South Africa Tightens Share Anti-Avoidance Provisions

Within the recently-issued Taxation Laws Amendment Bill, which legislates for the measures introduced in South Africa’s 2012-13 Budget, it has been disclosed that technical corrections have been made to the third-party-backed preference share anti-avoidance provisions.

In tax terms, debt payments are typically deductible by the payer with the same payments being included as income by the payee. With the advent of the new dividends tax in South Africa, dividend payments in respect of shares are not now deductible by the payer, but are potentially subject to a 15% charge falling on the payee (subject to exemptions). Depending on the circumstances, a tax incentive may then exist for a taxpayer to attach a label to a debt or share instrument that differs from the underlying substance.

The main purpose of these anti-avoidance provisions is therefore to ensure that the holder of the shares directly or indirectly bears some form of equity risk associated with the issuer. Without this indirect risk, it is said, the shares should not be viewed as generating exempt dividends but taxable interest.

Anti-avoidance rules in legislation introduced in 2011 targeted share issues where the dividends in respect of those shares were guaranteed by unrelated third parties. These third party guarantees effectively meant that the holder of the share had no direct or indirect meaningful stake in the risks associated with the issuer.

It also targeted share issues where the dividends in respect of those shares were fully secured by financial instruments, where the secured financial instrument served as the basis for the dividend yield as opposed to a mix of assets associated with the issuing company as a whole.

The revised legislation, however, has recognised the use of such “preference share” funding to acquire shares in operating companies as necessary to avoid indirect double taxation (because debt used to acquire shares generally does not allow for deductible interest).

The new provisions contain an exception for preference share schemes where the funding received for the preference share issue is ultimately applied to directly or indirectly acquire a pure equity stake in an active operating company. The exception means that preference share funding can continue as a means for acquiring the shares of active operating companies.

The proposed amendments apply to dividends received or accrued on or after October 1, 2012, in respect of years of assessment commencing on or after that date.

Finally, concerns have also been expressed that certain schemes that purport to generate interest-like dividends via artificial preference share holdings are trying to avoid the legislation through suspect means. Therefore, a second review of these schemes will be undertaken to ensure that the targeted schemes do not bypass the anti-avoidance legislation proposed.
Concerns also exist that derivatives can be used to shift risk to wholly unrelated parties so as to bypass the proposed anti-avoidance rules. It was advised that he proposed legislation may accordingly have to be tightened to address this possible problem.

TAXtalk: www.taxtalkblog.com

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