCC investment

Subscription in VCC shares R100,000 R100,000

Income tax rate 40% 28%

(Less) tax relief (R40,000) (R28,000)

Net cost of the investment R60,000 R72,000

Initial value of the VCC

investment

Gross subscription by the investor R100,000 R100,000

Issue costs (say 5%) R5,000 R5,000

Initial net asset value R95,000 R95,000

Initial uplift: (Rand) R35,000 R23,000

Initial uplift ( As a percentage of

net cost)

58% 32%

Taxable recoupment

The Act specifically makes taxable any recoupment or recovery of an amount

which was allowed to be deducted under the provisions of section 12J.

According to the Taxation Laws Amendment Bill there will be no claw back of

the upfront income tax relief if the VCC shares are held by the VCC investor for

5 years.

VCC shares are not listed

Unlike shares in real estate investment trusts there is no statutory requirement

for VCC shares to be listed. Thus, VCC shares tend to be highly illiquid.

No capital gains tax (CGT) relief

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The investor does not enjoy any VCC-specific CGT exemption on the disposal

of the VCC shares. Accordingly, CGT is payable upon the sale of the VCC

shares. For individuals the maximum rate of CGT is 13.3%; for companies,

18.6%, and for trusts, 26.6%. Where a VCC investor claims the section 12J tax

deduction on the subscription price for the VCC shares then the base cost of the

VCC shares will be reduced to zero. As a result the investor will not have any

base cost in the VCC shares to shield the subsequent proceeds from CGT. To

make the investment in a VCC more attractive, an exemption from CGT on the

disposal of the VCC shares would be welcomed.

Dividends tax

Investors will seek to make a return on their VCC investments either through

dividends arising from dividends paid by the underlying companies to the VCC

or dividends arising from the VCC disposing of the shares in the underlying

companies.

Dividends received by the VCC investors in respect of their VCC shares are

subject to the 15% dividends tax unless the investor qualifies for an existing

dividends tax exemption. SA resident company VCC investors will enjoy the

company-to-company dividends tax exemption. However, individual VCC

investors remain subject to the 15% dividends tax.

No CGT reinvestment relief

It is not possible for an investor to defer the gain on another investment by

applying the sale proceeds to subscribe for VCC shares. Thus, investors that sell

their, say, Sasol or MTN shares in order to reinvest the proceeds in VCC shares

will be subject to CGT on the sale of the Sasol or MTN shares. The after-tax

proceeds from the sale of those shares may then be invested in VCC shares.

No capital loss relief against income

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Losses of a revenue nature can usually be set off against both income and

capital gains, while capital losses may only be set off against capital gains. An

investor in VCC shares that derives a capital loss (although very unlikely) will

not be able to set off that capital loss against its income gains.

The investment in the VCC must take the form of equity shares

Equity shares are defined more restrictively than shares

The section 12J deduction is limited to a subset of shares defined as ‘equity

shares’. The terms ‘shares’ and ‘equity shares’ are used frequently throughout

the Act. The ‘equity share’ incorporates the ‘share’ definition (equity share

means any share) with an important exclusion. Equity shares exclude so-called

fixed rate shares. Thus, where a share entitles an investor to a fixed rate

dividend it is excluded from the definition of equity share.

Debt instruments ineligible

Since the tax relief is limited to ‘equity shares’, it follows that VCC investors

will not qualify for the section 12J tax deduction if they subscribe for debt

instruments in the VCC.

Hybrid equity instruments and third party backed shares ineligible

The VCC scheme also excludes hybrid equity instruments and third-party

backed shares as these types of instruments have features in common with debt

instruments and are therefore considered safer forms of investment.

Can a VCC investor borrow to fund its investment?

Although there is no prohibition on VCC investors borrowing funds to acquire

VCC shares, the calculation of the section 12J deductible amount is subject to a

number of requirements and limiting factors. There are two basic requirements:

The first requirement: has the taxpayer used any loan or credit for the

payment or financing of the whole or any portion of the VCC shares?

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The second requirement: does the taxpayer owe any portion of the loan or

credit at the end of the tax year?

If the answers to both requirements are ‘yes’, then the taxpayer has cleared the

first hurdle.

The second hurdle is a limiting factor. The amount which may be taken into

account as expenditure that qualifies for a deduction must be limited to the

amount for which the taxpayer is deemed to be ‘at risk’ on the last day of the

relevant tax year.

A taxpayer is deemed to be at risk to the extent that the incurral of the

expenditure to acquire the VCC shares (or the repayment of the loan or credit

used by the taxpayer for the payment or the financing of the expenditure to

acquire the VCC shares), may result in an economic loss to the taxpayer were

no income to be received by or accrue to the taxpayer in future years from the

disposal of any VCC shares.

A taxpayer is not deemed to be at risk to the extent that the loan or credit is not

repayable within a period of 5 years from the date on which the loan or credit

was advanced to the taxpayer.

A taxpayer is also not deemed to be at risk to the extent that the loan or credit is

granted directly or indirectly to the taxpayer by the VCC itself.

The exit mechanisms

Unlike a real estate investment trust (regulated by section 25BB of the Act), the

VCC shares do not have to be listed. This means that there is no ready market

for the secondary trade in these VCC shares. It also means that existing

investors cannot exit their investments by placing them for sale on the JSE.

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The absence of a secondary market for the trade in VCC shares makes it

difficult to understand how the proposal in the 2014 National Budget Review

(proposing transferability of tax benefits when investors dispose of their

holdings) would be practically implemented. In reality, VCC shares will be

illiquid. The VCC will have to offer the investors an exit route. Existing

investors will in all likelihood realise value for their investments through:

trade sale of investments by the VCC followed by a distribution of cash

to the investors;

a repurchase of the investors’ VCC shares by the VCC; or

a consolidation and listing of underlying investments and distribution of

shares as dividends in specie to the investors.

Trade sale of investments by the VCC followed by a distribution of cash to

the investors

In a trade sale, the VCC sells all of its shares in an investee company to a trade

buyer, i.e. a third party often operating in the same industry as the company

itself. This method provides a complete and immediate exit from the

investment.

The VCC will be subject to capital gains tax at the rate of 18.6% on the sale of

the shares in the investee companies to the trade buyers. The VCC may

distribute the after-CGT cash proceeds it derives from the trade sale to the VCC

investors. These distributions may constitute a dividend or a return of capital or

a combination of the two. Dividends distributed by the VCC to the VCC

investors generally attract dividends tax at the rate of 15%. Certain VCC

investors such as resident companies are exempt from dividends tax.

Return of capital payments fall under a different system of tax compared to tax

on dividends. Return of capital payments are treated as proceeds subject to

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capital gains tax. The main distinction between a dividends versus a return of

capital distribution is based on whether the distribution comes from Contributed

Tax Capital (CTC). Distributions from CTC qualify as a return of capital while

distributions from other sources qualify as dividends.

Repurchase of the investors’ VCC shares by the VCC

The investors will be subject to either dividends tax or capital gains tax or a

combination of the two on the repurchase of their VCC shares. SA resident

corporate investors will enjoy the dividends tax exemption. Thus, only

individual investors will be subject to the dividends tax. One method for

individual investors to defer the dividends tax is to hold their VCC shares

through a passive investment holding company. The dividends paid by the VCC

to the passive investment holding company will be exempt from dividends tax.

However, the eventual distribution of cash flow from the passive investment

holding company to the individual investor will be subject to dividends tax.

This structure allows the individual investor to defer - not avoid - dividends tax.

On the negative side the passive investment holding company is subject to

18.6% capital gains tax whereas the individual investor is subject to 13.3%

capital gains tax.

There is no capital gains tax exemption at the investor level on the disposal of

VCC shares. The VCC investor – whether an individual or juristic entity – will

be subject to capital gains tax on the repurchase of their shares by the VCC.

There is nothing in the present set of rules that prevents a VCC investor selling

its shares back to the VCC and using the proceeds to subscribe for another

shareholding in the VCC. Although there are no rules that prevent the

aforementioned repurchase-followed-by re-subscription scenario there are two

rules that lessen the tax benefit for the VCC investors.

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The first is that the VCC legislation contains a rule that an investor that

becomes a ‘connected person’ in relation to the VCC after the subscription for

the VCC shares is not allowed the upfront income tax deduction. However, a

corporate investor only becomes a connected person in relation to the VCC if,

inter alia, it forms part of the same group of companies as the VCC or if it holds

at least 20% of the equity shares or voting rights in the VCC and no other

shareholder holds the majority voting rights in the VCC. If a corporate investor

keeps its shareholding below these limits and avoids the connected person

classification, then it may be able to benefit from this arrangement.

The second is that there is presently no capital gains tax exemption for the VCC

investor when it disposes of the VCC shares. The VCC investor will have to

reduce the base cost of the VCC shares by the amount claimed as an income tax

deduction in terms of section 12J. Thus, a VCC investor which subscribes for

VCC shares for R100 000 and claims that amount as a section 12J tax deduction

has a base cost of zero.

Consolidation and listing of underlying investments and distribution of

shares as dividends in specie to the investors

A distribution by the VCC that results in the disposal of shares in the investee

companies generates a capital gain or loss for the VCC at market value as if the

shares distributed to the VCC investors were sold to the VCC investors at

market value. This rule exists as a matter of tax parity within the corporate tax

system – a straight asset distribution should have the same tax impact as the

VCC selling the shares in the investee companies followed by a distribution of

after-tax cash proceeds. The tax considerations should accordingly be similar to

the tax consequences of the trade sale of investments by the VCC followed by a

distribution of cash to the investors which is discussed above.

ENSafrica

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ITA: Sections 1(1) “definition of equity shares”, 12J and 25BB

Taxation Laws Amendment Bill 2014 (The Bill was promulgated as an Act

on Tuesday, 20 January 2015)

DEDUCTIONS

2387. Improvements on Government land

(Editorial note: Published SARS rulings are necessarily redacted summaries of

the facts and circumstances. Consequently, they (and articles discussing them)

should be treated with care and not simply relied on as they appear.)

On 1 October 2014, the South African Revenue Service (SARS) released

Binding Private Ruling 180 (BPR 180) dealing with the question of whether a

taxpayer, who is a party to a Public Private Partnership (PPP), would qualify for

a deduction under section 12N of the Income Tax Act No. 58 of 1962 (the Act)

in respect of improvements effected on land not owned by the taxpayer.

In respect of PPP’s, Government often undertakes to provide underlying land to

a private party for the construction of buildings or the improvement of the land,

without parting with ownership of such land.

Section 12N allows for private parties to a PPP to claim deductions in respect of

improvements effected on land or buildings owned by Government, even

though the private party only has a right of use or occupation of the land.

To qualify under section 12N, a private party must:

hold a right of use or occupation of the land or buildings;

effect improvements on the land or buildings in terms of a PPP;

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incur expenditure to effect the improvements; and

use or occupy the land or buildings for the production of income, or

derive income from the land or buildings.

By way of background, a company incorporated in and a resident of South

Africa (applicant) and a department of the National Government (department)

entered into a PPP in terms of which it was agreed that under the proposed

transaction, the applicant would:

finance, design, construct, operate and maintain a new serviced head

office building for the Department that is to be constructed on land owned

by the Government; and

assume the financial, technical and operational risk for the project.

The applicant would be able to use subcontractors to carry out its obligations for

both the construction and the operational phases of the PPP. The PPP provided

for a unitary payment to be made by the department to the applicant of the

capital amount owed to the applicant, together with interest and service fees.

Furthermore, during the construction phase, the applicant would be granted

possession of and access to the project site to construct the serviced head office

building. The operational phase would commence thereafter.

It is important to note that the applicant would not hold any right of use or

occupation of the land or the serviced head office building by virtue of any term

of the PPP. The applicant would only be given access to the new building

exclusively for purposes of providing the services as described in the PPP.

The issue under consideration before SARS was whether the applicant qualified

for any of the deductions referred to in section 12N in respect of the

improvements effected on land not owned by the taxpayer.

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SARS ruled that the applicant did not comply with the requirements of section

12N and therefore did not qualify for any deduction under any provision

referred to in section 12N.

The Taxation Laws Amendment Bill of 2014 (the Bill) was introduced to

Parliament on 22 October 2014. The Explanatory Memorandum on the Bill

notes that under certain PPP arrangements a private party is not able to meet the

criteria of section 12N. Specifically, the private party will not necessarily have

the right of use or occupation of the land or buildings. The private party could,

for example, only have a right to access the land or building in order to perform

under the PPP. As a result, the private party is not able to claim any deduction

under section 12N and this has an effect on the overall pricing of the project.

The Bill proposes the insertion of section 12NA into the Act, which addresses

the above problem and will essentially allow a private party to claim a special

capital allowance in respect of improvements to State-owned land and buildings

where the Government has the right to use or occupy the land or buildings, and

not the private party.

In order to claim this special allowance, the private party must:

be a party to a PPP agreement with Government; and

incur expenditure of a capital nature.

The proposed insertion of section 12NA to the Act will come into operation on

1 April 2015 and will apply in respect of expenditure incurred to effect

improvements during any year of assessment commencing on or after that date.

It is evident that the insertion of section 12NA to the Act will provide relief to

those private parties to PPPs, who find themselves in a position similar to the

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applicant, where they do not have the right of use or occupation of land or

buildings owned by the Government and to which improvements have been

effected.

Cliffe Dekker Hofmeyr

BPR: 180

ITA: Sections 12N and 12NA

Taxation Laws Amendment Bill of 2014 (The Bill was promulgated as an

Act on Tuesday, 20 January 2015)

GENERAL

2388. Conducting farming operations

If only all judgments were formulated with the elegant reasoning and

perspicacity of the judgment delivered by Rogers J in the Western Cape

Division of the High Court in Kluh Investments (Pty) Ltd v Commissioner for

the South African Revenue Service (case number A48/2014, as yet unreported)

on 9 September 2014.

The appeal was against the dismissal of an appeal brought in the tax court

against an additional assessment levied by the South African Revenue Service

(SARS) in respect of the 2004 year of assessment. SARS added an amount of

R110 million to the appellant's taxable income on the basis that the gross

income giving rise to such taxable income had accrued to the appellant during

its 2004 year of assessment on disposal of a plantation as contemplated in

paragraph 14 of the First Schedule to the Income Tax Act No. 58 of 1962 (the

Act).

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Section 26(1) of the Act provides that the taxable income of any person carrying

on pastoral, agricultural or other farming operations must, to the extent that it is

derived from such operations, be determined in accordance with the ordinary

provisions of the Act but subject to the special provisions set out in the First

Schedule to the Act. The relevant excerpt from paragraph 14 of the First

Schedule to the Act states that any amount that accrues to or is received by a

farmer (i.e. any person conducting pastoral, agricultural or other farming

operations) from the disposal of any plantation, irrespective of whether such

plantation is disposed of separately or with the land on which it is growing,

shall be deemed not to be capital in nature and shall constitute part of the

farmer's gross income.

The fact that the appellant had disposed of a plantation during its 2004 year of

assessment was undisputed. The nub of the appeal was whether the appellant

was conducting farming operations from whence the disposal proceeds

emanated – the prerequisite for applying the statutory provisions SARS had

applied in raising the additional assessment.

The facts of the case were as follows:

The appellant, a special purpose subsidiary of a Swiss company, had been

engaged by Steinhoff Southern Cape (Pty) Ltd (Steinhoff) to assume

Steinhoff's place as purchaser of certain land with a timber plantation on

it. The rationale behind the appellant's substitution as purchaser was

Steinhoff's aversion to owning fixed property in South Africa but still

wanting access to the plantation.

Steinhoff purchased all the machinery and equipment (including a

sawmill) while the appellant acquired the land, the timber plantation and

certain other assets. Both transactions were executed in writing in

October 2001, back-dated to 29 June 2001, and concluded as going

concern acquisitions, ostensibly qualifying for zero rating in terms of

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section 11(1)(e) of the Value-Added Tax Act No.89 of 1991 ( the VAT

Act).

In May/June 2001 by virtue of the relationship of trust between them,

Steinhoff and the appellant agreed orally that Steinhoff would be entitled

to conduct the plantation business on the appellant's land for Steinhoff's

own profit and loss. Steinhoff was granted access to the land on which the

plantation stood and was entitled to harvest the timber for its own

account. Steinhoff used its own equipment to conduct the plantation

operations, employed employees to work on the plantation and contracted

with service providers in relation to the plantation operations. All

plantation operational income and expenditure was earned and incurred

by Steinhoff and reflected in its accounts. It was not obliged to render

reports to the appellant regarding the plantation operations.

The appellant owned no equipment and had no employees. It had no

expertise in operating plantations. It was common cause that the appellant

considered the acquisition of the land and plantation as a strategically

advantageous long-term investment. To protect its investment, the

appellant and Steinhoff agreed that upon termination of the oral

agreement, which was to subsist indefinitely, Steinhoff would ensure that

the plantation comprised trees of the same volume and quality as at

commencement.

The oral arrangement was terminated by agreement in June 2004 when

Steinhoff changed its policy, in light of escalating timber prices and the

scarcity of timber resources, and became amenable to purchasing fixed

property in South Africa.

The purchase price was determined by an independent valuer and heads

of agreement were concluded in terms of which 'the plantation business'

was to be sold by the appellant to Steinhoff as a going concern, zero-rated

in terms of section 11(1)(e) of the VAT Act.

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Certain disputes arose between the parties which were duly settled and

recorded in a settlement agreement in terms of which the reference to the

sale of 'the plantation business' was altered to refer to the sale of

immovable property, standing timber, the plantation sale assets,

machinery and equipment and plantation contracts. In addition it was

recorded that VAT at the standard rate may be payable on the transaction

in respect of which the appellant was to issue invoices to Steinhoff.

Further it was agreed that the appellant was to pay Steinhoff a 'bonus

management fee' for the exemplary manner in which it had looked after

the appellant's investment.

In its 2004 tax return the appellant treated the disposal proceeds as capital

in nature. It declared a capital gain of R45,6 million being the difference

between the disposal proceeds of R144,7 million and the CGT valuation

of the plantation of R99,1 million as at 1 October 2001 (as opposed to the

lesser purchase consideration actually paid as at 29 June 2001). The

appellant also claimed a section 11(a) deduction of R12 million in respect

of the 'bonus management fee' due to Steinhoff.

SARS issued an additional assessment in August 2010 in terms of which

it rejected the appellant's treatment of the plantation disposal proceeds as

capital in nature. SARS averred that section 26(1) read with paragraph 14

of the First Schedule deemed the disposal proceeds to be part of the

appellant's gross income. The appellant objected to the additional

assessment. In its grounds of assessment SARS maintained its stance.

However, SARS contended in the alternative that if the appellant was

correct in treating the disposal proceeds as capital in nature, it had

calculated the gain incorrectly. The CGT issue was left over by

agreement pending the outcome of the main issue.

Before the tax court, SARS had argued that the mere disposal of a plantation

was sufficient to trigger the relevant statutory provisions. In effect SARS

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submitted that it was not necessary to satisfy section 26(1) as a separate

jurisdictional fact before rendering the deeming provision of paragraph 14 of

the First Schedule applicable to the plantation disposal proceeds. Plainly put, it

was not necessary to first establish whether or not the appellant was conducting

farming operations. The mere fact that the appellant sold a plantation was

sufficient to render paragraph 14 applicable and deem the plantation disposal

proceeds to be part of the appellant's gross income.

In the alternative, SARS argued that even if Steinhoff had conducted the

plantation operations independently of the appellant, such operations had been

physically conducted on the appellant's land, the appellant retained a direct

interest in such operations and Steinhoff was required to restore the plantation

in the same condition upon termination of the oral agreement as it had stood at

commencement. As such SARS argued that there was a sufficiently close

connection between the disposal proceeds and the plantation operations during

the subsistence of the oral arrangement to render section 26(1) and paragraph 14

of the First Schedule applicable.

The tax court found it unnecessary to consider SARS' first argument as it found

in SARS' favour on strength of the alternative basis. In so finding, Rogers J

concludes that the tax court conflated two distinct issues:

"Section 26(1) does not apply merely because there has accrued to the taxpayer

income which has 'derived from' farming operations; the section applies to a

person carrying on farming operations to the extent that his income is derived

from such operations. Two questions must therefore be answered:

(i) Was the person whom SARS wishes to tax a person carrying on farming

operations during the year of assessment in question?

(ii) If so, did the particular item of income in dispute derive from those farming

operations?"

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Rogers J then proceeds to review the relevant case law and concludes that a

number of tax court decisions1 have similarly conflated the two questions. In

rejecting SARS' first argument he states that the objective of "paragraph 14 is

not to define what constitutes the carrying on of farming operations, but to

characterise a particular type of accrual as gross income rather than capital."

The mere disposal of a plantation previously acquired by a taxpayer is

insufficient to constitute the carrying on of farming operations; and the conduct

of farming operations is the prerequisite for triggering the paragraph 14

deeming provision.

Rogers J concluded in favour of the appellant on the basis it was not conducting

farming operations. As section 26(1) was inapplicable, the characterisation of

the plantation disposal proceeds fell to be determined in accordance with the

normal provisions of the Act.

In upholding the appeal, he wryly observes that had SARS' contentions been

upheld, a Pandora's Box may have been opened for non-farming taxpayers

disposing of pastoral, agricultural or farming assets.

Cliffe Dekker Hofmeyr

ITA: Section 11(a) and 26(1) and paragraph 14 of the First Schedule

VAT Act: Section 11(1)(e)

MINING

2389. Provision for mining rehabilitation

Mining companies generally make financial provision for rehabilitation by way

of rehabilitation trusts or financial guarantees through a financial institution or

1 ITC 66 (1930) 5 SATC 85, ITC 1630 (1996) 60 SATC 59

23

with insurance policies. Although a deduction can be claimed for contributions

to a rehabilitation trust and the income derived by such rehabilitation trust is

exempt from tax, cash strapped mining companies in the current economic

environment are finding it tough to contribute the required amount of cash to

rehabilitation trusts. Insurance policies therefore have become a more lucrative

option as it enables mining companies to spread the premiums, and therefore

payment burden, over a longer period of time and even led to some mining

companies transferring the funds in rehabilitation trusts into the insurance

policies. The potential pitfalls of these methods are firstly, the adverse penalties

in excess of 200% of the value of the funds in the rehabilitation trust which

could be imposed by the South African Revenue Service (SARS) upon the

transfer out of rehabilitation trusts and the potential non-deductibility of the

premiums paid towards the insurance policies.

Mining companies in South Africa are required to make financial provision in

terms of the Mineral and Petroleum Resources Development Act No. 28 of

2002 (the MPRDA), read with the National Environmental Management Act

No. 107 of 1998 (NEMA), for the rehabilitation of the mining areas on which

mining activities are conducted (this will in future solely be governed by

NEMA). From an administrative and practical perspective, mining companies

are required to re-evaluate their rehabilitation liabilities and ensure that they

must be able to provide upfront for any shortfall in the provision for such

rehabilitation liabilities. In this regard, the Department of Mineral Resources

(the DMR) insists that mining companies must be able to provide upfront for

any shortfall in the provision for rehabilitation liabilities. For companies which

merely provide for rehabilitation through a rehabilitation trust, this would imply

that a cash contribution of the entire shortfall amount would need to be

contributed towards the rehabilitation trust. Commercially, many mining

companies (especially junior mining companies) are not in a position to make

24

such contributions as this would lead to cash flow constraints for the already

cash strapped mining companies.

As alluded to earlier, section 37A of the Income Tax Act No. 58 of 1962 (the

Act) provides for the deduction for income tax purposes of contributions made

to a qualifying rehabilitation trust. This deduction would not necessarily benefit

mining companies which are not in a tax paying position. Instead, additional

funding would need to be obtained to firstly fund the operations and secondly to

fund the rehabilitation trust. As a result, mining companies have opted to

provide for rehabilitation expenses through the various insurance products

which are currently in the market (and have been for quite some time) as this is

regarded by the mining companies as a more effective method to manage the

cash flow constraints and provide the DMR with the required guarantee(s) for

the future rehabilitation liabilities. The benefit of these insurance products is

that although the guarantee is received upfront, the mining companies have a

longer period during which the actual premiums can be paid as the insurance

policies typically extend over 3 years (which could be extended further),

thereby easing the cash flow constraints.

Due to the use of the funds contributed to a rehabilitation trust being restricted

and which can only be withdrawn for rehabilitation purposes (or used for

purposes set out in section 37A), many mining companies have opted to provide

for rehabilitation solely through insurance policies rather than to establish

rehabilitation trusts (i.e. mining companies regard insurance products to be a

more effective method to provide for future rehabilitation expenditure). In some

instances, mining companies have gone so far as to transfer funds out of already

established rehabilitation trusts into the aforementioned insurance policies.

SARS does not favour such transfers and has indicated that the application of

the penalty provisions provided for in section 37A (which would lead to a

penalty in excess of 200% of the value of the funds in the rehabilitation trust)

25

would be strictly applied to any transfer which contravenes the provisions of

section 37A.

From an insurance policy perspective, National Treasury has inserted section

23L into the Act which came into effect on 31 March 2014. In essence, the

purpose of section 23L is to disallow the deduction of any premiums incurred

by a taxpayer on short-term insurance policies, unless the required criteria are

met. The required criteria include, inter alia, recognising the insurance

premiums as an expense in the financial statements (and not capitalise the

expense as many mining companies would typically do). In this regard, the

question which should be considered by taxpayers is whether the specific

insurance policy which has been entered into to provide for future rehabilitation

expenditure would be regarded as a short-term insurance policy as envisaged in

section 23L of the Act and, if so, would the criteria be met so as not to fall

within the ambit of section 23L.

It is recommended that careful consideration be given and advice sought from

tax advisors who also understand and are knowledgeable as to the requirements

of the MPRDA and NEMA before a taxpayer opts to transfer any funds out of

an established rehabilitation trust into any other fund or policy not specifically

mentioned in section 37A. This is to ensure that the adverse (and arguably

draconian) penalty provisions contained in section 37A are not triggered. It is

further advisable that tax advice be sought before any mining rehabilitation

insurance policy is entered into by a mining company in order to ascertain

whether there is not a more efficient manner in which the policy could be

structured, thereby not falling within the ambit of section 23L.

It would be interesting to see how the Davis Committee will approach the

current tax incentives for mining rehabilitation and whether, going forward,

insurance policies of the nature discussed above would be recognised by the

26

Davis Committee and adequate provision be made in the Act for the treatment

of insurance premiums paid on such insurance policies.

ENSafrica

ITA: Sections 23L and 37A

Mineral and Petroleum Resources Development Act No. 28 of 2002

National Environmental Management Act No. 107 of 1998

TRUSTS

2390. Pitfalls in dealing with trusts

In two fairly recent cases, the Supreme Court of Appeal (SCA) has gone out of

its way to warn about some of the legal dangers facing people who transact with

trusts. These dangers relate mainly to the capacity of the trust to conclude the

transaction and the authority of a trustee to bind the trust.

In Nieuwoudt & Another NNO v Vrystaat Mielies (Edms) Bpk [2004] 3 SA 486

N and his wife W were the sole trustees of the family trust, through which they

conducted their farming business. Purporting to act on behalf of the trust, N

concluded a forward sale of the following year’s mealie crop at a price of R785

per ton. A year later, when the price of mealies had risen to R1 239 per ton, he

denied the validity of the sale on the grounds that his fellow trustee W had not

consented to or signed the deed of sale. The SCA accepted that the trustees had

to act jointly in order to bind the trust, but referred the matter for the hearing of

oral evidence on the question whether the trustees, acting jointly, had authorised

N to conclude the transaction on behalf of the trust, as their agent.

27

Similarly, in Land and Agricultural Bank of SA v Parker and Others [2005] (2)

SA 77 P and his wife W conducted their farming business through a family

trust, with themselves and their attorney as trustees. When the trust defaulted on

loan obligations (in excess of R16 million) owed to the Land Bank, the bank

successfully applied to the High Court for the sequestration of the trust and its

founder, P. On appeal, counsel for the trust argued that the loans were invalid

because at the time when they were entered into there were only two trustees in

office (the attorney having earlier resigned as trustee), and the trust deed

required a minimum of three trustees. The SCA agreed with this contention, but

dismissed the appeal nonetheless, on similar grounds: upon his sequestration P

was disqualified from acting as trustee, and there being a sub-minimum number

of trustees in office, the trust lacked the capacity to prosecute the appeal.

Legal capacity of a trust

Unlike a company, a trust is not a legal person. The assets of the trust vest in the

body of trustees whose powers to deal with the assets are determined by the

provisions of the trust deed – the ‘constitutive charter’ of the trust, as Cameron

JA described it in Parker’s case. Any action taken by the trustees outside the

scope of their powers is null and void. Thus it is vitally important for anybody

contracting with a trust to have sight of the relevant trust deed in order to

ascertain not only the identity of the trustees but also the limits of their powers,

and the minimum number of trustees required to enable the trust to act. As

Parker’s case shows, if the number falls below the minimum prescribed by the

trust deed, the remaining trustees will be incapable of binding the trust and the

trust will lack the capacity to act until further trustees are appointed.

Moreover, it is a fundamental rule of trust law, confirmed by the two cases

above, that unless the trust deed provides otherwise, the trustees must act jointly

if the trust is to be bound by their acts. Thus, even if a majority of trustees

agrees to and signs the contract, the contract will not be binding upon the trust.

28

This goes to trust capacity: the majority of trustees in question is not the body of

trustees empowered by the trust deed to act.

If the trust deed provides for decisions to be taken by majority vote, the

majority cannot act without consulting the minority; the trustees as a group must

consider the matter and if there is disagreement the majority view will then

prevail.

Authority of trustee to bind the trust

Even if a trustee has been properly appointed in terms of the trust deed, or by

the court in terms of general trust law, he or she may not act on behalf of the

trust until authorised to do so by the Master. Any such act performed by a

trustee prior to receiving Letters of Authority from the Master will be null and

void and incapable of ratification. Such authorisation by the Master must be

clearly distinguished from an authority granted to an individual trustee by the

board of trustees to perform some act on its behalf.

The fact that trustees have to act jointly does not preclude them from expressly

or impliedly authorising someone to act on their behalf, and that person may be

one of the trustees. Thus, acting jointly, they may delegate certain functions to

one of their number, or even to an outsider, whilst retaining responsibility for

the actions taken on their behalf. This brings the law of agency into play.

In accordance with general principles of agency, when a trustee purports to

contract on behalf of the trust, the trust will be bound only if the board of

trustees had conferred upon the trustee the requisite authority so to act. The

granting of such authority may be express or implied. If the contract fails

because the trustee lacked authority, an action for damages will lie against the

trustee for breach of warranty of authority, but this may be of little solace in the

circumstances.

29

The trust will be bound despite the trustee’s lack of authority if:

the board of trustees subsequently ratifies the actions taken on its behalf,

or

if the trustee had “ostensible authority” to bind the trust; that is, if the

board of trustees created the impression that the trustee had the necessary

authority to represent them, and the other party reasonably relied on that

representation. In such circumstances the board would be precluded (i.e.

“estopped”) from denying the existence of the authority.

Ratification is not possible in circumstances where the agent is required by

statute to obtain authorisation from the principal before entering into the

transaction. On this ground a sale of land was declared invalid in Thorpe and

Others v Trittenwein and Another [2007] 2 SA 172 SCA. The deed of sale had

been signed on behalf of a trust by a single trustee whose conduct was thereafter

ratified by the remaining trustees. The court held that such ratification could not

save the transaction because section 2(1) of the Alienation of Land Act No.68 of

1981 requires prior written authorisation of the agent.

What if it is clear from the trust deed that an individual trustee can be authorised

to represent the trust provided that certain internal formal or procedural

requirements have been met, for example, that the body of trustees has resolved

to delegate to the trustee the power to sign contracts on its behalf? In those

circumstances, must a third party dealing with the trustee check that the

requirements have been met, or is it entitled to assume that all is regular? That

depends on whether or not the so-called “Turquand Rule” of company law

applies to trusts too.

The Turquand Rule: applicable to trusts?

30

The Turquand Rule is part of the common law relating to companies, and

derives from the famous English case of Royal British Bank v Turquand [1856]

6 E&B 327, where it was held that –

“Persons contracting with a company and dealing in good faith may assume

that acts within its constitution and powers have been properly and duly

performed, and are not bound to enquire whether acts of internal management

have been regular.”

A statutory version of the rule is now to be found in section 20(7) of the

Companies Act No. 71 of 2008:

“A person dealing with a company in good faith … is entitled to presume that

the company, in making any decision in the exercise of its powers, has complied

with all of the formal and procedural requirements in terms of this Act, its

Memorandum of Incorporation and any rules of the company, unless, in the

circumstances, the person knew or ought reasonably to have known of any

failure by the company to comply with any such requirement.”

Thus, for example, if a company’s Memorandum of Incorporation provides that

the managing director can conclude contracts on behalf of the company,

provided the board has delegated such power to the director, a third person

dealing with the company would generally be entitled to presume, when its

managing director signs the contract on behalf of the company, that the

necessary delegation has occurred. The effect of the rule is that the company

will be bound even if the director lacked authority because the internal

requirement of delegation had not been met.

Whether the Turquand Rule should be made applicable also to trusts is

somewhat controversial, and the issue was expressly left open by the Supreme

31

Court of Appeal in the two cases discussed above. In Nieuwoudt, Harms JA was

rather sceptical, because in company law the rule is closely associated with the

doctrine of constructive notice (third parties dealing with a company were, and

to some extent still are, deemed to have knowledge of the contents of the

company’s constitutional documents), and he doubted whether the general

public could similarly be deemed to have knowledge of the contents of trust

deeds, which are essentially private documents. However, in Parker’s case,

Cameron JA expressed the view that “[w]ithin its scope the rule may well in

suitable cases have a useful role to play in securing the position of outsiders

who deal in good faith with trusts that conclude business transactions.”

Clearly, in the present state of the law, it would be prudent for those dealing

with trusts to assume that the rule does not apply to trusts.

Conclusion

Persons who contemplate contracting with a trust should, before committing

themselves to the deal, take the following elementary precautions:

insist on seeing Letters of Authority from the Master authorising the

trustees to act as such;

insist on seeing the trust deed itself, to make sure that the board of

trustees is properly constituted and has the capacity to enter into the type

of contract in question; and

check that all internal formal or procedural requirements have been met,

particularly as regards the granting of authority to a particular trustee to

enter into and sign the contract on behalf of the trust. An assurance from

the co-trustees that the contracting trustee has the necessary authority will

usually suffice, since that will preclude the board from subsequently

denying his or her authority.

32

By the same token, trustees who conclude contracts on behalf of the trust should

ensure not only that they have the necessary authority to do so, but also that

there is strict compliance with all the provisions of the trust deed.

ENSafrica

Alienation of Land Act: Section 2(1)

Companies Act: Section 20(7)

Trust Property Control Act: Section 6

SARS NEWS

2391. Interpretation notes, media releases and other documents

Readers are reminded that the latest developments at SARS can be accessed on

their website http://www.sars.gov.za.

Editor: Mr P Nel

Editorial Panel: Mr KG Karro (Chairman), Dr BJ Croome, Mr MA Khan,

Prof KI Mitchell, Prof JJ Roeleveld, Prof PG Surtees, Mr Z Mabhoza, Ms MC

Foster

The Integritax Newsletter is published as a service to members and associates of

The South African Institute of Chartered Accountants (SAICA) and includes

items selected from the newsletters of firms in public practice and commerce

and industry, as well as other contributors. The information contained herein is

for general guidance only and should not be used as a basis for action without

further research or specialist advice. The views of the authors are not

necessarily the views of SAICA.