In (April 2022)
ASA 'Uneven barter transactions', I dealt with the consequences that can arise when there is a divergence in values in a barter transaction because of the valuation rules in para 31 of the Eighth Schedule to the Income Tax Act 58 of 1962 (the Act). I mentioned that this problem could also be caused by a sale subject to a suspensive condition but did not explore that situation in any detail. This article examines s 40CA of the Act when a company issues shares in exchange for an asset and the transaction is subject to a suspensive condition.
What is a suspensive condition?
In
Design & Planning Service v Kruger Botha J described a suspensive condition as follows:
'In the case of a suspensive condition, the operation of the obligations flowing from the contract is suspended, in whole or in part, pending the occurrence or non-occurrence of a particular specified event (cf
Thiart v Kraukamp, 1967 (3) SA 219 (T) at p 225).'
A typical example of a suspensive condition or 'condition precedent' (as it is otherwise known) arises when X sells a property to Y and the agreement contains a condition that the sale is subject to Y obtaining a mortgage bond within a specified period. Until Y obtains the bond, there is no sale and should Y be unable to obtain the bond, the sale will not come into existence. Other examples involve statutory approval for a transaction, such as South African Reserve Bank or Competition Commission approval.
The legal effect of a suspensive condition was set out by Wallis AJA (as he then was) in
Mia v Verimark Holdings (Pty) Ltd in which he stated the following:
'The conclusion of a contract subject to a suspensive condition creates "a very real and definite contractual relationship" between the parties. Pending fulfilment of the suspensive condition the exigible content of the contract is suspended. On fulfilment of the condition the contract becomes of full force and effect and enforceable by the parties in accordance with its terms.'
Section 40CA
Section 40CA was inserted into the Act by the Taxation Laws Amendment Act 22 of 2012 because of the decision in
C: SARS v Labat Africa Ltd in which it was held that a company does not incur expenditure on an asset when it acquires it through the issue of its shares.
The word 'expenditure' in s 40CA thus ensures that a company that issues shares in exchange for an asset will have base cost for the asset under para 20 or, if the asset comprises trading stock, expenditure under s 11(a). Section 40CA is thus intended to assist taxpayers and is not an anti-avoidance provision — that function is left to s 24BA. Section 40CA does not, however, create expenditure when a company issues its shares in exchange for services rendered.
In so far as it addresses an asset-for-share transaction outside the roll-over rules in section 42, s 40CA provides as follows:
'40CA. Acquisitions of assets in exchange for shares.—Where a company acquires any asset, as defined in paragraph 1 of the Eighth Schedule—
(a)
from any person in exchange for shares issued by that company, that company must be deemed to have actually incurred an amount of expenditure in respect of the acquisition of that asset which is equal to the sum of—
(i)
the market value of the shares immediately after the acquisition; and
(ii)
any deemed capital gain determined in terms of section 24BA(3)(a) in respect of the acquisition of that asset; or ...'
Section 24BA
Section 40CA needs to be read with its companion provision, s 24BA, which is aimed at tax avoidance through value mismatches. Section 24BA(2) provides:
'(2)
Subject to subsection (4), this section applies where—
(a)
in terms of any transaction, a company, for consideration, acquires an asset from a person in exchange for the issue by that company to that person of shares in that company; and
(b)
the consideration contemplated in paragraph (a) is (before taking into account any other transaction, operation, scheme, agreement or understanding that directly or indirectly affects that consideration) different from the consideration that would have applied had that asset been acquired in exchange for the issue of those shares in terms of a transaction between independent persons dealing at arm's length.'
A comparison therefore needs to be made between the actual consideration and the consideration payable by independent persons dealing at arm's length.
When there is a mismatch in values, a capital gain or dividends tax can arise under s 24BA(3).
A capital gain will be triggered in the acquiring company when the value of the shares it issued is less than the value of the asset it acquired.
Under barter or exchange principles, the expenditure incurred in acquiring the shares is equal to the market value of the asset given in exchange as this is the amount by which the person was impoverished. Section 24BA(3), however, provides that the acquirer of the shares must reduce the expenditure incurred on their acquisition by the amount of the capital gain triggered in the company.
A dividend
in specie is triggered when the value of the shares exceeds the value of the asset.
Example — Base cost of asset acquired in exchange for issue of shares
Facts:
Two companies, X and Y, which are unconnected, enter into an agreement in which they will each dispose of their shares in a company (Sub 1 and Sub 2) to Newco in exchange for shares in Newco, a resident company to be formed once Competition Commission approval has been obtained. The agreement contains a clause that the parties have elected out of s 42 in accordance with s 42(8A)(a). After employing the services of an independent professional valuer, they agree that the value of their respective shares to be contributed are worth R100 million (33,3%) and R200 million (66,7%), and that they will receive a commensurate number of shares in Newco reflecting these values.
A year later the transaction is approved by the Competition Commission. At that time the Sub 1 and Sub 2 shares to be contributed by Company X and Y have changed in value to R150 million (40%) and R225 million (60%) respectively.
The value of the Newco shares is equal to the value of the Sub 1 and Sub 2 shares it acquired. In other words, there is no deferred tax in Newco or accumulated losses which could depress the value of the Newco shares.
What is the base cost of the shares acquired by Newco from Company X and Y under s 40CA?
Result:
Market value determined without regard to the agreement
It might be argued that since s 40CA refers to the market value of the shares in Newco immediately after the acquisition by it of the shares in Sub 1 and Sub 2, the base cost of the Sub 1 and Sub 2 shares would be determined with reference to the value of the Newco shares at that time based on what a third party would pay for them, namely, R150 million and R225 million. Those supporting this view might argue that the time of disposal under para 13(1)(a)(i) and the time of acquisition under para 13(2) is when the suspensive condition is satisfied, and that the proceeds and base cost should be determined at the same time.
The problem here is that this interpretation will cause a value mismatch under s 24BA:
Company X will receive 33,3% of the shares in Newco, worth approximately R125 million (R150 million (Sub 1) + R225 million (Sub 2) = R375 million × 33.3%) in exchange for the Sub 1 shares worth R150 million, thus triggering a capital gain of R25 million in Newco under s 24BA(3)(a)(i). In addition, Company X must reduce the base cost of its Newco shares from R150 million to R125 million under s 24BA(3)(a)(ii)(aa).
Company Y will receive 66,7% of the Newco shares worth approximately R250 million (R150 million + R225 million = R375 million × 66,7%) in exchange for the Sub 2 shares worth R225 million, thus triggering a dividend
in specie in Newco of R25 million, which would be exempt from dividends tax under s 64FA(1)(a).
Under s 40CA the base cost of the Sub 1 shares in Newco will be R125 million + R25 million (capital gain) = R150 million.
The base cost of the Sub 2 shares will be R250 million.
Market value based on the agreement
Under this interpretation, the base cost of the Sub 1 and Sub 2 shares is R100 million and R200 million respectively. Company X and Y would account for proceeds of R100 million and R200 million respectively, resulting in no value mismatch under s 24BA.
There is a compelling argument set out in the remainder of this article that the valuation of the shares should reflect the agreed terms at contract formation, not the market fluctuations at condition fulfilment.
The case for determining market value based on the agreement
The operative provision for determining the base cost of the asset acquired by the company is s 40CA and not the time of disposal and acquisition rules in para 13 of the Eighth Schedule.
No mention is made in s 24BA of 'market value'. The parties to the agreement were independent and acted at arm's length. In these circumstances, it is implausible that s 24BA was intended to trigger a value mismatch merely because the agreement was subject to a suspensive condition. Recognising that the market value is determined under the agreement leads to a harmonious interpretation of s 40CA and s 24BA.
Meaning of market value
The term 'market value' is not defined for purposes of s 40CA. Nevertheless, given that base cost needs to be determined, it would seem reasonable to rely on the valuation rule specified in para 31(4) which states that the market value of any shares of a person in a company not listed on a recognised exchange must be determined at a value equal to the price which could have been obtained upon a sale of the share between a willing buyer and a willing seller dealing at arm's length in an open market subject to three conditions which for present purposes are irrelevant.
I would argue that the two shareholders and Newco negotiated the terms of their arrangement at arm's length on a willing buyer, willing seller basis and that effect should be given to the values agreed upon.
Some support for this approach can be found in an example dealing with para 38 of the Eighth Schedule in the SARS
Comprehensive Guide to Capital Gains tax (Issue 9) in which two connected persons enter into an option agreement in which the one party acquires an option from the other at a market-related price. When the option is exercised five years later, it is accepted that the strike price is market related despite the actual market price being much higher. Consequently, the actual market value at the time of acquisition will not be substituted under para 38 for the price agreed upon by the parties. The example emphasises that full effect must be given to the facts and circumstances when determining market value and that one cannot simply ignore the terms of an agreement.
In the English case of
IRC v Gray, Lord Hoffman stated the following:
'It is often said that the hypothetical vendor and purchaser must be assumed to have been "willing", but I doubt whether this adds anything to the assumption that they must have behaved as one would reasonably expect of prudent parties who had in fact agreed a sale on the relevant date. It certainly does not mean that having calculated the price which the property might reasonably have been expected to fetch in the way I have described, one then asks whether the hypothetical parties would have been pleased or disappointed with the result; for example, by reference to what the property might have been worth at a different time or in different circumstances. Such considerations are irrelevant'.
In
South Atlantic Jazz Festival (Pty) Ltd v C: SARS, Binns-Ward J stated the following:
'In an ordinary arms' length barter transaction the value that the parties to it have attributed to the goods or supplies that are exchanged seems to me, in the absence of any contrary indication, to be a reliable indicator of their market value.'
Conclusion
The valuation of assets exchanged under a barter transaction subject to a suspensive condition demands a purposive and commercially coherent interpretation of s 40CA. When parties act independently and at arm's length, and the suspensive condition delays enforceability, it is both logical and equitable to defer the recognition of the market value agreed between the parties in the agreement until the condition is fulfilled. This approach not only aligns with established jurisprudence but also mitigates the risk of arbitrary tax outcomes under s 24BA.
This article was first published by ASA in its
November 2025 issue.
