Member Article

SARS Interpretation Note 94 – contingent liabilities assumed in the acquisition of a going concern Importantly, SARS’ application of the latter distinction appears to follow the reasoning put forward by the Privy Council in Commissioner of Inland Revenue v New Zealand Forest Research Institute Ltd, wherein it was held that expenditure incurred in respect of provisions taken over was incurred as part of the purchase price, which was capital in nature and therefore not deductible.

In a previous ENSight, we commented on the uncertainty that exists in relation to the assumption of contingent liabilities in the context of a sale of business.

This topic was subsequently dealt with in a discussion paper issued by the South African Revenue Service (“SARS”) in 2013, and in a draft interpretation note released for public comment in 2015.

Following on from these documents, SARS released a very comprehensive and detailed analysis of the issue in their final Interpretation Note 94, dated 19 December 2016 (“IN94”), which concluded that:

“when the seller disposes of a business as a going concern and the purchase price of the assets disposed of is partly settled by the purchaser assuming a free-standing contingent liability –

· the seller must include the agreed value of the free-standing contingent liability assumed by the purchaser in gross income and proceeds (as appropriate);

· the seller does not incur expenditure in relation to the assumption of the freestanding contingent liability by the purchaser and is not entitled to a deduction;

· the purchaser will incur expenditure only if the free-standing contingent liability materialises and the purchaser is required to incur expenditure in settling the liability at that time; and

· in the purchaser’s hands the assumption of the free-standing contingent liability relates to the assets acquired and any deduction must be determined with reference to the deduction and allowance provisions which apply to the particular assets whose purchase price was settled or partly settled by the assumption of the free-standing contingent liability.

Embedded obligations and valuation provisions ... depress the value of the asset and do not represent an additional amount of proceeds.”

In arriving at these conclusions, SARS draws a distinction between free-standing liabilities and liabilities that relate to particular assets. SARS also draws a distinction between liabilities that are taken over as a free-standing item, and liabilities that are taken over as a way of paying for the business being acquired.

IN94 accordingly seems to suggest that SARS disagrees with the potentially contradictory views which have been touched upon by the tax court in South Africa when dealing with this topic.

Taxpayers should therefore be careful to ensure that they obtain comprehensive tax advice when considering the structure of, inter alia, M&A transactions involving contingent liabilities, in order to avoid unnecessary uncertainty and/or disputes with SARS.

Robert Gad

tax corporate, indirect, disputes and share schemes director

[email protected]

+27 82 567 9082

Megan McCormack

tax associate

[email protected]

+27 82 382 8963