As expected, because we operate in a global economy, South Africa has followed the footsteps of the rest of the world into recession. This has brought new meaning to the term ‘survival of the fittest’ for the businesses operating here.
The consequence of recession is that many businesses find themselves suddenly in a tax loss position. This can, in a small way, bring some relief to their cash flow in that they would no longer have to make payment of income tax to our Revenue authorities three times a year to the extent that the taxable income they generate is offset by their tax loss.
However, many companies do not operate in isolation, but are part of a group of companies. This latter term is defined differently for different purposes, but in tax parlance, put very simply, it largely relates to corporate structures in which at least 70% of the shares in a company are held directly by another company. All members of the group that are held in this way will constitute a ‘group of companies’ for tax purposes.
Currently, a company that has an assessed loss may only use that loss to offset future income that it, alone, generates. Thus, in a group of companies, there may be one or more companies in an assessed loss position, and other companies that are making taxable income and paying tax over to the South African Revenue Service (SARS). Often the loss companies in the group are being funded by the profitable companies in the group, but the latter receive no tax benefit for this.
Although losses may not be moved between group companies, South African tax legislation under specific circumstances does allow the transfer of assets between group companies without the incurral of taxes. Thus, the question may be asked, why not simply “divisionalise” the group, i.e. move all businesses conducted by the group to one company and operate these businesses as separate divisions? In this way, losses generated by one business can for tax purposes be used to offset income earned by another. However, divisionalisation is not always as easy as it might sound. There are often commercial reasons why it is not possible to have businesses together in the same company. Such reasons may, for example, relate to risks attached to different types of businesses, or liability considerations. The loss companies may be retained in the group because they are strategic to the group, or the loss is viewed as being temporary.
Furthermore, tax legislation has anti-avoidance provisions that prohibit a profitable business being moved into a loss-making company, unless there is a commercial reason for doing so, which is stronger than the tax reason.
Thus, although the ownership in the group is almost the same as if the group were one company, tax laws prohibit the cross-utilisation of tax losses. In a recession economy, the ability to cross-utilise the losses could be viewed as critical for the survival of the group.
In other countries, this problem is dealt with in a different way: by what is commonly known as ‘group taxation’. The current group rationalisation provisions in our South African tax legislation, introduced in 2001, were a response to recommendations made in the Katz Commission Report (issued in the early 1990s) that group taxation needed to be considered for South Africa.
However, the next step to full group taxation, i.e. allowing the use of losses across the group, has never been taken. It could be that the Treasury has considered that the cost of such a move would be too high. However, drastic measures are sometimes required in drastic times: The cost of losing some of the taxpayer groups altogether, because tax is being extracted from the better businesses, whilst others in the group are dragging it down, may be a higher cost to pay in the long run.
Although the term ‘group taxation’ refers to one concept, different countries have chosen different models for applying it. These include the consolidation model, the group contribution model, the group relief model and the Organschaft model.
The consolidation model is the method most commonly used around the world, although its application differs from jurisdiction to jurisdiction. In essence, this method requires each company to determine its income in the normal fashion, and this income is then ‘consolidated’ at the parent company level so that the parent company pays all the tax for the group companies.
The group contribution model involves profitable companies making tax deductible contributions to their sister loss-making companies within the group. This effectively ensures that only the net taxable income of the group is taxed. Each company, however, submits its own tax return reflecting the income from contributions made by, or expenditure from contributions made to, the sister company.
The group relief model allows group companies to transfer losses to profit- making companies in the group. These profitable companies simply use the losses, which the transferring company then loses. The transferring company transfers the losses until it is in a tax neutral position. Each company still submits its own tax return.
In the Organschaft model, all profits and losses are attributable to the parent company in the group. In this way the group is taxed as a whole, through the parent company, and tax is paid only on the overall taxable profits of the group.
Generally, a group (which has to be clearly defined to ensure that only specified ‘groups’ are eligible for the regime) will be entitled to elect whether or not its business is to be made subject to the relevant group taxation model.
Clearly, certain decisions would need to be made in South Africa: Which model would be most appropriate? What would constitute a group? Under what circumstances would a group qualify for election? It would also need to be decided whether it would apply only to group companies within South Africa, or whether foreign group companies would fall within the regime (currently no foreign losses may be set off against South African profits for tax purposes, even within the same company). However, there is plenty of precedent to draw from elsewhere.
In these days of economic downturn, perhaps the time is right for Treasury to reconsider South Africa’s current group rationalisation provisions and move them up to the next level: to full group taxation.
Deborah Tickle CA(SA), is a Partner International Corporate Tax, KPMG.