Treasury companies

​The term 'treasury company' is used here to refer to a subsidiary of a holding company that holds its holding company's shares. This arrangement has some tax advantages but there are also some pitfalls that need to be borne in mind. References in this article to paragraphs are to paragraphs of the Eighth Schedule to the Income Tax Act 58 of 1962 (Act).

In South Africa it is not possible for a company to hold its own shares as an asset on its balance sheet. The moment it acquires them, they are extinguished through merger[1]and restored to the status of authorised capital.[2] The extinction of the shares In this way is a non-disposal under para 11(2)(b). There has been some debate in academic circles whether a company actually acquires its shares as an asset but SARS accepts that the shares are an asset for an instant before being disposed of for no consideration, and hence the reason for para 11(2)(b) to prevent capital losses.

Using an employee share incentive trust for this purpose is one way to prevent the shares from disappearing. The use of a treasury company is another way.

The downside of a share buy-back for natural persons

One of the downsides of a share buy-back is that natural person shareholders will often receive the bulk of the consideration in the form of a dividend, with a relatively small portion comprising contributed tax capital (CTC). The CTC will comprise proceeds under para 35, while the dividend , which is included in gross income under para (k) of the definition of that term, is excluded from proceeds under para 35(3)(a).[3] The dividend is subject to dividends tax at 20%. Often, a capital loss will result on disposal of the shares because the CTC may be insufficient to cover the base cost of the shares.

When shares are issued in tranches over a long period, later shareholders tend to be prejudiced because their proportionate share of CTC is diluted by earlier shareholders. For example, if the first shareholder had 100 shares acquired for R100 and a later shareholder subscribes for 100 shares at R500, the later shareholder's share of the CTC pool will be only R300 [(R100 + R500) × 100/200]. This dilution means that the later shareholder has immediately lost R200 of CTC which will be replaced by a dividend of R200 attracting dividends tax at 20% upon distribution or a share buy-back.

A capital loss resulting from a share buy-back, even assuming it is not clogged under para 39,[4] can be carried forward indefinitely for set-off against a capital gain. However, the time value of money will erode its value the longer it is unused.

There is an additional downside to a share buy-back for an individual and that is that dividends tax is imposed at 20% while the maximum CGT effective rate is 18% (40% inclusion rate × 45% marginal tax rate).

This differential of 2% means that a natural person shareholder would achieve a better tax outcome if their shares were sold to a fellow shareholder instead of being sold to the company.

These examples illustrate that selling shares back to a company can have serious tax disadvantages for a natural person shareholder, particularly when the base cost of the shares is significant.

The use of a treasury company can level the playing field.

Operation of the treasury company

Under section 48(2)(b) of the Companies Act 71 of 2008, and subject to the solvency and liquidity requirements in s 46, a subsidiary can acquire its holding company's shares but

• not more than 10%, in aggregate, of the number of issued shares of any class of shares of a company may be held by, or for the benefit of, all of the subsidiaries of that company, taken together; and
• no voting rights attached to those shares may be exercised while the shares are held by the subsidiary, and it remains a subsidiary of the company whose shares it holds.

The treasury company will obtain base cost for the shares acquired under para 20(1)(a) including any securities transfer tax under para 20(1)(c)(iii). These acquisitions would typically be funded by the holding company on loan account.

If the shares can be disposed of within a reasonably short time to new shareholders, capital gains can be avoided in the treasury company.

Since the purpose of acquiring such shares is simply to acquire them from departing shareholders and then to dispose of them to qualifying directors and employees, there is no intention to trade in such shares. Any capital gains realised on such shares will simply be fortuitous and an incidental by product. See in this regard CIR v Pick 'N Pay Employee Share Purchase Trust[5] in which the court cited the following extract from Meyerowitz and Spiro on Income Tax in para 299:[6]

'[t]he rather clumsy phrase: “Operation of business in carrying out a scheme of profit-making" in plain language really means that receipts or accruals bear the imprint of revenue if they are not fortuitous, but designedly sought for and worked for'.

Deductibility of expenses in the treasury company

The main sources of revenue for the treasury company are likely to be exempt dividend income from its holding company and interest income on the investment of the dividends it derives. It may also receive management fees for managing the share scheme. If it is carrying on a trade, its expenses are likely to be disallowed under s 23(f) to the extent that they are incurred in the production of exempt dividend income. Nevertheless, to the extent it derives taxable income, an apportionment may result in some deductible expenses.[7] Practice Note 31 and s 11G which is due to replace it in 2026[8] should not be lost sight of.

Using the corporate rules

Transferring the shares by way of a s 45 intra-group transaction to the holding company is barred under s 45(6)(f).

However, liquidating the treasury company using s 47 is possible.

In BPR 336[9] a listed holding company owned 100% of the shares in a treasury company. The sole asset of the treasury company comprised shares in the holding company which were funded by a loan from the holding company.

It was proposed that the holding company would waive the loan and the treasury company would distribute the shares to the holding company as a liquidation distribution under s 47.

The shares were then to be cancelled in the holding company and the treasury company deregistered. The ruling held that:

• ​​The distribution of shares by the treasury company to the holding company will constitute a 'liquidation distribution' as defined in para (a) of the definition in s 47(1).
• The treasury company will be deemed to have disposed of the shares at their base cost and the holding company will be deemed to have acquired them at the same base cost and no capital gains tax consequences will result for the holding company and the treasury company from the transfer of the equity shares.
• Section 47(5) will apply to the proposed transaction. The holding company must disregard the disposal or any return of capital for purposes of determining its taxable income, assessed loss, aggregate capital gain or aggregate capital loss.
• The liquidation distribution will constitute a dividend and must be included in the gross income of the holding company.
• The dividend will be exempt under s 10(1)(k)(i).
• Section 64G(2)(b) will apply to the dividend. The treasury company must not withhold any dividends tax.
• Paragraphs 77 and 43A will not apply to the proposed transaction.
• Paragraph 11(2)(b)(i) will apply. The cancellation of the shares received by the holding company will not constitute a disposal.
• Section 8(1)(a)(v) of the STT Act will apply. No securities transfer tax will arise on the transfer of shares from the treasury company to the holding company.
• Paragraph 12A(6)(e) will apply to the loan which will be waived by the holding company.

​​The outcome was thus that there was no capital gain on the distribution of the shares and no adverse CGT consequences from the waiver of the loan. Similarly, there were no CGT consequences in the holding company and no STT on cancellation of the shares. It follows that unwinding one of these treasury companies can be done without tax consequences.

Disposing of the shares to the holding company shortly after acquisition

Disposing of the shares to the holding company by debiting the holding company's loan account soon after acquisition from a shareholder would avoid capital gains from arising in the treasury company. Such a transaction would be a share buy-back, and if made by way of dividend, there would be no dividends tax liability because the transaction would be between two resident companies.[10]

Could the use of a treasury company in this way constitute an impermissible tax avoidance arrangement?[11] It is beyond the scope of this article to investigate this issue fully. While this is a risk area, the arrangement does have a commercial purpose, which is to make it equally attractive to a shareholder to sell their shares to the holding company as compared to other shareholders and it is certainly not a sham. The use of treasury companies is recognised in the Companies Act and they are in widespread commercial use. Under the choice principle, taxpayers are free to arrange their tax affairs in a tax-efficient manner and tax avoidance is not per se impermissible.[12]That said, the issue should be approached with caution.

Paragraph 43A of the Eighth Schedule must also be considered. It applies when a company holds a qualifying interest in a target company, disposes of the target company shares and receives an extraordinary exempt dividend within 18 months before the disposal or as part of the disposal. Its effect is to deem a portion of the extraordinary dividend to comprise proceeds for CGT purposes. It would apply to a share buy-back by the holding company from a treasury company if the treasury company held the required qualifying interest.

Now, while a treasury company cannot under the Companies Act hold more than 10% of its holding company's equity shares, the definition of 'qualifying interest' in para 43A(1) requires the percentage interest to be determined 'whether alone or together with any connected persons in relation to that company'. Assuming an unlisted holding company holds 100% of the treasury company's equity shares, if a shareholder of the holding company, other than a company, holds, say, together with connected persons, 20% of the holding company's equity shares, it will indirectly hold 20% of the treasury company's equity shares. Such an indirect holding would make it a connected person in relation to the treasury company under para (d)(iv) of the definition of 'connected person' in s 1(1). Thus, even if the treasury company held only 1% of the holding company's equity shares, it would together with the 20% shareholder, hold at least 20% of the holding company's shares, which would give it a qualifying interest in the holding company assuming no other shareholder held a majority interest in the holding company together with connected persons.[13] Determining whether the treasury company holds a qualifying interest can be a mind boggling task, particularly when considering whether shareholders in the holding company are connected persons in relation to one another and a trust is involved.

An interesting point is that if a treasury company distributes its holding company's shares to the holding company, the transaction will be a distribution under para 75 for proceeds equal to market value. No part of the deemed consideration under para 75 received by or accrued to the treasury company will comprise a dividend because the holding company is not paying any consideration for the shares and the para 75 deemed consideration does not apply in the opposite direction.

Securities transfer tax (STT)

STT is imposed under the Securities Transfer Tax Act 25 of 2007. Section 2 of that Act imposes the tax on every transfer of a security issued by a company incorporated, established or formed in South Africa at the rate of 0,25% of the taxable amount of the security.

The treasury company will be liable for STT on any shares acquired from shareholders of the holding company. However, the issue of new shares by the holding company does not attract STT.[14] Shares transferred to the holding company by the treasury company which meet the requirements of the definition of 'intra-group transaction' in s 45(1), even if the transaction itself is excluded under s 45(6)(f), are exempt from STT under s 8(1)(a)(iii) of the STT Act. The reason is that s 8(1)(a) refers only to the definitions in the various corporate rules and does not require compliance with all the requirements of the various sections.,15]

​Conclusion

The use of a treasury company to hold its holding company's shares offers benefits for the company and its shareholders. But as with any tax planning arrangement, awareness of all the tax implications is essential.

This article was first published in ASA November 2024 - ASA Magazine : ASA November 2024​