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.