One such condition is that the market value of the asset being transferred (on the date of disposal) must be equal to or exceed the tax (base) cost. In other words, the “asset-for-share” provisions are not available where
the disposal would give rise to a loss.

It is interesting to note that this is the only express requirement (in section 42 at least) regarding the value of the asset being transferred. In other words, for purposes of section 42 itself, any contractual consideration for the asset is not determinative of whether the section applies, provided the market value of the asset being transferred equals or exceeds its base cost.

However, it’s a mistake to think that if section 42 applies, no further analysis is required as there could (for example) be latent tax consequences that arise where the value of the shares received as consideration pursuant to the “asset-for-share” transaction is not commensurate with the value of the asset. This article considers those consequences.

Deemed donation

At common law, a disposition qualifies as a donation if it is motivated by pure liberality or disinterested benevolence. In other words, without the donor receiving any consideration in return. Therefore, where the recipient gives some consideration, the disposition cannot arguably be regarded as a donation.

For purposes of donations tax, section 55(1) of the ITA defines a donation as “any gratuitous disposal of property including any gratuitous waiver or renunciation of a right”.

On the other hand, where property is disposed of for a consideration that, in the opinion of the Commissioner of the South African Revenue Service (SARS) (Commissioner), is not “adequate consideration”, it will be deemed to have been disposed of under a donation as contemplated in section 58(1). The court in Welch’s Estate v Commissioner, South African Revenue Service [2005] (4) SA 173 (SCA) confirmed that the definition of “donation” in section 55(1) plays no role in interpreting or giving effect to the provision in section 58.

Section 58(1) provides that:

“where property has been disposed of for a consideration which, in the opinion of the Commissioner, is not an adequate consideration, that property shall ... be deemed to have been disposed of under a donation; provided that, in determining the value of such property, a reduction shall be made of an amount equal to the value of that consideration.”

Therefore, and notwithstanding what constitutes a donation at common law, section 58 deems a disposition in return for a quid pro quo but for inadequate consideration as a donation that is (potentially) subject to donations tax as contemplated in section 54. This means that even if something has been done for non-gratuitous reasons (e.g. has a commercial purpose), it can still be a donation under section 58 if SARS is of the view that property was disposed of for inadequate consideration.

Potential impact on section 42 transactions

Given the wording of section 58(1), the Commissioner may invoke the section whenever the consideration for an asset is (in SARS’ opinion) inadequate, irrespective of whether there is an intention to donate. The Commissioner may therefore be entitled to apply section 58(1) where transfers of assets at prices lower than their fair market value are made by a sole beneficial shareholder to its company, or between associated companies with similar shareholders pursuant to section 42, even though the transferor is no better or worse off financially.

In practice, the Commissioner considers that the term “adequate consideration” does not necessarily mean ‘fair market value’; the Commissioner will have regard to all the circumstances surrounding a particular transaction in determining whether the consideration is adequate. As such, the consideration can qualify as “adequate” depending on the circumstances and the requirements of the particular transaction (see SARS Interpretation Note 91).

On this basis, there is a view that SARS does not usually challenge transfers of assets at less than market value between companies and their sole beneficial shareholders or between associated companies with the same shareholders, provided that there is no enrichment of any particular person under section 58(1) – or, conversely, impoverishment. Therefore, if, as a result of any transfer of assets at less than market value between a company and its shareholders, a shareholder is no better or worse off financially, SARS may be less likely to invoke section 58(1).

Conclusion

Section 42 provides a valuable tool for tax-neutral “asset-for-share” transactions. While it may be less likely that SARS will impose donations tax on the transferor where the value of the consideration shares is not commensurate with the value of the asset in circumstances where the transferor is no better or worse off financially and/or economically, the interplay between section 42 and the deemed donation provisions highlights the need for careful consideration of the tax implications of any transaction.

It should also be noted that the above does not consider the application of other provisions, such as section 24BA or Paragraph 38 of the Eighth Schedule to the ITA, which could potentially apply where there is a value mismatch between the asset transferred and the shares issued in consideration. Therefore, if a taxpayer or their professional adviser is not au fait with the technical tax aspects of the transaction they are contemplating, costly mistakes can occur.