There have been various amendments to the Income Tax Act 58 of 1962 (ITA) targeting the perceived abuse of share buybacks and dividend stripping arrangements since 2011. The most recent measures to target share buybacks were the 2017 amendments to section 22B and paragraph 43A in the Eighth Schedule of the ITA. Exempt dividends which are "extraordinary dividends" received or accrued (i) 18 months prior to a disposal of shares; or (ii) in respect, by reason or in consequence of such disposal, could result in these dividends being treated as income or proceeds for capital gains tax (CGT) purposes. This would be the case if a shareholder company holds a "qualifying interest" in the company distributing these "extraordinary dividends". These dividends would be treated as income if the shares were held as trading stock, and as proceeds, if held as capital assets.
For unlisted companies, a "qualifying interest" is at least 50% of the equity shares or voting rights in the company making the distribution, or 20% if no other shareholder holds a majority. For listed companies, any shareholder holding at least 10% of equity shares or voting rights would have a qualifying interest.
For preference shares with dividends expressed as a rate, an "extraordinary dividend" is any exempt dividend received or accrued which rate is more than 15%. For any other share, extraordinary dividends are exempt dividends that exceed 15% of the higher of the market value of the shares disposed of (i) at the beginning of the 18-month period; or (ii) on the date of disposal of the shares.
As is typical with anti-avoidance measures, these provisions came into effect on the date the draft Taxation Laws Amendment Bill 2017 (TLAB 2017) was circulated (19 July 2017), and applied to any disposals on or after this date. However, to provide some relief, these provisions do not apply to agreements which had been signed by 19 July 2017, although not yet unconditional on this date.
Furthermore, these amendments also take precedence over the corporate rules. This has resulted in the current uncertainty for groups of companies intending to streamline and wind-up their subsidiaries. Any corporate rule requiring a liquidation distribution to terminate the legal existence of a subsidiary being streamlined/wound up could result in CGT for the holding entity. This potential CGT struck at the core of the corporate rules, which was to provide corporate reorganisations with the flexibility of tax rollover relief where the economic ownership of the reorganised assets or businesses remained largely the same.
There are two corporate rules which require the winding-up or deregistration of the entity being streamlined, the section 44 amalgamation transaction and section 47 liquidation distribution. There would be liquidation distributions of any remaining residual assets on completion of the winding-up in terms of these rules. The winding-up of a company inevitably results in a disposal of shares held by the shareholder as the legal existence of the company comes to an end. A liquidation distribution received by a shareholder could arguably be received "in respect, by reason or in consequence" of such disposal, resulting in CGT if such dividend is an "extraordinary dividend" and the shareholder holds a "qualifying interest". This could be the case even if the legal existence had terminated with the company reflecting as "dissolved" on the Companies and Intellectual Property Commission website and the finalisation of the liquidation and distribution account by the liquidators taking place more than 18 months after the termination.
Other issues causing uncertainty in the 2017 amendments were the meaning of a "preference share" as this was not defined in section 22B and paragraph 43A; and the available definitions in the ITA only applied in specific sections of the ITA such as in the context of "hybrid equity instruments" in section 8E and "third-party backed shares" in section 8EA. Additional clarity was also required on whether the 15% threshold would be applied to cumulative preference dividends distributed on redemption of the share, or was the 15% threshold the coupon rate?
Any shareholder holding 10% equity interest or voting rights in a listed company was considered to hold a qualifying interest as opposed to the higher 20% for unlisted companies. The lower 10% threshold was also considered to be too low.
The Webber Wentzel Tax Team had made submissions on the above and other issues arising from the overly broad wording of the 2017 amendments. As a result of submissions made, the Budget Review 2018 (Budget) proposes to re-examine the interaction between the corporate rules and these new provisions to address the unintended consequences and also to clarify the meaning of preference shares in the 2017 amendments.
We hope that the proposed amendments in the 2018 draft bills to be circulated later this year will provide for section 22B and paragraph 43A not to override the corporate rules. Specific anti-avoidance provisions should be used to target the particular abuse of the corporate rules in mind. Furthermore, the preference share 15% threshold rate should only apply to a coupon rate, and not to a cumulative redemption rate. There should also be no difference between the qualifying interest held by a shareholder in a listed and unlisted company. Any proposed amendments should hopefully be implemented with retrospective effect, from 19 July 2017, in order to preserve the fundamental purpose of the corporate rules.
The Budget was required to address a shortfall in revenue as well as provide a stimulus for much-needed economic growth in a slowing economy. A clearer legislative environment would do much to encourage corporate reorganisations, mergers and acquisitions, and investments into South Africa. All of these would boost economic growth, and in some ways, better than more direct measures proposed in the Budget such as tax incentives.