Section 8E (together with section 8EA) of the Income Tax Act deals with the so-called hybrid equity regime. These sections target equity instruments with debt-like characteristics, and, if applicable, re-characterise the otherwise exempt dividend income thereon as normal (ie fully taxable) income in the holders' hands.
National Treasury announced that it intends to broaden the scope of section 8E*. If enacted as proposed, this could have a significant impact on most preference share structures. Furthermore, the effective date for the proposed amendment is 1 January 2026, and it will apply to dividends accruing in respect of years of assessment commencing on or after that date. As a result, both future and existing preference share structures could be adversely impacted by this amendment.
The key changes proposed by the National Treasury are:
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Three-year safe-harbour rule removed: There will no longer be a post three-year safe-harbour redemption rule. Simplistically, this means that any share which meets the proposed definition of "hybrid equity instrument" will be tainted by section 8E regardless of its term.
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IFRS alignment: Any share recognised as debt (ie a financial liability) in the issuer's hands under IFRS will be treated as a "hybrid equity instrument". This will apply to most preference share arrangements, as the issuer is typically contractually obliged to redeem such shares on a fixed or determinable date.
If enacted, these amendments will result in exempt dividend income on preference shares that constitute debt from an accounting perspective being fully taxed in the holders' hands. Economically, this additional cost may be passed on to the issuer under the "gross-up" provisions in the preference share funding documents.
Webber Wentzel will be making submissions to the National Treasury on the significant impact of the proposed amendments. It is advisable to review all existing preference share/share funding structures in anticipation of this proposed amendment.
