The shareholder-, buy and sell agreement and MOI in your business should cover all the taxation aspects of Income Tax, Capital Gains Tax, Donations Tax and Estate Duty, upon the departure any one or more owner[s] / shareholder[s].
It is imperitive that the buy and sell agreement is structured and aligned with the Shareholders Agreement and the Memorandum Of Incorporation of the company, in order provide the most tax efficient solution possible.
A correctly structured buy and sell agreement will ensure that Income Tax, Estate Duty, Capital Gains Tax and Donations Tax implications are either:
- Avoided entirely
- Reduced to manageable and acceptable levels
- Funded through tax efficient structures and mechanisms.
From an income tax perspective you need to consider Section 11(w) and all its implications. Although there are choices and decisions that can be made here, in very simple layman’s terms, if the premiums were deducted for income tax purposes by the company, then the proceeds of any life insurance policies paid to the company, will be taxable.
For the most part, Estate Duty is not a concern if life insurance is used to pay for the share transfer between owners / shareholders, assuming that the departing owner / shareholder is a natural person. There is an unusual anomaly to this, insofar as a company, which is a shareholder, is defined as a person by the Interpretation Act, Act No 33 of 1957 and so it is possible to maintain Estate Duty free payments to shareholder companies. Trusts on the hand do not enjoy the same exemption. There are nevertheless corporate structuring techniques available with a combination of trusts and companies, whereby Estate Duty benefits could still be obtained.
At any stage that the payment for the owner’s interest or shareholding exceeds the base cost of the interest / shares, there will be a capital gain and capital gains tax will ensue. Similarly, there could be a capital loss, which will not be deductible for tax purposes. It is vitally important that an acceptable valuation method is adopted and adopted in all relevant agreements and the MOI of the company, to avoid excessive CGT [capital gains tax] being raised by SARS.
Donations tax could arise if the payment for the ownership interest / shareholding is substantially less than a fair market value thereof. This is also why one needs to define the share valuation method in an acceptable manner and structure to SARS. If insufficient consideration is given to this aspect, you could find yourself in the unenviable position of incurring both Donations and Capital Gains Tax upon the transfer of ownership.