If a person disposes of an asset during the current tax year, but only becomes entitled to payment in future tax years, the Income Tax Act, 1962 (the Act) provides that the amount is deemed to have accrued to that person during the current tax year. Therefore a person disposing of an asset will have to account for Capital Gains Tax (CGT) in the current tax year in circumstances when he will only receive payment in future tax years. This may place a strain on cash flow, and is exactly what the parties to a sale of shares agreement were trying to avoid in thecaseGani v Hassim; in re East Coast Access (Pty) Ltd v Gani.
Gani and Hassim each held 50% of the sharesin an IT company. They concluded an agreement, without the assistance of an attorney, whereby Gani sold his 50% shareholding to Hassim for R5 million. R1 million was payable each year for three years with the remaining R2 million payable if a profit target of R2.7 million was achieved in year three. Hassim never paid the R2 million as he contended that ‘profit’ referred to after tax profit and the target was not achieved. Gani disagreed, alleging that ‘profit’ was before tax profit and the target was met.
The Court was of the view that the purpose of the profit target condition was simply to delay payment of CGT. There are provisions in the Act which can provide relief for taxpayers and defer payment of CGT, such as:
- Paragraph 13(1) of the 8th Schedule : a taxpayer will only have to account for CGT when an agreement subject to a suspensive condition becomes unconditional;
- Section 24M(1) : if the proceeds from the disposal of an asset are quantifiable at a future date, the taxpayer will only account for CGT when the amount becomes quantifiable;
- Section 24N : which deals with the disposal of equity shares for an amount payable in future tax years and certain conditions having been met.
Although the Court made no finding as such, the profit target condition in the agreement could, for tax purposes, be seen as a simulated transaction or an impermissible tax avoidance arrangement.Ultimately the Court held that a sensible and businesslike interpretation of the word ‘profit’ meant profit before tax, therefore the R2.7 million target was met, and Hassim was obliged to pay Gani.
This article has been written by Graeme Palmer, a Director in the Commercial Department of Garlicke & Bousfield Inc
For more information contact Graeme on telephone : +27 31 570 5496, cell : +27 83 637 1868, email : firstname.lastname@example.org
NOTE: This information should not be regarded as legal advice and is merely provided for information purposes on various aspects of tax law.