Exclusion of certain companies and shares from a “GROUP OF COMPANIES” as defined in Section 41(1) of the Income Tax Act

Relevant Acts:
Income Tax Act
The Taxation Laws Amendment Act
The Tax Administration Laws Amendment
The Rates and Monetary Amounts and Amendment of Revenue Laws Act

Under specified circumstances, the corporate rules provide relief from income tax when assets are disposed of between companies forming part of the same “group of companies” as defined in section 41(1). Generally, these relief measures defer the income tax on income and capital gains until the asset is disposed of to a third party or until a de-grouping occurs.

The Act contains a global definition of “group of companies” in section 1(1) and a narrower definition of the same term in section 41(1). The narrower definition generally applies for the purposes of the corporate rules but is also used elsewhere in the Act. The definition in section 41(1) starts with the definition in section 1(1) and then proceeds to exclude specified companies and shares by way of a proviso. At issue 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 1(1) and comprise a group of companies under the definition of “group of companies” in section 41(1). If not, the corporate rules may not apply to a transaction conducted between those remaining companies.

Application of the law

The term “group of companies” as defined in section 1(1) means two or more companies in which one company (the controlling group company) directly or indirectly holds shares in at least one other company (the controlled group company), to the extent that:

  • at least 70% of the equity shares in each controlled group company are directly held by the controlling group company, one or more other controlled groups of companies, or any combination thereof; and
  • the controlling group company directly holds at least 70% of the equity shares in at least one controlled group company.

The definition of “group of companies” in section 41(1) defines a group of companies as “a group of companies as defined in section 1(1)” but in applying that definition specifically excludes, through paragraphs (i) and (ii) of the proviso, the following companies and shares from consideration:

(i) (aa) a company that is a company contemplated in paragraphs (c), (d), or (e) of the definition of “company”;
(bb) a company that is a non-profit company as defined in section 1 of the Companies Act;
(cc) any amount constituting gross income of whatever nature would be exempt from tax in terms of section 10 were it to be received by or to accrue to the company;
(dd) the company is a public benefit organisation or recreational club that has been approved by the Commissioner in terms of section 30 or 30A;
(ee) the company is a company contemplated in paragraph (b) of the definition of “company” unless that company has its place of effective management in the Republic; or
(ff) the company has its place of effective management outside the Republic;
(ii) (aa) the share is held as trading stock; or
(bb) any person is under a contractual obligation to sell or purchase the share or has an option to sell or purchase the share unless that obligation or option provides for the sale or purchase of the share at its market value at the time of the sale or purchase;

For a group of companies to exist under the definition of “group of companies” in section 1(1), it must have a “controlling group company” and one or more “controlled group companies”. 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). Likewise, a company whose equity shares are deemed not to be equity shares by paragraph (ii) of the proviso cannot have a controlling group company and will accordingly be excluded from forming part of a “group of companies” as defined in section 41(1).

Tax discrimination under tax treaties

Article 24(5) of the OECD Model Tax Convention on Income and on Capital7 provides as follows:

“5. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.”

In reading the above clause, it has reference to double-taxation agreements between countries and these must be considered when applying tax rulings.

The question arises whether this could find application under the corporate rules, for example, when a foreign incorporated parent company, which is not effectively managed in South Africa, holds shares in two resident subsidiaries and the subsidiaries are denied roll-over relief on a transfer of assets between them under section 45 because of the operation of the proviso. The parent company in this example would be a non-resident for income tax purposes.

In deciding this question it is necessary to determine whether two resident subsidiaries of a resident parent company which is in a similar position would be denied group relief.

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. Rather it excludes the companies 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 relief is also denied to resident subsidiaries of a resident parent company when the parent company is exempt or partially exempt from normal tax.

For example, subsidiaries of the following resident companies are excluded from a group of companies under paragraph (i) of the proviso:

  • A co-operative [paragraph (i)(aa)].
  • An association formed in South Africa to serve a specified purpose, beneficial to the public or a section of the public [paragraph (i)(aa)].
  • A portfolio of a collective investment scheme in property that qualifies as a “REIT” as defined in the listing requirements of an “exchange”, as defined in section 1 of the Financial Markets Act 19 of 2012 and licensed under section 9 of that Act, when those listing requirements have been approved in consultation with the Director-General of the National Treasury and published by the
    appropriate authority, as contemplated in section 1 of the Financial Markets Act, under section 11 of that Act or by the Financial Sector Conduct Authority [paragraph (i)(aa)].
  • A “non-profit company” as defined in section 1 of the Companies Act 71 of 2008[paragraph (i)(bb)].
  • A company whose receipts or accruals of whatever nature would be exempt from normal tax under section 10 [paragraph (i)(cc)].
  • A company that is a public benefit organisation or recreational club that has been approved by the Commissioner under section 30 or 30A [paragraph (i)(dd)].

As a result, Article 24(5) will not apply when paragraph (i) of the proviso excludes a non-resident controlling company from a group of companies because resident companies who are similarly exempt from South African income tax are also excluded from relief under the corporate rules.