CHAPTER 10

10.1 INTRODUCTION

10.1.1 The South African tax system regards each individual company within a group as an entirely separate taxpayer. In this regard, South Africa is out of step with the tax treatment of companies in most industrialised economies. (In so far as corporate taxation impacts upon sectors of the economy which compare, and compete, with the developed world, the correct comparison is with more advanced economies.) Most of the submissions received by the Commission on the subject have urged that some form of group taxation be recommended.

10.1.2 The Commission is mindful of a view amongst some that the issue of group tax is not a priority. It disagrees with this view, and regards the current position as a structural defect in the system that cannot be passed over in any serious tax reform process. The Commission concludes that South Africa can no longer refuse the cogent arguments which favour movement to a group system. In so far as, amongst others, considerations of cost and complexity have inhibited such a move in the past, the answer is to commence the transition with controlled reforms which minimise such exposures. As experience is gained with the group basis of taxation both in revenue offices and in the private sector, and as the impact of the shift on the fiscus becomes clearer, further refinements in the group system can be effected.

10.2 ADVANTAGES AND DISADVANTAGES OF THE GROUP BASIS OF COMPANY TAXATION

Advantages

10.2.1 It is clear that a closely held group, although consisting of separate companies, can constitute a single economic unit for purposes of strategic management and financial planning. A tax system that ignores this reality can be expected to create economic and business distortions; the group system avoids this.

10.2.2 A first example of such a distortion is the manner in which the current system has caused the divisionalisation of many companies into one legal entity purely for tax reasons. This has had the effect of denying those companies the basic protection of limited liability in terms of company law. It has influenced, furthermore, capital formation and risk taking. It interferes with a whole range of operational, compensation, management and competition policy issues.

10.2.3 On the other hand, where a group of companies cannot divisionalise because of legal or strategic reasons, they have to continue to be taxed in denial of the economic reality of their association. If a wholly owned subsidiary in a group makes a profit while another makes a larger loss, for example, the current system causes the group to pay tax in the profitable company although the owners suffer a loss overall.

10.2.4 This situation is perceived as unfair, and as a result a whole battery of intra-group tax techniques have developed to counter this effect. Where these techniques have commercial substance, they represent actions that were induced by tax rather than commercial considerations, the very influence a tax system should seek to avoid. Where groups resort to techniques without commercial substance, including transfer pricing, bogus management fees or charges, "formal" partnerships and a host of other examples, the integrity of the system itself is undermined.

10.2.5 In a culture of intra-group manipulations, such as inevitably arises when there is no recognition in the law of the reality of a group economic interest, tax avoidance and even evasion do not stop at merely trying to match profits and losses. Because transactions have a tax effect between parties although they have no real economic or commercial effect due to common ownership, it becomes possible to manipulate cost bases, to engineer timing or capital/revenue mismatches, or simply to "lose" one end of a transaction. Despite complicated anti-avoidance measures, these transactions are often difficult to detect and police.

10.2.6 Under the current system the fiscus is at a serious disadvantage in combating these practices. Companies within a group are likely to be assessed separately, and may even be registered at different revenue offices. Under these circumstances the revenue authorities have incomplete information and cannot effectively counter the sort of intra-group manipulations referred to above. In an appropriate group system, a full audit trail of any intra-group transactions is available to the authorities. In a full group system, moreover, the transactions that have tax effects are those with parties outside the group, who have an independent commercial interest. That independent commercial interest, in a group system, becomes a powerful ally to revenue authorities in policing the system.

10.2.7 It is sometimes stated that group taxation would have the disadvantageous effect of encouraging the formation of conglomerates. While this might have been a valid concern in the past, the reverse situation might well be more common today. Group taxation facilitates the unbundling of large organisations into more efficient multi-company structures which, in the present system, would result in higher tax liabilities due to the higher profitability of sub-units. The restructuring of various government-owned enterprises, for example, might bring many sub-units of the business to smaller emerging investors. This process is inhibited as these corporations are discouraged from organising themselves into mobile multi-company structures since the overall protection of their typically large tax losses would then not extend to these profitable pockets. The Commission is particularly aware of the importance of facilitating not only shareholding as such, but the opportunity of actual ownership and control of companies by emerging investors, both in the existing market and in the privatisation process.

10.2.8 In keeping with international practice, foreign investors expect to find at least some form of group taxation under our system. Now that South Africa is again a full partner in the world investment and trading community, it is necessary to review the basis of our company taxation in this context.

Disadvantages

10.2.9 The Report of the Margo Commission listed several perceived disadvantages to a group system. Some of these either had doubtful validity in the first place or have since fallen away.

10.2.10 The remaining potential problems are the following:

1. complexity;
2. perceived cost to the fiscus; and
3. the need for anti-avoidance (dealt with below as part of the problem of complexity).

10.2.11 The Commission recognises these difficulties, particularly in the context of a full group system of taxation. However, the complexity and costs of a group tax system will depend on its nature. The Commission is persuaded that it is appropriate to introduce a compromised form of group taxation which would be neither complex nor costly, and would be amenable to further evolution in the direction of full group taxation. Before dealing with the compromises as such, it is necessary to note the reasons why the Commission proposes a consolidation system rather than the alternative of a loss transfer system.

10.3 CONSOLIDATION OR LOSS TRANSFER

10.3.1 There are two principal systems of group taxation:

1. The more common consolidation approach is adopted in the United States of America and much of continental Europe. The consolidation system basically treats the group of companies as if it were a single entity. Intercompany profits and losses are reversed, and the tax impacts of most intra-group transactions are ignored.
2. The loss transfer approach is applied in the United Kingdom, and is also in place in Australia. Each company in the group retains its own personality, and it is not generally required that intra-group transactions be reversed for tax purposes.

10.3.2 Although in relatively simple situations the two systems can give very much the same result, there are several factors of comparison which have persuaded the Commission to recommend the consolidation approach as the preferable route.

1. Conceptually, the loss transfer system, unlike the consolidation system, does very little about recognising the economic unity of a group.
2. In the loss transfer system, each company remains a separate taxpayer, and much of the potential for manipulation of intra-group transactions remains, including the engineering of timing differences, manipulation of cost bases and exploitation of capital/revenue mismatches. In the consolidated approach such manipulation largely loses its tax impact, and where this is not the case, with parties outside the group, the conflicting economic interest of the outside party will often act as an effective deterrent.
3. Whereas a loss transfer system is in effect a system of "group relief", a consolidation system, inhibiting many intra-group manipulations as it does in addition to allowing losses to be used group-wide, is more properly called a "group taxation" system.
4. In a consolidation system, real economic interests serve to limit manipulations aimed at tax avoidance, thus protecting the interests of the fiscus. In addition, the consolidated system has the advantage that the full group's results are presented to the Revenue in a single submission. This makes for an easy audit trail and resolves, within the group context, the serious problem that information for different companies is seldom available simultaneously when companies are separately assessed.
5. Although it is sometimes contended that the consolidation system is the more complex alternative, this depends on the degree and manner of consolidation. In several respects, the loss transfer system is inherently complex. The tax status of companies within a group can seldom be stated with certainty at year-end or even some years later, for example. As expressed in the Margo Report, "given the time span for making the election, a number of permutations and combinations arise, requiring great skill in forecasting future income or profits, and in making the right choice."

10.4 A GRADUAL APPROACH

10.4.1 Cost and complexity are identified in paragraph 10.2.10 above as the two main factors inhibiting progress towards a group taxation system. The Commission proposes a gradual approach in order to minimise these difficulties.

10.4.2 The Commission finds that claims regarding the substantial losses which the fiscus would incur in the transition to a group system are largely exaggerated or unsubstantiated. Not all tax losses are available to companies in groups, and not all groups have profits against which the losses of subsidiaries might be offset. Moreover, the potential cost to the fiscus of such offsetting consolidations can be largely eliminated through excluding losses accumulated prior to the first consolidation.

10.4.3 It is difficult to determine the impact of future group consolidations. The Commission, in consultation with the Central Statistical Service, conducted a survey of a number of companies listed on the Johannesburg Stock Exchange aimed at assessing the changes in tax liability which might result from the introduction of the limited group tax system envisaged. On the basis of the information gathered, it was estimated that the loss of revenue from all listed companies would amount to about R160 million. This result has reinforced the Commission's view that the revenue foregone would not be substantial.

10.4.4 In view of the capacity of companies to avoid taxation through manipulating intra-group transactions in the absence of group taxation, it is unlikely that there will be large benefits to existing groups from consolidation. It is, indeed, a central purpose of recommending a group system that the incentive which underlies these manipulations should be removed Artificial transactions between companies with a shared economic interest are difficult to control and they undermine the integrity of the entire corporate tax system.

10.4.5 In summary, as to cost, the Commission is of the view that the fiscus suffers from the worst of both worlds in the current system. Despite the absence of group taxation, groups with profitable companies are able to take tax advantage of loss-making companies, and the fiscus suffers from the many other manipulations between parties which are not disciplined by real economic considerations.

10.4.6 As to complexity, much depends on the consolidation mechanism. In view of the many perceptions that a consolidated group tax system must perforce be unmanageably complex, the Commission went to considerable lengths to establish whether, with the necessary compromises, a practical approach to implementing group taxation could be adopted. From section 10.5 below, a consolidation mechanism is proposed that should be manageable at this time, yet would secure many of the advantages sought for the system through a group dispensation. The proposed approach is sufficiently adaptable to grow in sophistication as those who administer and participate in the system gain experience of it.

10.4.7 There are three particular areas where the Commission recommends a compromise with a pure consolidation system in the proposed gradual approach to group taxation. Several other more common anti-avoidance measures are dealt with in the discussion below of the consolidation mechanism itself. Together these would address most of the problems of complexity and anti-avoidance, together with such cost inhibitions, as might otherwise have led, once more, to a deferral of the introduction of this needed reform.

1. The group should initially be defined as wholly owned (with appropriate exceptions being made only for employee participation, which the Commission would not wish to discourage). This should considerably reduce cost as well as complexity. The fear that a 100 per cent ownership requirement will result in "squeezing out minorities" is, in the view of the Commission, a lesser problem than the current situation which militates against the disposal of separate companies.
2. In the treatment of losses, there should not only be the usual rules excluding losses incurred prior to the introduction of the system or prior to a company becoming part of the group, but the consolidation should initially effectively allow losses and profits within the group to be off-set only on a current year basis. This removes the need for a plethora of specific anti-avoidance measures aimed at preventing false entry of "old" losses into the system. It also reduces the perceived loss to the fiscus, and does away with the complexity of having to keep track of various generations of losses for consolidation purposes.
3. It is proposed that, initially, a full consolidation need not be made. Also, a few special allowances which are currently limited to a company's income and which could make the fiscus particularly vulnerable will not initially be "consolidated"; details are given below, but they include allowances such as those under section 24 and section 24C of the Income Tax Act.

10.4.8 Finally, the Commission sees no need for a group system in respect of the value added tax.

10.5 THE CONSOLIDATION METHOD

Introduction

10.5.1 The initial emphasis in the recommended gradual approach to the introduction of a group tax system should be on simplicity and clarity. A tidy transition from the existing basis on which taxable income is calculated must be sought, so that a logical audit trail can be followed in respect of companies within the group.

10.5.2 The system should take into account that Revenue, at least in the short term, will have limited resources and few people trained in consolidations for accounting purposes.

10.5.3 The Commission proposes a method which aggregates the taxable incomes of group members, after certain adjustments, on a year by year basis, and not a method which would attempt to reconcile consolidated taxable income with consolidated accounting income. The latter would entail the involvement of Revenue in consolidation techniques, deferred tax calculations and the elimination of group transactions, where equity accounting problems and differences between definitions for accounting and tax purposes complicate the determination of the results of the group.

10.5.4 This aggregation of the adjusted taxable income of all group members should initially be done in the simplest way possible. Once the impact on fiscal income has been established and any problems with the administration of the system by Revenue have been identified and addressed, refinements and elaborations will be possible.

10.5.5 Although the reference is to a consolidation system, the group system which is proposed has some similarities to a compulsory loss transfer system (because of its simplicity) but with safeguards built in for the fiscus and with the opportunity for this simplified system to be improved over a period of time into a fully fledged consolidation system.

10.5.6 Again emphasising simplicity, the provisions regarding entrance to and exit from the group should be kept as uncomplicated as possible.

The Definition of a Group

10.5.7 It is proposed that group members should be limited to South African companies (as defined, but excluding close corporations).

10.5.8 As companies are required to be audited in terms of the Companies Act, this limitation will ease the administration of the proposed system.

10.5.9 It would seem to be inappropriate to allow two or more wholly-owned subsidiaries of an overseas holding company to take advantage of group consolidation. To take advantage of this concession, it is envisaged that such a group would be required to establish a local holding company.

10.5.10 Companies which are subject to a special tax regime, such as those engaged in long term insurance or mining activities, should not be permitted to take advantage of a group tax system applicable to ordinary companies. However, the group tax system should, in principle, apply to a group comprising companies engaged in a common specialised activity.

10.5.11 For the purpose of qualifying for group tax relief, a group should comprise a holding company and all its wholly-owned subsidiaries. The term "wholly-owned" should be defined to refer to both direct and indirect interests held by the holding company, determined on the equity share capital of the companies concerned.

10.5.12 It is recommended that the term "wholly-owned" should allow for equity shares to be held by full time employees, including executive directors, in terms of share incentives schemes. The shares held by or on behalf of employees and directors should not exceed 10 per cent of the equity share capital.

10.5.13 Once a consolidation system has been implemented successfully, it may be possible to drop the percentage ownership requirement to, say, 75 per cent of equity share capital.

10.5.14 Stringent requirements in this regard characterise overseas jurisdictions. Common ownership of 100 per cent is required in order to file consolidated returns in New Zealand and Denmark, 99 per cent in the Netherlands, 95 per cent in France, 90 per cent in Portugal and Spain and 80 per cent in the United States. For loss transfers in Australia the requirement is 100 per cent, in the United Kingdom it is 75 per cent and in New Zealand 66 per cent.

10.5.15 In addition to the recommendations in the Chapter which will limit the scope for tax avoidance, it will be necessary to consider specific anti-avoidance legislation, in the light of overseas experience, to prevent taxpayers from bringing companies together artificially on a temporary basis to take advantage of potential losses. The effectiveness of the existing general anti-avoidance measures in both sections 103(1) and 103(2) of the Income Tax Act will also need to be closely monitored.

Entrance and Exit Provisions

10.5.16 Once application has been made by a holding company for group tax relief, all companies which at the time of application or at a later stage qualify as part of the group should be obliged to be taxed in terms of the group tax system. Companies which fail to qualify should cease to be part of the group.

10.5.17 A holding company should be entitled to apply for the group to cease being taxed as a group with effect from the next year of assessment. Thereafter, it should be entitled to apply to go on to the group tax system again only after a period of three years has lapsed.

10.5.18 To form part of a group, a subsidiary should, in principle, have been wholly-owned throughout the year of assessment in question by the holding company.

10.5.19 Upon entry into the group, the consolidation of results should only start from the commencement of the first full tax year following entry, unless a subsidiary is incorporated or a dormant subsidiary purchased with the intention of acquiring a business in its own right whilst being owned by the group.

10.5.20 In the event of the exit of a group member, group filing should exclude the results of the departing company entirely during the tax year in which the exit occurs. The departing company should file separately for the full tax year during which it departs from the group.

10.5.21 If a group member is liquidated, the member's group results should be taken into account for tax consolidation purposes until the finalisation of the liquidation process.

Consolidation Method - Background

10.5.22 In an ideal consolidation system all intra-group transactions would be eliminated on consolidation and the tax result for the group would be identical to that which would have arisen if the subsidiaries had been divisions of the holding company.

10.5.23 Such a consolidation method would unduly extend Inland Revenue at this time. In the absence of sufficient audit capacity on the part of the authorities, there is an unacceptable risk of loss to the fiscus.

10.5.24 The Commission envisages that when a full consolidation system is introduced in South Africa, the following principle which is widely followed internationally should apply. Upon the entry of a company into a group, any assessed loss of the acquired company is ring-fenced and may only be set off against the income from that specific company (to the extent that it is not utilised in the consolidation process). However, any unutilised losses in any year of assessment may be carried forward as a consolidated loss and is available to be set off against the consolidated taxable income of the group in future years. The same practice is followed on the commencement of consolidated filing by a group.

10.5.25 In the simplified system proposed below, not only will the initial assessed losses be ring-fenced, but any loss incurred by a company in the group in a subsequent year of assessment will only be available to be set off against income from another company in the group in the same year of assessment. Any unutilised assessed loss in a current year will also be ring-fenced and will be available only for deduction against the future income of that company, once certain requirements have been met.

10.5.26 This simplified system of consolidation has some similarity to a loss transfer system, although on an obligatory basis and in terms of an obligatory procedure. The full elimination of intra-group transactions should not be contemplated until a full consolidation of profits and losses is introduced. However, it is considered that certain intra-group transactions could be eliminated at this stage without introducing undue complexity. These are listed in paragraph 10.5.41 below. Some favour the fiscus and some favour the taxpayer. Overall, these adjustments will go some way to minimising the cost to the fiscus of introducing the proposed consolidated tax system.

Consolidation Mechanism

10.5.27 The Commission proposes the following simplified consolidation mechanism.

10.5.28 The first step would be to calculate the taxable income (or assessed loss) for each company within the group under the current tax regime. For purpose of convenience, this determination can be referred to as the "sub-return".

10.5.29 The sub-return should provide the information required in the standard corporate tax return and in addition certain information on group-related transactions. This would include, for example:

1. intra-group sales or purchases;
2. dividends, interest and rentals;
3. intra-group asset transfers;
4. administration and other service fees;
5. royalties;
6. dividends and other pre-acquisition profits set off against the cost of investments; and
7. write-offs on group share investments.

10.5.30 In calculating the taxable income or assessed loss for each sub-return, the current tax regime would be applied, save for certain adjustments discussed in paragraphs 10.5.40 to 10.5.42 below. The assessed loss carried forward from the prior year of assessment would be taken into account in the calculation and all deductions based on income, such as those in terms of sections 24, 24C and 18A, would be determined in the usual way.

10.5.31 The second step would be to eliminate all unearned intra-group profits and losses on stock.

10.5.32 The third step would be to add back the assessed loss brought forward from the previous year in the case of each sub-return. The consolidation for group tax purposes would be based on this notional figure.

10.5.33 The simplified basis on which it is recommended that the consolidation results for each year of assessment should be determined is as follows:

1. A company which has taxable income for the current year of assessment but has an assessed loss brought forward from the previous year would be obliged to contribute income into the consolidated return only to the extent that it is required to be set off against current year losses of one or more companies in the group. (If there are no other current year losses within the group, it would be available for setting off against the loss brought forward from the prior year of that individual company.)
2. The balance of the assessed loss would then be set off against any income not required to be transferred (without making any adjustments in regard to sections 24, 24C or 18A calculations originally made) and any balance of assessed loss carried forward would be available for deduction only against income of that sub-return in the following year of assessment, once the above procedure had been repeated.
3. Any current year assessed loss of a company would first be set off against current year taxable income elsewhere in the group and, to the extent that it could not be deducted, would be carried forward in that sub-return as an assessed loss which would be available to be deducted only against the income of that sub-return in the following year of assessment, once the above procedure had been followed.
4. If more than one company has a current year assessed loss, and the total current year assessed losses exceed current year taxable income, a decision has to be made as to which company or companies will carry forward assessed losses, and to what extent. It is proposed that this decision should be left to the taxpayer.

Simple examples of the above calculations are set out in Appendix 1 of this Chapter.

10.5.34 It can be seen from the above procedure that there would be no consolidated assessed loss for the group. Assessed losses of each sub-return, apart from current year losses, would be ring-fenced and thus available only to the company in question.

Protection for the Fiscus

10.5.35 The system set out above has some built-in protection for the fiscus. Essentially, the consolidation of current year taxable income and losses eliminates the tax effect of intra-company transactions, thereby making it is more difficult to manipulate the results of the group in order to utilise brought forward assessed losses.

10.5.36 However, the above system will not protect the fiscus against the transfer, through excessive charges, from a profitable company in the group, where the group as a whole is trading at a profit, to one or more subsidiaries which have brought forward assessed losses.

10.5.37 A group member should therefore be required to deal on an arm's length basis with other group companies (in respect of rentals, interest recoveries, cost sharing, administrative recoveries, discounts and salary apportionments, for example). The existing connected person rules for intra-group transactions should be applied and, where necessary, the provisions of sections 103 of the Act. In practice, the authorities will only need to monitor the companies with brought forward assessed losses, as all other intra-group transactions will net out for tax purposes.

Current Tax Adjustments

10.5.38 Certain tax adjustments will take place in the calculation of taxable income in the sub-returns in respect of transactions between holding and subsidiary companies and connected persons. Adjustments provided for in the Income Tax Act include:

1. arrangements in terms of section 14(1B) regarding shipping activities;
2. wear and tear allowances granted in terms of section 11(e), calculated on the original cost to the seller in transactions between connected persons;
3. section 12C allowances calculated on the original cost to the seller in respect of transactions between connected persons;
4. section 11(gA) allowances calculated on the original cost to the seller in respect of intellectual property acquired by one connected person from another; and
5. adjustments made in respect of the sale and lease-back provisions under section 23D.

10.5.39 Some protection for the fiscus is thus already built into the proposed procedure.

Consolidation Adjustments

10.5.40 The procedure outlined is a very simplified form of consolidation to arrive at a group tax liability. Certain fundamental adjustments would be required if the consolidation mechanism were intended to bring about the same result as would arise in the case of a divisionalised structure. The Commission's approach does not have this aim, but it is considered that certain adjustments could usefully be made without introducing unnecessary complexities. These requirements should apply to any group which qualifies for group taxation.

10.5.41 The adjustments are as follows:

1. Fixed assets transferred within a group after the introduction of group taxation should be deemed to be transferred at tax value and be subject to recoupment in the transferee company up to the original cost to the group. This is a single adjustment of considerable potential impact.
2. There should be no allowances in terms of section 24C or section 24 on intra-group transactions.
3. No bad debt allowance should be granted in respect of any intra-group transaction entered into after the introduction of group taxation.
4. There should be an adjustment to unrealised profits and losses on trading stock purchased from group members which should be treated as taxable income in the following year of assessment. Again this should not give rise to undue complexity.
5. The provisions of section 23(g) of the Act should be applied in a group context in respect of companies operating in the group tax system.

10.5.42 The following adjustments in respect of intra-group transactions are examples of the further adjustments which the Commission considers might either be introduced initially or at a later stage after due consideration and once the consolidation method allows for a consolidated tax loss to be carried forward:

1. adjustments for intra-group lease premiums and leasehold improvements in terms of the leasehold obligations, to the extent that there are mismatches and write-offs on taxable income respectively (provided for in sections 11(f), 11(g), 11(gA) and 11(h) for example, and in the definition of gross income);
2. adjustments to group transactions involving capital / revenue differences (such as the seller being liable for tax on the profit or recoupment on the sale of fixed property whereas in the purchaser's hands the acquisition is capital and no wear and tear relief can be claimed);
3. adjustments to capitalised intra-group interest which is not subject to tax write-off relief (in terms of section 11(bA), for example) in the hands of the borrower; and
4. interest adjustments on intra-group loans to the extent that there are mismatches in regard to the tax treatment (section 24J).

Income Tax Returns

10.5.43 There must be a clear audit trail for Revenue to follow. The authorities must, for example, be able to track a company which enters or exits from a group. A straightforward option would be for the file of a group company to be identified as "consolidated", with a cross-reference to the group return. The full details of the sub-return would be filed as part of the group return. These would be filed under a separate reference number.

Other Tax Liabilities and Provisional Tax Payments

10.5.44 The Commission recommends that the introduction of group consolidated taxation should be limited to the income tax at this stage.

10.5.45 It should be noted that the above system, although simplified, will still mean that only a group tax return will need to be lodged, although individual companies may have assessed losses carried forward which have not been fully utilised.

10.5.46 Each group member should be jointly and severally liable for income tax, but should remain separately responsible for other tax liabilities.

10.5.47 As regards provisional tax, each group company should be liable for its first and second provisional tax payments until the first consolidated return has been assessed. Thereafter, the provisional tax should be lodged on a consolidated basis.

Acquisition of a Group

10.5.48 In the event of acquisition by one group of another, tax treatment should not differ significantly from the procedure to be followed when a group acquires an individual company.

10.5.49 Each company in the acquired group would retain its balance of assessed loss.

10.5.50 The consolidation of this sub-group should take place separately in the year of assessment in which it is acquired. The consolidation into the main group should take place with effect from the following year to prevent the acquisition of companies or groups in order to take advantage of current year losses.

10.6 RECOMMENDATIONS

10.6.1 The Commission recommends the adoption of a system of group taxation on the consolidation basis. A gradual approach to the introduction of a system of group taxation is proposed, beginning with a simplified consolidation method, details of which are set out in section 10.5 of this Chapter. [paras. 10.2.11; 10.3.2; 10.4.1]

10.6.2 The main features of the proposed simplified consolidation method are the following:

1. For the purpose of qualifying for group tax relief, a group should comprise a holding company and all its wholly-owned subsidiaries. The term "wholly-owned" should be defined to refer to both direct and indirect interests held by the holding company, determined on the equity share capital of the companies concerned, with allowance for equity shares to be held by full time employees, including executive directors, in terms of share incentives schemes, not exceeding 10 per cent of the company's equity share capital. [paras. 10.5.11-12]
2. The consolidated tax liability of a group will be calculated from "sub-returns" required for each member company in which taxable income or assessed loss will be determined on the basis of the current tax regime, save for a limited number of proposed adjustments. [para. 10.5.33]
3. The initial assessed losses of member companies will be ring-fenced, and any loss incurred by a company in the group in a subsequent year of assessment will only be available to be set off against income from another company in the group in the same year of assessment. [para. 10.5.25]

10.6.3 Specific anti-avoidance legislation should be considered, together with application of the existing general anti-avoidance measures in sections 103(1) and 103(2) of the Income Tax Act. [para. 10.5.15]

10.6.4 It is recommended that progress towards a full consolidation system, based on principles of loss offset and adjustments to taxable income which are widely followed internationally, should be deferred until the impact of the shift to group taxation on the fiscus can be evaluated and problems of administration have been identified and addressed. [paras. 10.1.2; 10.5.24; 10.5.26]

APPENDIX 1: BASIC EXAMPLES OF THE PROPOSED CONSOLIDATION MECHANISM

EXAMPLE 1

Step 1. Elimination of unearned intra-group profits on the sale of trading stock (tax effect on purchaser is neutral). (See paragraph 10.5.41 of the report in regard to the elimination of the tax effect of other intra-group transactions.)

Step 2. Consolidation of profits and losses of group companies which do not have a carried forward assessed loss.

Step 3. Deduction of assessed loss carried forward.

Step 4. Transfer of balance of taxable income to consolidated taxable income.

(Note: Any adjustment in respect of unrealised intra-group profits on the sale of trading stock must be treated as taxable income of that group company in the following year of assessment.)

EXAMPLE 2

Step 1. Elimination of unearned intra-group profits on the sale of trading stock (tax effect on purchaser is neutral).

Step 2. Consolidation of profits and losses of group companies which do not have a carried forward assessed loss.

Step 3. Transfer of taxable income up to but not exceeding calculated consolidated assessed loss.

Step 4. Deduction of assessed loss carried forward.

EXAMPLE 3

Step 1. Elimination of unearned intra-group profits on the sale of trading stock (tax effect on purchaser is neutral).

Step 2. Consolidation of profits and losses of group companies which do not have a carried forward assessed loss.

Step 3. Transfer of taxable income up to but not exceeding calculated consolidated assessed loss.

Step 4. Transfer of balance of calculated assessed loss back to group company.

Step 5. Deduction of assessed loss carried forward.