Various sections of The Income Tax Act, No. 58 of 1962, refer to and require the market value of assets. Determining an asset’s market value is the Taxpayer’s responsibility and the onus of substantiating a valuation rests with the Taxpayer. A poorly formulated or unsubstantiated valuation could lead to inaccurate tax assessments, penalties, and interest if SARS finds that a valuation is not supported by proper documentation or reasonable methods.
Fair market value is defined in section 1 of the Tax Administration Act as:
“… the price which could be obtained upon a sale of an asset between a willing buyer and willing seller dealings at arm’s length in an open market. ”
The market value of an asset is, therefore, the best price at which an interest in the asset would have been sold unconditionally for a cash consideration. For Private companies, there is usually limited comparable market information available to determine the fair market value. A valuation should be obtained in these circumstances to determine the fair market value.
Various tax events and transactions require the market value of a business or shares. Here are a few examples:
- Disposal of business or shares to connected persons
Certain assets are deemed to be disposed of at market value for capital gains purposes, and therefore, the market value of the assets should be determined. The taxable capital gain or loss determined using the market value of the assets is included in the Taxpayer’s taxable income. If an asset is disposed to a connected party, according to the Eighth Schedule to the Income Tax Act, the transactions are deemed to take place at the asset’s market value.
- Tax emigration and tax immigration
When a taxpayer ceases South African residency or if a controlled foreign company (CFC) ceases to be so or when a resident company becomes a headquarter company, the Taxpayer is deemed to have disposed of its assets on that day at market value. The capital gains tax is then based on the market value of the assets and included in the taxable income of the Taxpayer. Similarly, a person or company that commences to be a tax resident or a CFC is deemed to have disposed and reacquired its assets at that date. Such market value will be utilised as the taxpayer’s base cost for future asset disposals.
Suppose an asset is transferred as a gift or in exchange for a non-monetary consideration or to a connected person for a consideration that doesn’t represent a fair market price. In that case, they should be considered as having disposed of the asset at its market value at the time of the transfer. The Capital gains tax and donations tax is, therefore, payable with reference to the asset’s market value. If the Commissioner is of the opinion that shares were sold for inadequate consideration, a donation is deemed to take place. SARS will consider the market value of shares when determining whether the consideration received is adequate consideration. Donations tax may be payable on the difference between the market value and the consideration received for the shares.
- Corporate restructuring and corporate rules transaction
Commercial transactions can be structured on the basis that instead of a cash payment for the acquisition of an asset, shares are issued by the purchaser in favour of the seller, usually referred to as an “asset for share” transaction. A valuation of the shares is imperative for these restructuring transactions to determine the number of shares to be issued and to ensure that the transaction takes place at the correct terms and for adequate consideration.
Some employee share schemes rely on the market value of the company’s shares to determine the employee’s participation in the scheme. The market value of the shares can determine the application of section 8C to a taxpayer’s taxable income from an employee share scheme.
Assets need to be valued at their open market value to determine the value of the estate of a deceased person for estate duty purposes. The Commissioner must approve the value of shares owned by the deceased individual in unlisted companies, close corporations, or shareblock companies as of their passing.
Under section 102(1)(e) of the Tax Administration Act, the Taxpayer bears the burden of proving that a valuation of an asset is correct. The Commissioner can verify or audit the Taxpayer’s valuation or request further information or documents relating to the valuation.
A valuation should use relevant and appropriate methods and reasonable and realistic assumptions to determine the market value of an asset. There should be solid arguments, accurate calculations and supporting evidence for the inputs to the valuation. A valuation should be reasonable, given the current market conditions.
It is crucial that the Taxpayer obtains a valid valuation to substantiate the value used for shares in the anticipated transaction. The Taxpayer should be able to prove that he applied his mind and took the necessary steps to determine the accurate market value for the asset under consideration to avoid potential penalties. The valuation should be adequately prepared to defend valuation in case of a query or tax audit. An accurate market valuation is essential if the transaction is tax-sensitive and transaction values are significant.
Please feel free to reach out if you need a business valuation as part of your tax planning.