Potential negative tax consequences of 12J deductions for non-residents

BY BOBBY WESSELS Associate, AJM Tax

Ceasing to be a South African tax resident often does not come without tax consequences. In particular, section 9H of the Income Tax Act (ITA) triggers a deemed disposal of your worldwide assets, despite those assets not actually being disposed of. There are some assets that are noticeably excluded from the deemed disposal, but typically the most common assets that trigger a tax consequence are shares held in any company (or similarly, units held in unit trusts or ETFs).

While the tax consequences on the deemed disposal have typically been well documented in so far as it affects shares held in a company, being both listed and unlisted, what is often overlooked is how specific types of shares may trigger different consequences.

In particular, shares held in a Venture Capital Company (VCC) and for which a deduction against taxable income was claimed in terms of section 12J of the ITA, may trigger potentially adverse tax consequences as a result of the deeming provision. This is because any amount that has been allowed as a deduction, which amount has been recovered or recouped during the year of assessment, must be included in the taxable income of any person. The deduction claimed in terms of the VCC shares forms part of the deductions for which there can be a recoupment. Therefore, in the context of VCC shares, where a recoupment occurs, the amount to be included in the taxable income of the person could in some instances be equal to the deduction claimed. Typically, such a recoupment will be triggered where the VCC shares are sold; however, if those shares have been held for a period longer than five years, then the recoupment can be ignored for tax purposes.

What stands to be considered is whether a deemed disposal would trigger a recoupment for tax purposes on any VCC shares held

What stands to be considered is whether a deemed disposal would trigger a recoupment for tax purposes on any VCC shares held. In other words, whether a recoupment will be triggered where a person holds shares in a VCC, but which shares have been held for a period lessthan five years, and that person ceases to be a tax resident. The contention ultimately boils down to the interaction between a deemed disposal and the meaning to be attributed to ‘recoupment’. Despite the word ‘recoupment’ not being defined for tax purposes, South African courts have on occasion considered the true meaning to be attributable to the words ‘recover’ or ‘recoup’. In that context, the word ‘recover’ was held to connotate the regaining of possession, while the word ‘recoupment’ was regarded to be the act of ‘recovering or recompensing’. The crisp question is therefore whether a deemed disposal (not being an actual disposal) is considered akin to the recovery of the deduction claimed in respect of the VCC share. If this were to be the case, it would result in a recoupment of the deduction claimed in respect of VCC shares acquired.

The matter is not a settled one at all. There are various academics that have disputed this very point. The one school of thought advocates that a deeming provision should be treated as if there was an actual disposal. On that basis, the taxpayer must deemed to have recouped the deduction and therefore the deduction must be included in the taxable income of the taxpayer. Interestingly, this position accords with the position taken by the South African Revenue Services.

Contrastingly, where a literal approach to the meaning of the word recoupment is favoured, the argument is put forth that no recoupment can be created in the hands of the taxpayer. In the absence of any amount being physically received by the taxpayer, they can simply not be regarded to have recovered any amount.

Ultimately, the question is one for which no concrete answers exist, but of which taxpayers should take note so as to avoid any potential adverse tax consequences from being triggered.