Unpacking the tax implications in the Nepi-Rockcastle merger
Shareholders need to consider their share swap options following the approval of the property mega-merger
This week’s dual listing on the JSE and Euronext Amsterdam of newly merged Nepi Rockcastle Plc — now the JSE’s largest property stock with a market cap of about R93bn — will create plenty of upside for both sets of shareholders.
However, the deal has significant tax implications for SA investors. Individual shareholders of the two Central and Eastern Europe-focused rand-hedge counters will be particularly hard hit — some more than others, depending on how they choose to receive their share allocation in the merged entity.
The deal doesn’t have immediate adverse tax implications for shares held in the name of a company or pension fund.
Java Capital director Andrew Brooking, Nepi Rockcastle’s corporate adviser and JSE sponsor, says there was unfortunately no way to implement the merger without triggering a tax cost for individual shareholders.
"Because this is a merger between two offshore companies, someone was always going to pay tax," says Brooking.
SA’s taxation laws, he notes, don’t yet allow for a roll-over of tax incurred when foreign, inward-listed companies conclude share swap deals. The tax implications for Nepi Rockcastle shareholders also relate to the merger mechanism, which will result in the creation of a new, third company that acquires the combined businesses, assets and liabilities of Nepi and Rockcastle.
The merger is a share-for-share transaction in terms of which Nepi and Rockcastle shareholders have to sell their existing shares to receive shares of the same value in the new company, with the option of receiving the new shares as a return of capital or a dividend. Brooking says the deal is further complicated by the fact that the two existing companies are registered in different jurisdictions, governed by different laws — Nepi in the Isle of Man and Rockcastle in Mauritius.
"It’s a complex transaction that has taken
us many months to structure in a way that ensures maximum flexibility for all shareholders," he says.
Nepi and Rockcastle shareholders have until July 14 to exercise their choice on how they want to receive the shares they are entitled to in the new company.
Rockcastle shareholders have two options to receive their shares pursuant to a distribution in specie as a dividend, or a distribution in specie as a return of capital.
In addition to these two options, Nepi shareholders have a third choice: to have Nepi repurchase all their shares.
Interestingly, the default option for shareholders who take no action by July 14 will differ for Nepi and Rockcastle investors. Rockcastle’s shareholders who don’t exercise their choice will automatically receive their shares pursuant to a dividend, while Nepi shareholders will receive their shares pursuant to a return of capital.
Again, the differences in default options are mainly
due to different legal implications in Mauritius and the Isle of Man, and differences in the makeup of the companies’ share registers.
The default procedure is particularly relevant to individual Rockcastle shareholders, as the dividend option will almost certainly incur a higher tax cost than the return of capital option, says Brooking. "It’s important that individual investors do their own calculations, but we believe Nepi and Rockcastle individual shareholders will be better off taking the return of capital option, even if [they] paid close to nothing for [their] shares and are taxed at the maximum personal rate of 45%."
The dividend option in the hands of an SA individual shareholder is taxed as follows: the dividend is subject to income tax, with a portion of the dividend being exempt from income tax. This portion is worked out by applying a 25/45 ratio to the dividend.
Accordingly, 25/45 (approximately 55%) of the dividend will be exempt from income tax, with the balance being taxed at the shareholder’s applicable income tax rate. For example, an individual who is subject to the maximum income tax rate of 45% and who has a dividend amounting to R100,000 will be taxed at R20,000, an effective tax rate of 20% (R100,000 less R55,555.56 = R44,444.44 x 45%).
If the individual is subject to a lower tax rate, then the effective tax rate will be lower (see the tables). However, there is no deduction of the price that an individual shareholder paid when he or she originally bought the shares.
Though the maximum 20% rate is equivalent to the JSE’s dividend withholding tax rate, Brooking says the cost for shareholders who opt to receive their shares as a dividend will be raised as personal income tax.
So individual shareholders who choose the dividend option, whether they own shares in Nepi, Rockcastle or both, will need to account for the tax cost in their annual income tax returns for the year ending February 2018.
In contrast, the return of capital option will incur capital gains tax (CGT) and not personal income tax (assuming the shareholder holds the shares as capital assets). Here, the amount owed to Sars depends on the base cost of your shares, as well as your personal tax rate.
The cost will be 40% of your capital gain (the difference between the base cost and current value of your shares), taxed at your personal income tax rate.
If one uses the example of shares worth R100,000 — and assuming you paid R50,000 for your shares a few years ago and your personal tax rate is 45% — your CGT cost comes to R9,000 (40% of R50,000 = R20,000 x 45%).
That’s less than half the R20,000 you will owe Sars if you choose the dividend option. Of course, if you bought your shares at a much lower cost, your gain will be higher and so will your tax liability, and vice versa.
Brooking doesn’t expect many Nepi investors will choose to receive their shares via the third option — namely, to sell all their shares to Nepi — as doing so will trigger securities transfer tax. That will mean an additional cost of 0.25% of the total share value on top of the CGT liability.
Nepi Rockcastle will release the results of shareholder elections early next week.