In income tax, the question of valuation of shares often causes a great deal of uncertainty, especially where shares are not traded on a recognised exchange. Although the Eighth Schedule to the Income Tax Act[1] in paragraph 31 gives some guidance on the market value of certain assets, the ‘catch-all’ method is the price that could have been obtained upon the sale of an asset between a willing buyer and a willing seller dealing at arm’s length in the open market.
The rules of capital gains tax determine that a person is deemed, on the date of their death, to dispose of all their assets (except for a limited number of exclusions) for an amount equal to the market value of those assets. Market value, and how it should be determined, is therefore a very important consideration.
Recently, the Supreme Court of Appeal in CSARS v The Executors of Estate Late Sidney Ellerine 2018 ZASCA 39 recently provided some more guidance on the valuation of preference shares in such a case, by considering the rights attached to those preference shares. The South African Revenue Service (SARS) argued that at the time of the deceased’s death, he was entitled to convert preference shares that he held in a company to ordinary shares and that the shares should be valued on that basis. This was a crucial consideration since it made the difference between the shares being valued at R563 million compared to its nominal value of R112 000.
After the Tax Court initially found that the deceased was not entitled to convert the preference shares to ordinary shares, the Supreme Court of Appeal considered certain amendments made to the company’s Memorandum of Incorporation (as it then was) as well as two special resolutions. Factually, based on these documents, the court found that the deceased was indeed entitled to convert the preference shares to ordinary shares on the date of his death. The shares, therefore, had to be valued at R563 million instead of R112 000.
There are two key lessons from this judgement. Firstly, the precedent that has been set that where a person has the right to convert preferences shares to ordinary shares, the preference shares should be valued on that basis.
Secondly, the true intention of parties should be reflected in the wording and construction of all documents. The legal team for the respondent in the Ellerine-case argued strongly that a purposive and contextual approach should be adopted in considering the Memorandum of Incorporation and special resolutions. The court was, however, not persuaded and indicated that while intention is important, the basic interpretation should be made with reference to what is recorded. Taxpayers are encouraged to seek professional advice prior to executing agreements to ensure that their true intention and the purpose for which they execute documents are clear from the wording used.
As can be seen from the Ellerine-case, failure to do so could be very costly.
[1] No 58 of 1962
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)
