As foreshadowed by the Minister of Finance in his Budget speech on 20 February 2019, the Draft Taxation Laws Amendment Bill of 2019 (the Draft Bill) contains proposals aimed at broadening the scope of the anti-avoidance rules dealing with dividend stripping. The 2019 Budget was somewhat vague with regard to the details of the proposals, but nevertheless stated that the amendment would be effective from the same date i.e. 20 February 2019.
In essence, the current anti-dividend stripping rules, which are contained in section 22B of the Income Tax Act (the Act) and paragraph 43A of the Eighth Schedule to the Act, seek to address what National Treasury regards as abusive tax schemes. The perceived abuse arises mainly in the situation in which a South African resident company, say A, holds shares in another South African resident company, say B. If A wishes to dispose of the shares in B to another party C then, instead of A selling the shares and paying capital gains tax or revenue income tax on gains realised, A could dispose of its shares in B in terms of a buy-back of the shares by B, in the process, stripping out B’s value in favour of A. Thereafter, thus stripped of its value, B could issue shares at a nominal value to C, which would then hold all of the issued shares in B. From a technical perspective, most share buy-backs are regarded as exempt dividends for purposes of income tax and dividends tax. Absent the anti-avoidance rules, no dividends tax, income tax or capital gains tax would be payable on a transaction that was structured in this manner.
The trigger for the application of the current rules is the ‘disposal’ of shares (by A in the above example) and the proposed amendments broaden the scope of the current rules by catering for situations in which shares are not disposed of, but instead, new shares are issued to an incoming shareholder, with the current shareholder retaining its shares. Using the above example, once again dividends would be declared to A that would have the effect of stripping out the value of B in favour of A. Thereafter, with the value of the shares in B once again reduced to a low value, shares would be issued by B to C. Therefore, A would remain a shareholder in B, although typically with a small minority interest.
The current version of the rules only apply if A held a ‘qualifying interest’ (as defined) in B in the 18-month period prior to the disposal of shares, and to the extent to which dividends are ‘extraordinary dividends’ (as defined).
In terms of the proposal, the issue of shares by B to C would be treated as a disposal of shares by A if the effective interest (this term is not defined) of A in B were reduced by reason of the issue of the new shares to C. A would potentially therefore have to account for proceeds on a notional disposal of its shares for purposes of capital gains tax or (revenue) income tax. Dividends which had accrued to A in the 18-month period prior to the issue of shares to C, and dividends that accrued to A ‘in respect, by reason or in consequence of that disposal’ would have to be tested to determine if they were ‘extraordinary dividends’ as defined in the provision. It is not at all clear how one would determine the effective interest of a shareholder in a company if there were multiple classes of shares in issue, each with different rights.
Like the current version of the provision, the proposal also requires a ‘qualifying interest’ to have been held by A in B in the 18-month period prior to the (deemed) disposal. Were the proposal to apply, the disposal by A would be deemed to occur immediately after the issue of the new shares to C. The proposal would deem A to have disposed of the percentage of its shares in B that was equal to the percentage by which its effective interest in A had been reduced by reason of the issue of the new shares to C. The proposal would take effect on 20 February 2019 and would apply where the effective interest in the shares in B was reduced on or after that date.
The current provision already introduces a great deal of complexity in relation to ordinary transactions, with associated costs for taxpayers and tax penalties for non-compliance. These aspects would only be worsened if the proposal is enacted.
For example, in terms of the current version of the provision, whenever shares held by a company in another company are disposed of, taxpayers have to check whether they may fall foul of the provision in that dividends that were received or that accrued in the 18-month period prior to the disposal of the shares may become treated as proceeds on disposal for income tax or capital gains tax purposes. The current version requires a comparison of the market value of the shares on the date of the disposal and the market value of the shares at the beginning of the 18-month period in the determination of the amount of the extraordinary dividend. If the proposal is enacted, the possible impact of the provision would have to be considered in the commonplace situation where shares are issued by a company, since in the vast majority of cases, the issue of additional shares by a company will result in a change in the effective interests of the existing shareholders in the company. One would then need to check whether the ‘qualifying interest’ and ‘extraordinary dividend’ thresholds had been breached, which would result in an application of the provision to the (potentially unsuspecting) existing shareholders.
It is also evident that a great many BEE structures, which in many cases rely on the extraction of dividends in favour of the existing shareholders so as to facilitate the introduction of BEE shareholders, would be negatively impacted by the proposal.
The Draft Bills are open for comment until 23 August 2019.
Professor David Warneke
Director, Tax Services and Head of National Tax Technical
BDO South Africa
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