Tax consequences of the New Companies Act
The changes to company law arising from the new Companies Act had to be taken into account in the Income Tax Act, as the latter made reference to company law concepts that would fall away, for example, the par value of shares, a share premium or the concept of equity share capital, a concept defined in the Income Tax Act but borrowed from the old Companies Act.
The concepts of par value and share premium are primarily found in the definition of “dividend” in section 1 of the Income Tax Act, but as this definition was to be replaced concurrently with the “switch” from STC to the dividends tax, the continued use of these terms would in any event have fallen away. What the coming into effect of the new Companies Act has done is caused those new definitions to come into effect earlier than was otherwise anticipated, ie instead of coming into effect when the “switch” from STC takes place (likely to be only in 2013) they will now come into effect in 2011.
A number of amendments were made to the Income Tax Act in the 2010 Taxation Laws Amendment Act to align the Income Tax Act with the new Companies Act, but most of these amendments were technical in nature and not of great moment, for example, changing the reference of the Companies Act from the 1973 reference to the 2008 reference, eliminating the concept of equity share capital and instead changing the reference to equity shares, and so on.
But one of the more far reaching changes to the Income Tax Act which is being brought about is the definition of “contributed tax capital” which must be read in the context of the new definition of “dividend”. The current definition of “dividend” is one of the longest definitions in section 1 of the Income Tax Act, whereas the new definition is extremely short. In essence, the new definition says very little more than that a dividend will be any amount distributed by a company to its shareholder, but excluding any amount which results in a reduction of contributed tax capital. No reference is made to profits and, in this respect, there is an alignment with section 90 of the current Companies Act and section 46 of the new Act.
Because dividends will trigger tax (STC or dividends tax) but distributions from contributed tax capital will not (other than possibly CGT for the shareholder), it becomes necessary to understand what the latter expression means. Again, the definition is not very long and, in essence, all it says is that contributed tax capital equals –
– the share capital and share premium (or stated capital) immediately before 1 January 2011, ie when the new definition comes
into force, plus
– any consideration received by the company for the issue of shares thereafter, less
– any amount transferred by the company to shareholders.
But the situation does not stop there, because once the switch-over is complete, under certain of the corporate restructuring rules found in sections 41 to 47 of the Income Tax Act, these provisions are modified in certain circumstances. So one can well find an amount being credited to share capital on the issue of new shares, resulting from an acquisition of an asset, but there is no increase in contributed tax capital, ie it will constitute share capital under the Companies Act without constituting contributed tax capital for income tax purposes. As a result, it is possible that the repayment of that share capital for commercial, company law and accounting purposes will be treated as a dividend for tax purposes.
Although there is an effort made in a number of respects to align tax rules with GAAP, in other respects there is a growing divergence between the two, such that it might be necessary almost to keep two sets of records, ie one for financial accounting and one for tax accounting. Indeed, it has already been demonstrated above that the share capital for Companies Act purposes may differ quite markedly from share capital for tax purposes, ie from contributed tax capital. Moreover, the share capital for accounting purposes may yet differ from both of the aforegoing, for example, to the extent that redeemable preference shares have been issued, the financial statements will not reflect this as share capital but rather as debt.
One of the potential anomalies that can arise is that, in order to demonstrate that a distribution has been made out of contributed tax capital rather than something else (the “something else” being a dividend) it is necessary for the directors to determine that the payment is being made out of contributed tax capital. The expectation is that such a determination will be contained in the resolution making the distribution. But a resolution is an act of the directors in the course of their governance of the company under the Companies Act, the memorandum of incorporation and other similar rules, and, while it would be perfectly normal for a resolution to specify that there is a payment out of share capital, it would not be appropriate for a resolution to refer to a distribution out of contributed tax capital, which is not a concept found in company law but in income tax law. No doubt, though, for practical purposes, in order to protect the tax position of shareholders, this little nicety will be overlooked.
All material subject to our Legal Disclaimers.