Unlisted public companies may want to convert from public to private companies for various reasons. Often times it is the free transferability of shares that cause a concern where there is disagreement at shareholder level and the risk of having a third party introduced as shareholder becomes high.
Where such a conversion is indeed pursued, the question that always comes up from a tax perspective is what the tax consequences are for the shareholders. This question originates from the very wide definition of “disposal” in the Eighth Schedule to the Act.
According to that definition, any “variation” of rights constitute a disposal for capital gains tax purposes. Where a shareholder had a right to freely dispose of shares and that right is subsequently limited or changed in consequence of the conversion from public to private company, prudent taxpayers would enquire as to their liability for capital gains tax.
Whether or not a capital gains tax obligation arises depends on a myriad of factors, including whether or not there was a “disposal”. In Binding Class Ruling 33, SARS ruled that such a change in the bundle of rights for the shareholders that followed the conversion of a public to a private company indeed constituted a disposal for the shareholders. However, in that case, SARS ruled that there was no capital gains tax obligation. This conclusion ostensibly follows from the principles of paragraph 33 and 30(3) of the Eighth Schedule to the Act.
However, there exists foreign authority to the effect that while a share indeed constitutes a bundle of rights, such rights are not capable of separate disposal and therefore the bundle of rights that is a share in a company should be considered an inseparable whole. Where this argument holds water in South Africa, there could be no disposal in the case of a conversion from a public to a private company and hence no capital gains tax obligation.
The legal principles involved on the conversion and the liability or otherwise of a shareholder for tax on such conversion, to our knowledge, still stands to be tested by South African courts. Until such time as there is absolute certainty regarding the liability of shareholders for tax on the conversion, taxpayers would be well advised to seek certainty through the advance tax ruling process, as did the taxpayers in Binding Class Ruling 33.
Author: N Theron