Unbundling transactions, in the absence of rollover relief, trigger adverse tax consequences for the company making the in-specie distribution. These could arise because the distribution constitutes a disposal, and the market value of the unbundled company shares exceeds the base cost of the shares. A dividend withholding tax liability can also manifest in the hands of the unbundled company if the distribution constitutes a dividend and none of the dividend withholding tax exemptions apply.

The rollover relief can be found in section 46 of the ITA which provides qualifying transactions with tax neutral outcomes. 

It is possible that an unbundling only partly qualifies for the rollover relief and that adverse tax consequences are triggered in the unbundling company. Through their shareholding in the unbundling company, the tax costs are economically borne by all shareholders, regardless of whether the rollover relief applied to the distributions in which they participated.

The rollover relief, however, provides that a portion of the tax costs economically borne by shareholders who qualified for the rollover relief provisions can be allocated to the tax cost of their unbundled shares. The allocation ratio is calculated with reference to the market value of the unbundled shares, as at the end of the day after that distribution, in relation to the sum of the market value as at the end of that day, of the unbundling shares and the unbundled shares. The balance of the tax costs is forfeited and cannot be allocated to the unbundling company’s shares.

The Budget refers to changes made in 2020 to curb tax avoidance where unbundling transactions are used to distribute shares of unbundled companies to tax-exempt persons or non-resident investors, an issue which was the subject of much debate during the hearings hosted by National Treasury. It notes that these changes ensured a more equitable outcome in unbundling transactions, because only shares distributed to persons who are not disqualified persons will benefit from rollover relief.

The Budget further states that in 2021, further changes were made to the rules to allow shareholders in an unbundling company that only partially qualify for tax deferral to benefit from an increase in the base cost of the shares in the unbundled company, to the extent that the unbundling company did not qualify for tax deferral in accordance with its respective shareholding.

It is encouraging that the Minister now proposes that further consideration should be given to whether it is appropriate to only apportion the tax costs to the unbundling company and whether an allocation should not also be made if the tax consequences are absorbed by the unbundling company’s capital losses or assessed losses.