Things are seldom inherently bad ‐ poisons are typically compounds, made from elements that on their own are good, if not, beneficial; weapons are made from components that in isolation are generally harmless. In the same manner, tax and Exchange Control structures that are illegal / abusive can generally be cut up in to a series of individual, innocuous transactions.
For example, assume that I own a business (OpCo) that generates R10m profit per year, valuing my business at R50m. Should I wish to divert profits to a foreign shareholder, our Exchange Control Regulations require that the foreigner acquires shares in OpCo at market value (confirmed by an auditor's valuation certificate). So, the inflow of the sales price should compensate for the future outflow of profits ‐ not as exciting as selling 100% shares in OpCo to the foreigner for R1 and diverting R10m per year offshore, but that would be unlawful, correct? Let’s consider an example:
Assume that we register a new company (NewCo) in South Africa. On registration, NewCo has no assets and its value is negligible. So, it would be a simple matter to approach an auditor for a valuation certificate confirming that NewCo is valueless. Armed with this valuation, we obtain Exchange Control approval for the acquisition of 100% shares in NewCo by a foreigner for a negligible amount.
Ignoring tax for now, and assuming that no financial assistance is required, the two resident companies should be free to transact outside the scope of our Exchange Control Regulations. So, I arrange for OpCo to transfer its business to NewCo for R1. But, is the end result not the same as in the "unlawful" transaction? With negligible inflow of capital, we have managed to transfer 100% of OpCo's future profits to a foreigner.
Peering closely, each transaction appears legitimate. But, stepping back a little, the transaction as a whole mirrors an "unlawful" transaction.
Although, extremely common (for example, see the case of Anne Pratt v FirstRand Bank Ltd), the above transaction is in fact unlawful. Our Courts have consistently held that if one transaction is conditional upon the conclusion of another transaction, both "simple transactions" constitute a single, "composite transaction". This is irrespective of whether the two simple transactions are spaced in time or concluded by different parties. In this instance, transaction 2 (i.e. the sale of the business for R1 to NewCo) would not have occurred in the absence of transaction 1 (i.e. subscription of shares in NewCo by a specific foreigner) ‐ I would not have sold my business to anyone for R1.
Analyzing the composite transaction: the value of NewCo shares is not negligible ‐ NewCo is properly valued at R10m; and failure by the foreigner to pay market value for the NewCo shares results in the composite transaction contravening our Exchange Control Regulations.
The same principle applies to tax structures. So, when faced with a series of linked simple transactions, analyze each transaction individually. But don't end there. Also analyze the composite transaction as a whole before confirming that the arrangement is in fact legal.