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Exempt Dividends Treated as Taxable Interest

South Africa

Section 8E of the Act was introduced many years ago in order to counter tax avoidance involving, inter alia, preference share financing arrangements. This section operates to deem dividends received by or accrued to the holder as interest in the hands of the holder. The application of section 8E therefore results in the shareholder being subject to tax on the interest. Taxand South Africa explores why the distribution is still treated as a dividend for the issuer.

To fall within the ambit of section 8E, the shares have to constitute a "hybrid equity instrument". In respect of redeemable preference shares, in terms of section 8E such shares constitute a hybrid equity instrument if, inter alia, in terms of the rights to the preference shares any of the following rights are granted:

  • The issuer is obliged to redeem the preference shares within a period of three years from the date of issue; or
  • The holder has the option to require the redemption of the preference shares within a period of three years from the date of issue.
  • The "date of issue" is defined in section 8E as, inter alia:
  • the date on which it is issued by that company; and
  • the date on which the holder at any time after the share is issued acquires a right of disposal in respect of that share, other than as a result of the acquisition of that share by that holder.

The main issues arising in relation to redeemable preference shares include whether the holder of such shares has a right to require the issuing company to redeem the shares or whether the issuer of such shares has a right, but not an obligation to redeem such shares.

In order to avoid any such suggestion of such right in the hands of the shareholder any right by the shareholder to dispose of the redeemable preference shares should be limited to events which are objectively defined and outside the control of the relevant parties. In this regard it should also be ensured that the objectively stated events are not events which are certain to take place, ie, these should be contingent events otherwise a risk arises that they merely constitute a time clause and the shareholder then may have a right of disposal.

Section 8EA of the Act was introduced into the Act by the Taxation Laws Amendment Act 2011. It essentially applies where the shareholder has a right to dispose of the hybrid equity instrument (ie the relevant shares) to a party other than the issuer of such shares and this party has the obligation to acquire the shares.

In such cases, as is the position with section 8E of the Act, the dividends are treated as interest in the hands of the shareholder.

Taxand's Take

This section is not intended to apply to traditional Black Economic Empowerment transactions. Therefore where the issuing company uses the subscription proceeds to subscribe for ordinary shares in an operating company and the shareholder has a put option against that operating company or certain related parties thereto, then the provisions of section 8EA do not apply.

The provisions also only apply if the put option or other arrangement is triggered by the non-declaration of a dividend. Therefore if the trigger is not related to a non-declared dividend then the provisions of section 8EA do not apply. This provision comes into effect on 1 October 2012. Again certain amendments are being made to this section so by the time it comes into operation it will have slightly different provisions from those set out in the Taxation Laws Amendment Act.

It is therefore important to note that the amended versions of section 8E and section 8EA as contained in the Taxation Laws Amendment Act 2011 are not the final word on the subject. These provisions are currently being revised and it is hoped that the changes will be made public by the end of February. It is also hoped that the effective date of the section 8E changes will be moved from 1 April to 1 October in order to accommodate these revisions.

Your Taxand contacts for further queries are:
Peter Dachs
T. +27 21 410 6620

Bernard du Plessis
T. +27 11 269 7891

Taxand's Take Author