Limited time to utilise contributed tax capital for specific share buy-backs

Companies may at times be obliged to or wish to repurchase shares from its shareholders. The repurchase or buy-back of shares may be due to an obligation, for instance due to an agreed redemption date for preference shares, or for commercial reasons, such as cancelling the shareholding of a retiring or exiting shareholder.

When a share buy-back takes place, the consideration paid to the shareholder is by default defined as a dividend for income tax purposes. However, to the extent that the directors of the company elect for the payment to a shareholder to be paid out of the contributed tax capital (hereafter referred to as ‘CTC’) of the company, this amount is not a dividend.

CTC is a defined term in section 1 of the Income Tax. For the purposes of this article, the amounts which make-up CTC is not discussed in detail. In essence, CTC represents the consideration received by a company in exchange for issuing its shares and is reduced to the extent that the directors have previously elected to transfer amounts to shareholders out of CTC. CTC is ring-fenced per class of share issued by the company. Therefore, separate balances of CTC exist and may be used for each class of shares issued by a company.

In terms of a proviso to the definition of CTC, the CTC that may be returned to a shareholder is limited to the shareholder’s portion of the total CTC for that class of shares held. The shareholder’s portion of the CTC is determined using the ratio of the number of shares held by the shareholder to the total number of shares issued for that class. As a result, there is a limit to the amount of CTC that may be returned to a specific shareholder and this limit may not be equal to the amount contributed by the shareholder.

The income tax treatment of dividends may vary depending on the circumstances and the nature of a shareholder. For instance, a shareholder who is not a South African resident company would ordinarily pay dividends tax on a dividend paid to the shareholder, whereas a dividend paid to a South African resident company should not attract dividends tax, but may, in certain circumstances, be re-characterised to attract capital gains tax. In contrast, the payment or the return of CTC to a shareholder, depending on the shareholder’s specific circumstances, may not attract income tax. The rationale for a return of CTC not attracting income tax is that CTC represents the shareholder’s capital originally invested and therefore when this invested capital is returned to the shareholder, no income tax should arise.

In cases where shares are bought back from a specific shareholder, a portion of the consideration for the buy-back may be paid out of CTC, thereby achieving an income tax-free receipt for the shareholder. 

In the draft Explanatory Memorandum on the Taxation Laws Amendment Bill, 2021, National Treasury noted that the Government has become aware of companies allocating CTC to specific shareholders on the basis of an alleged ‘share premium’ contributed by the shareholder. To curb this abuse, the Taxation Laws Amendment Bill (Bill No. 22 of 2021) tabled in Parliament on 11 November 2021, proposes to amend the definition of CTC. In terms of this proposed amendment, an amount transferred would not constitute CTC unless all of the shareholders, in that class of shares to which the CTC relates, participate in the transfer “in the same manner and are actually allocated an amount of [CTC] based on their proportional shareholding within that class”. Unfortunately, the effect of the wording used in this proposed amendment may be that unless all of the shareholders within a particular class of shares participate in the return of CTC and are actually allocated a portion of the CTC based on their proportional shares held in that class, the amount paid by the company would not constitute CTC, but rather would represent a dividend. This amendment should not apply in the case of a general repurchase of shares listed on the JSE or any other South African exchange.

The original effective date for this draft amendment was 28 July 2021.  Following public comments on this draft tax legislation, the proposed effective date for this amendment has been delayed to 1 January 2022.

In light of this draft legislation, companies looking to repurchase shares from specific shareholders and in so doing intending to return CTC to specific shareholders, may need to do so before 1 January 2022.

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