Continuation Funds: The New Dawn in Private Equity Fund Formation

by | Jan 17, 2025 | BTCLQ, BTCLQ V15 I4

Continuation Funds: The New Dawn in Private Equity Fund Formation

Authors: Michael Rudnicki

ISSN: 2219-1585
Affiliations: Tax Executive, Bowman’s Attorneys
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 4, 2024, p. 1 – 8

 Abstract

This article explores the principal tax themes emanating from a new fund structure in the Private Equity industry referred to as a Continuation Fund. A Private Equity fund in South Africa is established in the form of a common law partnership, more specifically an en commandite partnership, meaning a distinction between so-called limited partners (limited in liability to their partnership contribution) and general partners (unlimited in terms of their liability to third parties, but share in profits disproportionate to their capital contribution).
Given the life expectancy of a PE Fund (typically a maximum of 10 years), the disposal of portfolio assets may be premature upon termination, given their inherent future value and poor market conditions. An appropriate investment remedy for investors wishing to further exploit the intrinsic value of PE portfolios is the establishment of a Continuation Fund.
Simplistically, the Continuation Fund is a new partnership whereby partners of the existing fund contribute their interests from the old fund. Issues such as the term of the fund, establishing which partners are limited and general, and fees, are key aspects that required consideration.
In South Africa, a partnership under common law is not a legal person distinct from the partners, nor is a partnership a taxable person.
An important consideration relating to partners exiting partnerships is the theory that partners co-own, in an abstract sense, undivided shares in the underlying assets. Accordingly, a partner does not own a piece of the land or a portion of the shares in the object sense, but rather jointly owns an indefinite whole until action is taken to divide the common asset. So when a partnership dissolves, the partner’s interest becomes a divided interest in the assets. For tax purposes, a partnership interest includes an undivided share in the assets of the partnership.
A ‘disposal’ for Capital Gains Tax purposes is defined in paragraph 11 of the Eighth Schedule to the Income Tax Act 58 of 1962 (the Act), and includes ‘any event, act, forbearance or operation of law which results in the creation, variation, transfer, or extinction of an asset’ (my emphasis).
In terms of the common law, partners entering and leaving the partnership results in the extinction of the old partnership and the creation of a new partnership.
For tax purposes, the disposal of an interest in the underlying assets, will result in a disposal subject to CGT.
In the context of a re-investment in a Continuation Fund, it is submitted that the disposal must have resulted in a parting with the asset, in whole or in part. On dissolution of the old fund, the fund’s assets are distributed in accordance with the respective partners’ contractual interest, established upfront. An abstract interest in the assets is replaced with actual ownership of not parted with anything nor gained anything. A limited partner in the old fund which contributes its shares to the Continuation Fund, as a general partner, will not give up value on the date of entry to the new partnership. This is because the value of the contribution equals the value of the shares distributed from the old fund. A reconstitution of partner rights to profits does not result in the giving up of anything on the date of the contribution. The sharing of profits from that point on determines the profit allocation.
Accordingly, a disposal for CGT purpose should not arise upon entry in the Continuation Fund.

 

Hidden Complexities in the Right of Recourse Between Co-debtors and Co-sureties

by | Jan 17, 2025 | BTCLQ, BTCLQ V15 I4

Hidden Complexities in the Right of Recourse Between Co-debtors and Co-sureties

Authors: Leon Kuschke SC, John Butler SC and Matthew Blumberg SC

ISSN: 2219-1585
Affiliations: Members, Cape Bar
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 4, 2024, p. 9 – 20

 Abstract

Does a co-debtor or co-surety who is called upon to pay, and does pay, more than his or her proportionate share of the principal debt enjoy an ex lege (i e automatic) right of recourse or contribution against his or her co-debtors or co-sureties? This is the question that the authors — sitting as an arbitration appeal panel of three — were called upon to answer in recent arbitration proceedings.
The common assumption, amongst lawyers and businesspeople alike, is that there is an ex lege or automatic right of recourse or contribution in these circumstances. However, as appears from the analysis below, that assumption oversimplifies the legal position — which, on an overview of the relevant authorities, has two central tenets.
The first is that the default or presumptive position is that co-debtors and co-sureties do enjoy a mutual right of recourse or contribution in the circumstances described above.
The second is that the default or presumptive position may be displaced by the nature of the underlying relationship between the individual co-debtors or co-sureties. It is their underlying relationship — not merely the existence of a relationship of co-debtorship or co-suretyship — that is ultimately determinative of whether or not a mutual right of recourse or contribution exists.
As an example, assume that budding entrepreneur A wishes to start a business. A seeks to borrow R100 as start-up finance from lending institution X. To satisfy X’s requirements in respect of security, A’s wealthy relative B agrees to assume personal liability, jointly and severally alongside A, for repayment of the loan. The position then is that Y, as creditor, is owed R100 by A and B as co-principal debtors.
On settling the loan in full, does A then enjoy a right to recover R50 (half of the total debt paid by A) from his co-debtor B?
On the common assumption referred to above, the answer would be yes. But the legal principles, properly understood and applied, yield the opposite answer. Unlike A, B (the wealthy relative) has no genuine interest in the advance of the loan. The law recognises that in these circumstances, the underlying relationship between A and B is inconsistent with the latter owing the former an obligation to relieve him or her of the full debt burden (i e by distributing it between the two of them).
In this example, the nature of the underlying relationship between the co-debtors A and B — which, again, is inconsistent with a mutual right of recourse or contribution between them — has the result that the default or presumptive position is displaced and does not apply.

 

Early Termination of a Lease: Tax Implications in the Hands of the Lessor

by | Jan 17, 2025 | BTCLQ, BTCLQ V15 I4

Early Termination of a Lease: Tax Implications in the Hands of the Lessor

Author: Des Kruger and Karabo Mogashoa

ISSN: 2219-1585
Affiliations: Consultant, Webber Wentzel Attorneys; Candidate Attorney, Webber Wentzel Attorneys
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 4, 2024, p. 21 – 32

Abstract

It is not uncommon for a lessee to seek to exit a lease prior to termination date, for varied reasons. The lessor will usually only be amenable to such early termination in exchange for an early termination payment. The crisp issue is: is such termination payment a receipt of a capital or revenue nature. Intuitively, the answer is that the compensation is of a revenue nature as the compensation is to compensate the lessor for a loss of the rentals that would have been paid by the lessee had the lease run its course.
However, the answer, as argued in this article, is not that straight forward. The answer is very dependent on the facts. The premise of this article is that where compensation is paid by a lessee to a lessor as compensation for the lessor agreeing to cancellation of a lease agreement, the compensation will be of a capital nature where the lease agreement constitutes the major, or the whole, business of the lessor. The fact that the lessor will in all probability be able to find a new tenant does not affect this conclusion. Nor is the conclusion different if the compensation is determined by reference to the loss of rentals that will arise in consequence of the termination of the lease agreement. By contrast, where the lease arrangement is merely a part (i e not a major or the whole) of the lessor’s business, the compensation will in all likelihood be regarded as a receipt of a revenue nature.
On the basis that the compensation derived by the lessor for the early termination of the lease agreement is a receipt of a capital nature in these specific circumstances, the issue arises as to the capital gains tax (CGT) implications that arise in consequence of such receipt. The authors conclude that while the termination payment will constitute proceeds for CGT purposes, as the lessor will not have incurred any expenditure in respect of the acquisition or creation of the lease agreement qua asset, the base cost in such asset is nil.
As the termination of the lease agreement constitutes the surrender of a right, and accordingly the supply of a service for value-added tax (VAT) purposes, VAT will need to be accounted for by the lessor (if a VAT vendor) on receipt of the termination payment.

 

Beneficial Ownership Disclosure and Trusts

by | Oct 30, 2024 | BTCLQ, BTCLQ V15 I3

Beneficial Ownership Disclosure and Trusts

Author: Aneria Bouwer

ISSN: 2219-1585
Affiliations: Senior Consultant, Bowmans Attorneys
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 3, 2024, p. 1 – 8

Abstract

This article deals with the obligation of trustees to submit an electronic register of the beneficial owners of a trust to the Master of the High Court. The article explores the aim of these disclosure requirements and considers the application of the beneficial ownership definition in the Trust Property Control Act to employee share ownership plan trusts. The writer laments the fact that share ownership plans are not excluded from these disclosure obligations, taking into account the comprehensive tax reporting obligations of a share ownership plan.

 

The Companies Second Amendment Act 17 of 2024: Ameliorating the Timebarring Regime under Sections 77 and 162 of the Companies Act

by | Oct 30, 2024 | BTCLQ, BTCLQ V15 I3

The Companies Second Amendment Act 17 of 2024: Ameliorating the Timebarring Regime under Sections 77 and 162 of the Companies Act

Author: Milton Seligson SC and Matthew Blumberg SC

ISSN: 2219-1585
Affiliations: Honorary Member, Cape Bar; Member, Cape Bar
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 3, 2024, p. 9 – 22

Abstract

A director owes duties to the company of which he or she is director. These include, in the main, a fiduciary duty and a duty to exercise reasonable care, skill and diligence. This is the position at common law, as well as under the Companies Act. Sections 77 and 162 of the Companies Act contain the two principal remedies for breach of these duties. Section 77 provides for the director concerned to be liable for loss sustained by the company as a consequence of the breach. Section 162 provides for the director to be declared delinquent or under probation. Both sections have time-barring provisions. In terms of the existing section 77(7), proceedings by the company concerned to recover loss from the director may not be commenced more than three years after the act or omission that gave rise to the liability — i e irrespective of when the company did, or could have, acquired knowledge of the act or omission in question. In terms of the existing section 162(2)(a), stakeholders in a particular company wishing to bring delinquency proceedings against an individual who was, but no longer is, a director of the company, are required to do so within 24 months of the date on which the individual ceased to be a director — i e, even if the stakeholder concerned did not have knowledge of the delinquent conduct, and could not reasonably have acquired it, within the stipulated 24-month period. These time-barring provisions have the potential to operate harshly — and so it has been contended, unconstitutionally. In light thereof, and following recommendations by the Zondo Commission, the time-periods have been revisited, and substantially ameliorated, in the recently enacted Companies Second Amendment Act. As part of these amendments, a discretion is now conferred on the court, in the context of both remedies, to extend the relevant time-period on good cause shown. The article analyses the existing time-barring regime (i e, that are currently in place and which will remain in place until the Companies Second Amendment Act comes into operation); identifies the deficiencies in that regime and the likely rationale for amendment thereof; and explores the pros and cons of the more flexible time-barring regime introduced by the Companies Second Amendment Act.

 

VAT, Indemnity Payments and Capitec Bank: The Good, the Bad and the Ugly (Part 2)

by | Oct 30, 2024 | BTCLQ, BTCLQ V15 I3

VAT, Indemnity Payments and Capitec Bank: The Good, the Bad and the Ugly (Part 2)

Author: Des Kruger

ISSN: 2219-1585
Affiliations: Independent Consultant
Source: Business Tax & Company Law Quarterly, Volume 15 Issue 3, 2024, p. 23 – 30

Abstract

In the previous edition of this journal, the writer dealt with the substantive issue that was required to be addressed by the Constitutional Court in Capitec Bank Ltd v Commissioner for the South African Revenue Service, namely whether Capitec Bank Ltd was entitled to claim a deduction under section 16(3)(c) of the Value-Added Tax Act, 1991, in respect of amounts credited to borrowers accounts under a loan cover arrangement on the happening of specified events, namely the death or retrenchment of the borrower. Capitec had essentially undertaken to apply the claim proceeds derived by it under a credit life policy entered into with an insurer against the indebtedness of the borrower on his or her death or retrenchment. No consideration was payable for the loan cover by Capitec. This Part of the article address the remaining issues dealt with in this seminal case, namely apportionment, capitalisation and supplies for no consideration. It is, with respect, submitted that the court addressed these related issues succinctly and appropriately. As regards apportionment, the court held that while section 16(3)(c) did not deal specifically with apportionment, it would in essence be fair and reasonable to do so given that the loan cover related to the bank’s taxable and exempt activities. As noted by the writer, the court’s dicta is apposite as regards supplies that fall to be dealt with under section 8(15). Section 8(15) provides that where a single supply of goods or services would, if separate considerations had been payable, been standard rated and zero rated, each part of the single supply is deemed to be a separate supply. However, there are no rules as to how the consideration related to each notional separate supply is to be determined. Rogers J in Capitec Bank provides a practical answer — apportionment under general principals. As regards capitalisation, Rogers J held that the components of the borrowers’ accounts retain their character of interest (exempt) and fees (taxable) and fell to be dealt as such for VAT purposes. While the writer acknowledges the correctness of the analysis and conclusion arrived at by the court, he notes that this approach gives rise to issues where a trust makes distributions to a beneficiary after many years out of capitalised trust capital and is required to apply Binding General Ruiling No 16 (‘BGR 16’) in relation to that distribution. BGR 16 provides for a mandatory apportionment methodology, the so-called turnover-based method. The writer suggest this is something that needs to be considered by SARS. The final issue relates to supplies made for no consideration. The court confirmed that a supply for no consideration does not per se mean that the underlying supply is not an ‘enterprise’ (taxable) supply in every circumstance. Rather, it must be considered to what extent the free supply is a part of the enterprise (taxable) activities carried on by the vendor. Where for example, a vendor gives a free giveaway to encourage the purchase of the vendor’s wares, the supply of the giveaways for no consideration is still in the course or furtherance of the vendor’s enterprise, albeit for nil consideration (section 10(23)). In the context of the Capitec Bank case, the court had accepted that the supply of the loan cover related to both taxable and non-taxable supplies.