Draft Taxation Laws Amendment Bill

Publication | 28 March 2012


The first draft of the Taxation Laws Amendment Bill, 2012 (TLAB) was issued by National Treasury on 13 March 2012.

The Bill contains numerous complicated and technical amendments to important sections, and of particular interest, is the clarification on the proposed taxation of hybrid equity instruments and third-party backed shares.

Taxpayers that have used preference share funding in any of their structures have been given an opportunity to ensure that their affairs are in order as, of significance, the effective date of the changes to the taxation of hybrid equity instruments has been extended.  It is crucial that taxpayers utilise this opportunity to sit down with their advisers to take stock of their financing arrangements, and to ensure that their affairs do not fall foul of the required provisions.

Hybrid shares and third party backed share guarantees

The TLAB amends certain of the provisions relating to section 8E as well as a newly introduced section 8EA of the Income Tax Act No. 58 of 1962 (the Act).  

The proposed amendments, over and above the old tests to section 8E, are set to take effect on 1 October 2012, providing that dividends flowing from a hybrid equity instrument will be characterised as interest -

  • where, dividend is calculated with reference to a specified interest rate or the time value of money; and
  • the share is secured by a financial instrument.

An additional definition of financial instrument is now incorporated in the body of section 8E which will have the effect of narrowing the previous definition to any interest bearing arrangement, or financial instrument based on or determined with reference to the time value of money. 

If the above criteria are met, any dividend yield generated by the share will be deemed to be interest income and taxed accordingly.  Having said that, this anti-avoidance provision will not apply to hybrid equity instruments where the consideration received for the instruments is utilised for the purpose of acquiring equity shares in an operating company.  In particular, the consideration for the instrument must either be utilised to –

  • acquire equity shares in an operating company;
  • retiring bridging loans initially used for the acquisition of shares in an operating company; or
  • re-finance the hybrid shares which were initially employed for the purposes of acquiring equity shares in an operating company.  

Section 8EA of the Act, which deals with “third party backed shares” is set to take effect on 1 October 2012.  In terms of this section, any dividend either foreign or local flowing from a third‑party backed share will be deemed to be income in the hands of the recipient; in other words, it loses its status as a tax-free dividend.  In order to qualify as a third party-backed share –

  • such share must be subject to an enforcement right or obligation in relation to a third party;
  • which is triggered upon the failure to pay a dividend or return of a capital distribution.  

Similar, to the proposed exceptions introduced under section 8E, a third party-backed share will not lose its tax-free dividend status if the consideration for the issue of such shares is applied directly or indirectly for the purpose of:

  • acquiring equity shares of an operating company;
  • retiring bridging loans used for the same purpose of acquiring equity shares in an operating company; or
  • the consideration must be dedicated to re-financing shares initially used to finance the acquisition of shares in an operating company.  

In both section 8E and 8EA, the above exceptions will not apply if the preference share consideration is used to acquire ordinary shares in an operating company that forms part of the same group of companies as the issuer.

Unlike section 8E, the proposed amendments to section 8EA introduce a definition of “operating company” which is defined to mean any company:

  • that carries on business continuously, and in the course or furtherance of that business provides goods or services for consideration;
  • any company that is a controlling group company relation to such a company; or
  • any listed company.  

The practical result of the aforementioned definition read with the exceptions discussed above, is that many of the financing arrangements used to facilitate black economic empowerment transactions will no longer fall within the ambit of these anti-avoidance provisions.

Dividends tax

Amendments are introduced to clarify the transition from Secondary Tax on Companies (STC) to the new dividends tax:

  • To prevent double taxation, dividends concurrently subject to normal tax, without the benefit of an exemption or previously subject to STC at a rate of 10% will not be subject to the new dividends tax which is levied at 15%;
  • the TLAB also provides clarity with respect to dividends declared before 1 April 2012.  The proposed amendment effectively provides that any dividend declared before such date and payable thereafter will be subject to STC and not the new dividends tax;
  • in addition, it is confirmed that STC transitional credits will only be available for a period of three years, and not the initial proposed five year period.

Headquarter company regime

Many of the requirements associated with the participation exemption for the disposal of shares in a foreign company have been eliminated to provide a far more flexible regime in order to facilitate the regime’s intended use as an ideal location for investment. Similarly, the transfer of headquarter company shares will no longer be subject to securities transferred tax.

Dividend stripping

Dividend anti-stripping legislation, is aimed at preventing the reduction of the value of shares (and the associated capital gains tax) for a purchaser by the declaration of dividends prior to the sale of such shares.  To this end, the previous legislation intended to treat dividends as ordinary revenue if such dividends arose 45-days before such a disposal.  Legislature has now recognised that this 45-day holding period is impractical and that taxpayers may legitimately hold an underlying share even if only for a short period of time, prior to a disposal.



Andrew Wellsted

Andrew Wellsted