The acquirer’s ability to influence the most sensitive value drivers determine the extent to which synergy benefits can realise.

Mergers and acquisitions should be undertaken to create shareholder value. Simplistically this means that the net present value of future cash flows from an acquired asset should exceed the capital invested. In order to achieve this, either a bargain purchase is concluded or synergy benefits are realised.

In my view a true bargain purchase is very rare and will only occur as a result of truly exceptional and unusual circumstances. Normally a reduced purchase price is merely the reflection of a higher than expected risk attached to future earnings or a lack of confidence in the future earnings potential of the target.

Synergy benefits are realised when the acquirer has the ability to either increase the future earnings of the acquired company or mitigate the risk discounted into the purchase price. These synergy benefits can be maximised by truly understanding the value drivers of the target and assessing the ability of the acquirer to leverage these value drivers.

So, what are the value drivers of the target company? When a valuation is done on a Discounted Cash Flow (“DCF”) basis there are numerous assumptions supporting the calculated value. Generally speaking there are three main components: Expected cash flows in foreseeable future, long-term growth expectations and a risk-adjusted discount rate. Each one of these components can be influenced by multiples of factors. An analysis of these factors and (to the extent needed) the testing thereof through sensitivity analysis to perceive the influence on the value should give a good indication of what can drive the value upwards.

The acquirer’s ability to influence the most sensitive value drivers determine the extent to which synergy benefits can realise. Market commentators refer to this as a natural fit. Practically this means that where the acquirer has particular strengths that can be practically applied to leverage identified value drivers, substantial synergy benefits can be realised in the future.

Below follows an example of typical value drivers and strengths suited to unlock synergy benefits:

A growth policy driven by acquisitions should be based on a clear plan of identifying the most appropriate target companies and extracting the synergy benefits anticipated. This requires a clear understanding of the relative strengths of the acquirers and sensitive value drivers of the target which will, if applied and focussed correctly, build substantial value for shareholders.

Please don’t hesitate to contact me if you are planning acquisitions and seek to maximise your gains.

Johann de Lange

With less than 4 months remaining to submit applications, it is now or never to qualify for the benefits under the VDP

The clock is ticking for the submission of VDP applications to SARS and the Financial Surveillance Department of SARB. With less than 4 months left to submit applications within the 31 October 2011 deadline, SARS is urging taxpayers to take an in-depth look into their tax affairs to ascertain whether they will not benefit from the VDP programme as it provides a substantial saving for interest and penalties that would otherwise be levied against tax transgressions.

It is understood that SARS has received in excess of 2 500 applications to date but due to the sheer volumes and limited resources to deal with the applications, only a limited number of applications have in fact been finalised at this stage. It appears that the average turnaround time for an application is in the region of 6 months and according to our experience to date, the process is quite user friendly and SARS really comes to the party during the process. However, this does not mean that all applications ended successfully and hence one should consult properly prior to making a decision to submit an application – in any form of tax dispute resolution, forewarned is forearmed.

In a previous newsletter issued shortly before the advent of the VDP, we summarised the basic qualifying requirements and benefits of the tax VDP.  Having now had the advantage of practical experience, we now revisit the VDP in order to provide prospective applicants with guidance as to the actual process as well as taking a more practical look at the benefits of the VDP.

The VDP process

The process essentially entails the following steps -

• The submission of a compliant application (it is suggested that professional advice be sought in this regard as SARS is rather prescriptive as to the format);
• The application should be submitted via e-filing upon which a VDP number will be allocated by SARS via electronic correspondence;
• SARS confirms internally whether the “tax default” disclosed is subject to an audit which could take several weeks;
• Upon confirmation that there is no pending audit, the application is assigned to a VDP specialist that will vet and consider the application, and the specialist will consult with the applicant (or their adviser) where necessary and the interaction between the parties would of course depend on the information submitted and the complexity of the application;
• A draft VDP agreement will be prepared by SARS and will state the tax due, etc. The VDP agreement may provide for extended payment terms of the tax due if so agreed by the parties and must be signed by both parties;
• Once the VDP agreement is signed it is binding on the parties and the VDP process completed.

If subsequent to the finalisation of a VDP, it comes to SARS’ attention that full and accurate disclosure has not been made, the agreement will be regarded as null and void and the applicant will lose all the benefits awarded by the VDP.

It is therefore vital that when an application is submitted, the information is complete and accurate in all respects, as a simple oversight or a mistake could have dire consequences.

The Benefits

As previously reported, the benefits under the VDP relate to (a) the waiver of interest, penalties and additional tax that would have resulted from the tax default disclosed under the VDP, and (b) amnesty from any potential criminal proceedings.

Given the uncertainty as to whether the relief from interest, penalties and additional tax was indeed all encompassing under the VDP, SARS eventually published guidelines to assist taxpayers in ascertaining what relief will be guaranteed under the VDP by clearly delineating between relief to be granted and not to be granted.

To summarise these guidelines -

• Basically any penalties for the late submission of returns, late payment of any tax type and so-called administrative penalties for non-compliance as per section 75B of the Income Tax Act, 58 of 1962 will not be waived.
• Additional taxes, including under estimation penalties for provisional tax, will be waived.
• Interest levied by SARS as a result of the default will also be waived.

It should be remembered that where SARS is aware of the default being disclosed (i.e. it is subject to audit), and SARS has accepted the application notwithstanding, said applicant will quality for 50% relief in relation to interest stemming from the default but full relief for qualifying additional tax and penalties will still be granted.

A further practical issue that applicants should bear in mind is that the usual remedies for requesting the waiver of penalties and/or additional tax contained in the various tax acts remain in place.  In certain instances one may therefore need to compare the advantages of submitting a VDP application with simply requesting the waiver of the particular penalty as the last-mentioned process may be more viable for the default in question.

Given what has been stated above, the VDP is a good opportunity for taxpayers to benefit from relief from interest, penalties and additional tax where tax defaults have occurred prior to 17 February 2010. However, the deadline is looming and notwithstanding the good response to the programme and the steady receipt of applications, SARS’ spokesperson has confirmed that there will be no extension of the deadline and hence taxpayers should make use of the remaining window period or be left out in the cold.

You are welcome to contact us to discuss any questions or uncertainties you may experience in relation to identifying the potential benefits to you in terms of a particular application.



Section 45 suspended?
Treasury freezes tax rollover relief for intra-group disposals with immediate effect

The Taxation Laws Amendment Bill, 2011 was published on 2 June and the amendments included the usual corrections to sections, provisions aimed at closing suspected loopholes and a couple of surprises.  One rather nasty surprise for corporate taxpayers is the immediate moratorium on section 45 or so-called intra-group relief transactions.

With effect from 3 June 2011, should companies within a group (as defined for purposes of the Income Tax Act, 58 of 1962 (“the Act”)) pursuant to tax planning & structuring exercises, transfer assets between such companies, the tax rollover relief provided for in terms of section 45 will no longer be available and hence where such transactions are undertaken, the disposing company may well end up with a rather unexpected tax cost (naturally all tax relief including income tax, CGT, VAT, Transfer Duty and security transfer tax will be suspended).

Treasury has not provided any satisfactory explanation for this sudden freeze on intra-group disposals but it would appear that they have identified some new form of abuse in relation to section 45 and now all bona fide group disposals need to suffer the consequences. One can only hope that the powers that be reconsider their aggressive stance to curb such alleged abusive transactions prior to the Taxations Laws Amendment Act coming into effect, either by means of removing the suspension in its entirety or at the very least to allow for some lead period prior to closing the door to legitimate group disposals undertaken for sound commercial reasons.

Should the proposed moratorium on section 45 be passed into law in its current form, it is of course very important to consider how this will impact group transactions that are not completed by 3 June 2011.  For instance, what is the effect where an agreement has been reached at board level that subsidiary A will sell assets to subsidiary B however, the formal agreements giving effect to this decision have not been signed or, for instance, an agreement has been signed but not implemented?

The amendment simply refers to section 45 not being applicable to any “disposals” on or after 3 June 2011.The crux is thus what is meant with a “disposal” in the context of this amendment.  The Eighth Schedules defines disposal in detail and includes rules as to the time of a disposal. Of interest is the fact that a disposal, in the context of ownership being passed, occurs on the date that a contract is concluded, but where it is subject to a suspensive condition, the disposal only occurs when the suspensive condition is met. But on what date is the agreement concluded?

From a legal perspective, a contract is concluded when the parties reach consensus as to the essentialia of the specific agreement they wish to enter into.  For an agreement of sale, these include agreement as to the sale object, the price and the parties evidencing the intention to buy and sell respectively. Our law does not require an agreement for the sale of movables to be reduced to writing in order to have effect, so where parties have simply verbally agreed to enter into a certain agreement and have reached clear consensus as to its terms, the agreement is in fact concluded.  We are therefore of the view that unless SARS intends detracting from the common law meaning by means of legislative intervention, a contract will be concluded even if a formal contract reduced to writing has not been signed by the parties.  Of course, if the legislature provides a definition of disposal that differs to what is contained in the Eighth Schedule, this could also impact on whether a certain disposal is subject to the suspension or not.

We caution taxpayers in the midst of section 45 transactions to ensure that their respective disposals will still benefit from the rollover relief and to stay abreast of any further developments on this front. Taxpayers wishing to enter into group related transactions may well be able to utilise other relief provisions contained in the Act and hence we suggest you contact us to ascertain whether any relief is available.

Glaringly inflated inter-company transactions, especially where an assessed tax loss is utilized, may be attacked by SARS

A recent judgment of the Johannesburg Tax Court illustrates that the concept of “transfer pricing” is not only limited to transactions between cross-border related parties but that it is also very much a real consideration applicable to domestic scenarios.

Albeit that our domestic law does not contain a dedicated section that operates as an anti-avoidance measure such as section 31 of the Income Tax Act, 58 of 1962 (“ITA”) to limit the shifting of profits between local related parties, SARS merely relies on the “general deduction formula” as set out in section 11(a) read with 23(g) of the ITA to counter such practices.

In essence the case in question highlighted that where management (and marketing) fees are charged by a holding company to its local subsidiary, the fee so charged should be defendable on the basis that it is underpinned by market considerations.  If not, SARS will argue that the expense incurred by the subsidiary is “excessive” under the circumstances and disallow such excessive portion of the expense as a deduction.

There is no standard formula, but rather a combination of factors that will determine the transaction premium

As discussed in our August 2010 newsletter, acquisitions are often done at a price in excess of the intrinsic value of the business. Why, you may ask… Well simply because it doesn’t make sense to acquire a business if there are no strategic benefits realised subsequently. The potential of such benefits means that the acquirer will be willing to pay more than the intrinsic value for the business.

Likewise, it does not make sense to sell a business at intrinsic value if the seller is not in a forced disposal position. The reason for this, as previously mentioned, is because one set of future cash flows will merely be exchanged for an upfront payment, based on the net present value of such future cash flows. As such, it is more than likely that a significant number of acquisitions take place at a price that includes a transaction premium. A number of readers of our August newsletter expressed their interest in how one should then go about to calculate such premium. The purpose of this newsletter is to shed some light on this question.

One should note that there is no standard formula but rather a combination of factors that will determine the transaction premium. The basic principle is that value, like beauty, lies in the eye of the beholder (in this case the purchaser). This means that the incremental benefits that the acquirer anticipates from the acquisition, is a material driving force behind the ultimate transaction value. Will the acquirer pay for the full value of these synergy benefits? More than likely not, but market circumstances and the information at hand at that point will have a substantial bearing on the portion of synergy benefits that will accrue to the seller, i.e. the transaction premium

Some of the more important factors to consider in determining the transaction premium are:

• Value  to  the  acquirer – What  are  the  incremental benefits to the acquirer arising from synergy benefits? An example  of  this  is  when  a  company  with  a  wide geographical footprint and distribution network acquires a company with premium products but  a limited market presence.  The  incremental  profits  from  an  expanded product  range  over  the  long  term  will  comprise  the synergy benefits for the acquirer
• Is  there  a  competitive  bidder? – This  places  the acquirer  in  a  weaker  negotiation  position.  In  such instance,  the  transaction  premium  will  depend  on  the synergy  benefits  for  the  competitive  bidder.  The  lower these synergy benefits are for the competitive bidder, the lower the price  at which the ultimate acquirer will cease to  bid  for  the  target  company.  It  is  therefore  critical  to understand  the  competitor’s  strategy  and  estimated synergy benefits
• Are  there  other  opportunities? – Other  acquisition opportunities  may  offer  the  same  potential  synergy benefits at a lower price for the acquirer. In such a case, the  likely  transaction  premium  for  alternative opportunities will indicate the top end of the negotiation range for a particular acquisition
• How much does the seller know? – A seller’s intimate knowledge of  the potential  acquirer’s business leads  to  a better  understanding  of  the  likely  synergy  benefits, which  in  turn  provides  a  better  understanding  of  the acquirer’s price negotiation range. The likely negotiation ranges  of  other  potential  acquirers  also  need  to  be understood  by  the  seller  as  the  highest  bid  will  not substantially  exceed  the  second  highest  bid,  as  well  as alternative opportunities available to all bidders

The above is a basic overview to create an awareness of the important principles.  Please don’t hesitate to contact us if you are involved in an acquisition or disposing of a business. Our knowledge and experience in mergers and acquisitions can assist materially when negotiating the optimum transaction value

Use this opportunity to regularise exchange control contraventions

In a previous newsletter, we provided a brief overview of the VDP as applicable to tax matters (“Tax VDP”). It was noted that, in essence, the VDP enables taxpayers to regularise their tax affairs without incurring the usual interest and penalties in most instances and is available to all taxpayers that have any tax defaults which occurred prior to 17 February 2010.This newsletter investigates the Exchange Control VDP (“Excon VDP”) that will run concurrently with the Tax VDP from 1 November 2010 to 31 October 2011.

As with the Tax VDP, the purpose of the Excon VDP is to provide persons subject to the Exchange Control Regulations, 1961 (“Regulations”) that may have contravened such Regulations prior to 28 February 2010, with an opportunity to regularise such contraventions (similar to the previous Exchange Control Amnesty that ended on 29 February 2004).

Essentially, the Excon VDP is aimed at all unauthorised foreign assets. Although this concept is not specifically defined, it presumably means the same as under the 2004 amnesty, i.e. “any funds or assets which were accumulated outside the Republic or were transferred from the Republic in contravention of Exchange Control Regulations” up and until 28th February 2010.

The regularisation of any unauthorised foreign assets may result in the payment of a levy of 10% of the applicable funds or value of the foreign assets depending on the nature of the contravention as elaborated on below. Furthermore, the levy should be settled by means of repatriated foreign funds and if it cannot be settled from such funds, a levy of 12% is payable from local funds. The levy may be waived.

The Excon VDP essentially caters for the following three scenarios –

• Certain technical offences that may be regularised by means of merely declaring and  disclosing  such to  any  Authorised  Dealer  of  the  Financial  Surveillance Department (“FSD”) (previously the Exchange Control Department) by means of a prescribed Declaration.  In other words, the specifically listed contraventions in relation  to  natural  persons  and  corporate  entities  do  not  require  formal administrative  relief  in  the  form  of  a  Regulation  24  application.  All  that  is required is the completion of a Declaration in the prescribed form. Noteworthy is that such a Declaration will not attract any levy as mentioned above in relation to natural persons. In relation to corporate entities, the levy may be payable where the transaction does not accord with present FSD policies.
• Specified contraventions, such  as  the use of loop structures  and  the donation of funds/assets  to offshore  trusts which require  formal  administrative relief in  the form of an application to the FSD under Regulation 24, will attract a levy of 10%.
• Any  other  contraventions  not  specifically  listed  may  qualify  for  general administrative relief in terms of Regulation 24 and will also attract a levy of 10% of  the  market  value  of  the  foreign  asset/s  or  fund/s  held  offshore.  Such contraventions include, inter alia -
  -the unauthorised sale of intellectual property,
  -the failure to repatriate unused travel allowances, and
  -the acquisition of foreign assets.

An  application  under  Regulation  24  requires  the  completion  of  a  prescribed Affidavit. Regulation 24 sets out the details that must be included in the said Affidavit and where  the  Affidavit  is  compliant  with  the  administrative  requirements  thereof,  the application must be granted.

The  approval of  the  application ensures no criminal prosecution  against  the person  and avoids the levying by the FSD of penalties between 20 – 40% on the fund value for non-compliance with the Regulations.

A last point is that the application under the Excon VDP may be disclosed to SARS and it is therefore imperative that a separate application for the Tax VDP be submitted by a person who believes that a tax default also arose as a result of the contravention of the Regulations.

Intrinsic value does not include the synergy benefits derived from the merged entity after the transaction

What is the right price when acquiring a business? This is why we do a valuation, right? Have you considered whether the valuation is appropriate for the buyer or seller? Are you paying for synergy benefits not yet realised when taking the future returns into consideration? Most mergers don’t create value for shareholders and I am of the opinion that a fair portion of these are because of a disproportionate transaction premium over intrinsic value being paid.

The  basis  of  intrinsic  value  is  that  the  seller,  under  normal  and  unfettered circumstances,  be  indifferent  as  to  whether  to  retain  or  sell  an  asset.  This effectively  means  that  the  transaction  value  equates  all  expected  future  returns when  applying  a  risk  adjusted  fair  rate  of  return.  Another way  of  looking  at  it would be that a capital sum is received in exchange for future cash streams.

An important  aspect  to  note is  that  the  future  cash  flows  used  to  determine  the equivalent cash sum (i.e. transaction value) should be based on a pre-transaction cash generating  ability. This will be  a  true reflection of  the intrinsic value of  the business  before  any  synergy  benefits  arising  from  an  acquisition.  The  synergy benefits  can  be  determined  by  calculating  the  net  present  value  (“NPV”)  of  the cash  flows  generated  after  the  transaction  (i.e.  where  expected  synergy  benefits results in increased cash generated). The difference between this calculated NPV and the intrinsic value is an indication of the value of synergy benefits arising as a result  of  the  acquisition.

The  value  of  synergy  benefits  can  be  illustrated  as follows:

Value  (Synergy  benefits)  =  Value  (Post-transaction)  – Value  (Pre-transaction)

I  have  come  across many  acquirers  whom include  the  value  of  synergy  benefits when negotiating a transaction value. It effectively means that the buyer pays for the value that they also bring to the table, i.e. the upside from the transaction goes to  the  seller  and  the  buyer  pays  fair  value  only  if  those  synergy  benefits materialise.

Does this mean that the buyer should not pay more than the value based on pre-transaction earnings and cash flows? It is unlikely that the seller will be interested if  there is not some premium over intrinsic value. The negotiation range  for  this premium  depends  on  the  value  of  the  synergy  benefits  and  the  respective contributions  from  the  sellers  and  acquirers towards  the  unlocking  of  those synergy benefits. Typical synergy benefits include:

• BEE status enabling increased revenue opportunities
• Cross selling of complimentary products to respective customer bases
• Market share increase with resulting increase in margins
• Technology fits that can lead to new products and speed to market
• Lower cost of capital- Economies of scale
• Excess capacity utilisation
• Many, many others….

Synergy benefits are strategic advantages that accrue from  carefully  planned acquisitions. Buyers should not squander this benefit. It takes careful negotiation and awareness in an acquisition process to arrive at a value where the seller earns an  attractive  premium  and  the  buyer  has  the  prospect  to  realise  significant synergy benefits after the transaction, resulting in creating shareholder value.

Who foots the bill – Company or exiting shareholder?

A share buy-back can be funded from either share capital  (ie share capital or qualifying share premium) or  distributable  reserves. Where the  buy-back is funded from  distributable  reserves, this portion of the buy-back price constitutes a dividend for income tax purposes. Any amount that is returned to the shareholder of a company that represents capital (in other words, the par value of the shares or share premium) does not constitute a dividend.

A  dividend  distribution  results in STC  being payable  at  a  rate  of  10%  on the  dividend  amount and  is  borne  by the  declaring  company. The  remaining  shareholders  end  up  funding  this  tax cost  when  other  shareholders  exit. There  are  exemptions  from  STC  in  the  Act,  but  none  of these are applicable to the case where a dividend is paid to an individual (where it is paid to a local group company, there should be an exemption from STC). Where of course, the buy-back is funded from capital, the company will not have a STC liability.

The different tax treatment can be illustrated by the following example:

Companies  and  shareholders  must  be  aware  how  a  share  buy-back  was  funded  due  to  the different  tax  treatment  described  above. If  companies  and  shareholders  get the  classification wrong, the potential  risk is that the party that treated the share buy-back incorrectly will still be liable for either the STC or the CGT with resultant penalties and interest.

A  further  point to  remember  with  share  buy-backs  is that  securities  transfer  tax  (STT)  will  be payable  by  the  company  at  the  rate  of  0.25%  on  the  proceeds  in  relation  to  the  buy-back, another cost that the other shareholders effectively carry.

In many instances (especially with private companies) when a shareholder exits via a buy-back, the  company  carries  the  tax  costs  (share  buyback  funded  by  revenue  reserves). However, should the exiting shareholder sell his shares to the other shareholders, the effect would be that the selling shareholder would be subject to CGT on the difference between the base cost of his shares and the proceeds at a maximum rate of 10% if he is an individual or 14% where it is a company. With the normal sale of share transactions STT will be born by the company but would be recoverable from the purchasing shareholders.

If  there  is  thus  merely  a  vanilla  sale  of  shares,  the  shareholder  pays  10%-14%  of  the  tax whereas under a buy-back from reserves, the company carries the tax cost of 10%.

The  tax  treatment  of  share  buy-backs  can  be  very  technical  and  readers  are  advised  to  plan carefully in advance. Please do not hesitate to contact us in this planning phase.

Disclose tax defaults and avoid interest and penalties until 31 October 2011

In  the Budget  Speech  of  17  February  2010,  the Minister  of  Finance  announced  a Voluntary Disclosure  Relief  (“VDR”)  programme  aimed  at  encouraging  taxpayers  to  come  forward  to disclose any possible tax defaults and to regularise their tax affairs.

The  legislative  framework  for  the  VDP  has  recently  been  published  as  Part  A  to  the  draft Taxation Laws Second Amendment Bill, 2010 (“Bill”) and basically provides taxpayers with a window  period  within  which  to  disclose  any  possible  defaults  in  terms  of  the  Acts administered  by  the Commissioner  of  the  South African  Revenue  Service  without  the  usual negative consequences attaching to any such defaults.

The benefit of utilising this VDR opportunity is –

• immunity from criminal sanctions,
• in the case of complete voluntary disclosure, i.e. where the taxpayer is not aware of any audit or investigation in relation to the subject matter of the VDR application –
  o full relief from penalties (save for administrative penalties levied in terms of the regulations issued under section 75B of the Income Tax Act, 58 of 1962)
  o full relief from any additional tax; and
  o full relief from interest in relation to amounts owing to SARS
• where,  notwithstanding  the  fact  that  there  is  an  audit  or  investigation  under  way, SARS directs the taxpayer to apply for VDR, the interest relief is limited to 50% but full relief will still be available in relation to additional tax and penalties.

It is important to note that the actual tax that has not been paid to SARS will remain due and payable.  Nevertheless,  the  interest  and  penalties  may  in  some  instances  be  substantial  and therefore  disclosing  any  administrative  oversights  or  incorrect  tax  treatment  under  this programme may result in substantial savings should the oversight etc. be identified during a SARS audit.

The relief under the VDR programme is available to all taxpayers but a successful application is subject to the following requirements-

• voluntary and complete disclosure in all material aspects
• a default must be involved
• a  penalty  or  additional  tax  would  have  been  imposed  had  SARS  discovered  the default

A default is basically  the provision of inaccurate or incomplete information, non-submission of information to SARS or the adoption of a tax position (for instance, treating an amount as a capital  receipt  instead  of  as  gross  income).  For  example,  a  default  would  include  the  non-submission of a STC return coupled with non-payment, not reflecting a capital gain in a return or disclosing an item incorrectly. At this point there is still some debate as to whether the non-rendering of an income tax return qualifies as a default given that it may well only be subject to  an  administrative  penalty  and  not  additional  tax  going  forward. As  there  has  been  some criticism against the current definition of “default” in the Bill, amendments may well address this uncertainty.

Of interest to note is that the approval of a VDR application is not within SARS’ discretion and should  the  application  comply  with  the  stated  requirements,  SARS  is  obliged  to  approve it. However, the approval may be withdrawn should it be shown that it was based on false or incorrect information.

Although the Bill states that the provisions of Part A will become effective by way of notice in the Government Gazette,  the Minister in  the Budget Speech specifically referred  to  the VDR programme  commencing  on  1  November  2010  and  ending  on  or  before  31  October 2011. Although it is seriously contemplated that the VDR programme would become effective on  the  dates  announced  by  the  Minister,  there  is  always  a  chance  of  the  commencement thereof being postponed.

Also of importance to note is that VDR is NOT available to defaults which occurred less than 12 months prior to the commencement of the VDR programme.

Taxpayers  are  therefore reminded  to  review  their  tax  affairs  with  a  view  of  identifying  any potential  non-disclosures  or  defaults in  order  to  establish  whether it may  qualify  under  the VDR  programme  as  this  would  result  in  a  large  saving  as  interest  and  penalties  may  well amount to a substantial portion of any debt due to SARS. Rather than waiting for an audit or tax  query,  it  may  be  worthwhile  to  regularise  all  tax  matters  under  this  programme  as  this would at least provide certainty and finality. Should you require any assistance in this regard, we can provide you with the relevant assistance, not only in identifying any potential defaults but also to facilitate your application to SARS once the window period becomes effective.

Lower market values may necessitate impairments in terms of IAS36

Mergers and acquisitions took place at aggressive prices before the event of the global credit crisis. The recent recession and sluggish economic recovery have resulted in many companies adjusting their expectations for the future downwards. These declining expectations result in lower intrinsic values, which may necessitate the adjustment of investments and intangible asset s in the audited financial statements of companies.

How does this decline specifically affect the balance sheets of companies, other than the obvious influence on its trading activities? It depends on the assets reflected on its Balance Sheet. Merger and Acquisition activities were on a record high before the decline in market values. This means that many companies have acquired subsidiaries and other investments in this period. These subsidiaries, upon consolidation, reflect a goodwill asset on the balance sheet where the purchase price exceeded the net tangible asset value (which, with a few exceptions, is normally the case). The purchase price of such acquisitions had to be allocated to the respective asset categories (tangible and intangible) in terms of IFRS3 – Business combinations. These assets had to be considered in the context of separately identifiable cash generating units (CGUs) in terms of the statement. Other investments, where financial statements are not consolidated, are also recorded at the values in which they were acquired during a period of high corporate values. All of the above means that a company involved in acquiring other businesses probably have a fair number of assets that may be worth less in the current year than at its last year-end. These values need to be reconsidered and impaired in terms of IAS36 – Impairment of assets.

The uncertainty in the market, reflected by the volatile price fluctuations, is addressed and eliminated by IAS36, to a certain extent. The statement allows for an investment to be considered at the highest of market value or its value in use. The rationale behind this argument is that the owners of an investment will not sell it if the market value is below the net present value of its future returns, i.e. the value of its use for the current owner. This negates, to a large extent, the need to state assets in the balance sheet at values where buyers can be attracted but sellers will be unwilling to participate. The value in use is largely based on the budgets and forecasts of management, which may be subjective in order to achieve certain value outcomes where it is not desirable to impair the assets.

One of the requirements of IAS36 is that impairment valuations need to be done for each CGU of the investment. In the event that a specific CGU’s asset’s value in use is lower than its balance sheet carrying value, an impairment charge has to be provided for in order to reduce the value of the asset. The opposite (i.e. where the value is larger than the carrying value) effect, however, may not be reflected as an increase in investment value. This may result in an impairment charge even if the total value of all the components of an investment’s value exceeds the carrying value (i.e. some CGUs increase in value but others decrease). This will especially happen where some CGUs are counter cyclical to the recession and other affected by it.

The shareholders and stakeholders of a company rely on financial statements as a reliable source of information on which business decisions are based. It is thus of the utmost importance for Management and the auditors to ensure that the correct assumptions and methods are applied in valuing a company’s investments for IAS36 purposes, as any deviation there from may result in a balance sheet that does not reflect materially accurate information