Potential tax consequences of the waiver of a contractual right
27 Jun 2017
The term ‘disposal’ is widely defined in section 11 of the Eighth Schedule to the Income Tax Act 58 of 1962 (“the Income Tax Act”), and includes the waiver of an asset.
For purposes of donations tax, a donation is defined in section 55(1) of the ITA as “any gratuitous disposal of property including any gratuitous waiver or renunciation of a right”. Accordingly, the waiver of a contractual right may give rise to donations tax. However, donations tax can only arise where there is an element of gratuity when the right is waived and generally in commercial transactions there exists commercial rationale other than pure gratuity.
However, where the element of gratuity is not present and the transaction does not constitute a donation under section 55 of the Income Tax Act, section 58 of the Income Tax Act deems there to be a donation where any property has been disposed of for a consideration which, in the opinion of the Commissioner, is not an adequate consideration.
In addition, there may also be capital gains tax consequences, as a result of paragraph 38 of the Eighth Schedule to the Income Tax Act, which states that any person that disposes of an asset by way of a donation or for consideration not measurable in money or to a person who is a connected person for a consideration that does not reflect an arm’s length consideration, will be deemed to have disposed of such asset at market value. This means that the market value of the asset will constitute a capital gain that may be subject to capital gains tax.
The South African Revenue Service (“SARS”) published Binding Private Ruling 273 (“the BPR”) on 2 May 2017, in which it ruled that the waiver of a contractual right by a taxpayer does not give rise to donations tax and capital gains tax.
The facts in the BPR are as follows:
- Two companies, Company C (“Co C”) and Company B (“Co B”) were both wholly-owned subsidiaries of a third company, Company A.
- Co B had the right in terms of an agreement with Co C to receive from Co C “an annual quantity of produce” which would be determined each year in terms of an agreed upon formula.
- Co B waived its right against Co C to receive the annual quantity of produce.
- No further information regarding the transaction was disclosed in the BPR.
In the BPR, SARS was asked to consider, inter alia, whether the transaction would give rise to donations tax and/or capital gains tax.
SARS ruled that no donations tax would arise when Co B waives its contractual rights against Co C, despite the fact that a waiver of a right for no quid pro quo may well fall within the ambit of a deemed donation as contemplated in section 58 of the Income Tax Act. SARS further ruled that the waiver of the right by Co B will not give rise to adverse donations tax implications as contemplated in paragraph 38 of the Income Tax Act, despite the fact that Co B and Co C are connected persons in relation to each other.
No further facts relating to the transaction are disclosed by SARS in the BPR and thus we do not have the full context of SARS’ ruling. It is also important to note that this ruling is only binding on the parties to whom the ruling was issued and that all other taxpayer’s must therefore assess their own facts to determine whether donations tax and/or capital gains tax may arise when rights pertaining to assets are unilaterally waived. However, SARS’ ruling does create a good indication of SARS’ view on the matter and SARS may issue the same ruling in matters with similar facts.
Taxpayer’s must seek legal advice prior to entering into transactions where rights attaching to assets are disposed of for no consideration or for a consideration that is less than market value to assess whether any adverse tax consequences could arise.(This article is provided for informational purposes only and not for the purpose of providing legal advice. For more information on the topic, please contact the author/s or the relevant provider.)