Story audio is generated using AI
The Cape Town tax court has found that the “dividend-stripping” used in the 2017 multimillion-rand transaction in which Stor-Age Property REIT bought smaller rival Storage RSA is an impermissible avoidance arrangement under the country’s tax laws.The judgment will, if it holds pending any possible appeal, have far-reaching implications on the tax treatment in merger & acquisition deals in South Africa.The Stor-Age deal saw it buy Storage RSA in a transaction driven by the former’s growth strategy to target high-quality competitors in a fragmented self-storage market and establish a larger national footprint across major metropolitan areas.(Karen Moolman) The judgment shows that Storage RSA’s capital since it was established in the early 2000s was invested mainly through shareholder loans, with shares issued at nominal value, and it applied its profit to new developments, paying no dividends throughout its existence.When some of the shareholders decided to dispose of the business in about 2016, the company’s tax advisers advised it that an outright sale of its properties to Stor-Age would attract capital gains tax, with dividend tax on the distribution of the proceeds by the investment companies.To get around this, their tax experts advised Stor-Age RSA shareholders that one way to achieve the same commercial objective without attracting tax would be for the company to distribute its full value as a dividend, and Stor-Age would subscribe to new shares at the underlying value and the remnant shares would be sold at nominal value.This was implemented in four steps:Storage RSA declared a distribution of R274.6m;Stor-Age subscribed for new shares for R280.3m giving it 99.99% of Storage RSA;Storage used the subscription proceeds to pay the dividend; andThe existing shareholders then sold their original shares for R1,000.None of Storage RSA’s shareholders declared a capital gain in their 2017 returns — treating the amounts received from the transaction as exempt dividends.The South African Revenue Service (Sars) took umbrage at this structure of the deal and disregarded the dividend and subscription steps, assessing capital gains tax on a deemed disposal of shares for full value — sparking a dispute between it and Storage RSA shareholders who participated in the scheme.Read: Sars sniffer dog shortage leaves R415m customs enforcement gapThe tax court last week sided with Sars and said the structure cheated the fiscus of monies due to it.“The appellants [Storage RSA shareholders] say their risk profile changed because they exchanged illiquid shares for cash. So it did. But that change is attributable to the disposal itself, not to the mechanism by which the disposal was dressed,” the judgment reads.“A direct sale of the shares for R274.666m would have produced exactly the same change in the appellants’ risk and cash position, the same illiquid asset surrendered, the same cash received, and the same exposure to the business extinguished.“The dividend-and-subscription mechanism added nothing to that change and subtracted nothing from it. It introduced no new business risk, deferred or accelerated no net cash flow and altered no commercial exposure beyond what the underlying sale already carried. Where the only difference between doing the thing directly and doing it through the mechanism is the tax result, the mechanism has no significant effect on business risk or net cash flow apart from the tax benefit.”Experts at commercial law firm Bowmans weighed in on the watershed judgement: “While this is a tax court judgment and thus not legally binding on higher courts, it provides a clear indication that a subscription-and-buyback structure could (depending on the facts) be vulnerable to a general anti-avoidance rule attack.”The country’s largest law firm, ENSafrica, said the judgment focused on the substance of the transaction rather than the parties’ intentions.“A key aspect of this case was the declaration of the pre-acquisition dividend which constituted an additional step in relation to the proposed transactions,” the firm said.“The facts may therefore potentially be distinguishable from a subscription and buy-back structure, where the purchaser subscribes for new shares in a company and the company uses the subscription proceeds simply to buy back shares from the existing shareholder, without a separate dividend declaration.”
