Shares for goods and services – Be afraid, be very afraid…

Arrangements where shares are issued in exchange for goods or services are common in practice. The tax implications of such arrangements are often overlooked resulting in a lot of unwanted consequences.

Introduction

Issuing equity shares for the acquisition of goods or services is quite common in practice. The income tax and VAT implications of such arrangements are however often overlooked or ignored. 

In this short series of articles we shall examine the income tax and VAT implications of issuing equity shares for the acquisition of goods or services.

This article deals with the general income tax implications of such arrangements. It does not deal with the corporate rules contained in sections 42 and 43 of the income tax act.

Let’s lay down the law …

Lower courts have in the past consistently held that the issuing of shares for the acquisition of goods or services results in the incurring of expenditure for the acquisition of such goods or services.

And everybody was happy …

Then entered Big Brother in the form of the Labat case, a judgement handed down in the Supreme Court of Appeal. The court held that the issuing of shares does not result in the incurral of expenditure and therefore no deductions for income tax purposes.

Relief in the form of legislation

The income tax act was subsequently amended in the form of the introduction of sections 24BA and 40CA.

So what are the good news?

Section 40CA deems a company that has issued shares in exchange for assets to have incurred an amount of expenditure equal to the market value of the shares.

Assets for the purposes of the section includes all movable assets. It therefore includes capital assets and trading stock.

Capital gains tax implications

Enter section 24BA …

Impact on the company

The section determines that where the value of the shares is less than the value of the assets acquired, the company that issues the shares is deemed to have made a capital gain and will be liable for capital gains tax on the difference.

Well at least the company may add the capital gain to the market value of the shares to determine the cost assets for income tax purposes.

But there is more …

If the market value of the shares issued exceeds the market value of the assets acquired, the company is deemed to have distributed a dividend to the new shareholder and is liable for dividends tax!

Impact on the new shareholder

There is no immediate impact on the new shareholder.

In the hands of the person that receives the shares, the market value of the shares must be reduced by the value of the capital gain made by the company. If the shareholder therefore subsequently disposes of the shares, the base cost of the shares will effectively be the same as the base cost of the original asset. No dodging the taxman.

And what about shares issues for services supplied?

The principles established in the Labat case will apply under these circumstances. The company issuing the shares will therefore not be entitled to any income tax deductions as it would not be incurring any expenditure by issuing the shares.

In short, don’t do it!

Summary

This article only touches on the basic issues to consider when issuing shares for goods or services. This is unmistakably an area that is fraught with danger and professional advice should always be sought before transactions of this nature are entered into.

In the next article we shall deal with the VAT implications of issuing shares for goods and services.