The favourable tax treatment afforded to dividends in contrast to other forms of income (including capital gains subject to capital gains tax) in terms of South African tax law has resulted in many opportunities for tax arbitrage especially where one is dealing with the sale of shares.

Given that dividends are generally exempt from tax in terms of the Income Tax Act No. 58 of 1962 (“the ITA”) and in certain instances (most notably payments by South African tax resident companies to other South African tax resident companies) exempt from dividends tax, many transactions have typically been structured to take advantage of the favourable dispensation afforded to dividends. A classic example would be for a corporate shareholder to exit its share investment in a company by means of a share repurchase transaction as opposed to the direct sale of shares. There are many commercial benefits of doing so but the tax benefit definitely cannot be ignored when one considers no tax being paid in terms of a sale structured as a repurchase of shares as opposed to tax at an effective rate of 22.4 per cent (in the case of shares held on capital account) being paid in terms of a conventional sale.

The benefits achieved were, however, substantially curtailed by the introduction in 2017 of provisions (through substantial amendments to section 22B of the ITA and to paragraph 43A of the Eighth Schedule to the ITA) to counter the perceived abuse of the tax dispensation discussed above. Notwithstanding these amendments, not all variations of transactions were caught as the provisions were just not broad enough. Most notably, certain transactions which had the effect of diluting shareholdings (so-called subscription and dividend transactions) prior to disposal of the relevant shares were not caught. The latter transactions typically involved a target company declaring a substantial dividend to the existing shareholders prior to a prospective shareholder subscribing for shares in the target company which would have the effect of reducing the effective interest of the existing shareholders to nominal percentages. The proceeds derived on the subscription would then, typically, be applied in settlement of the dividend declared to the existing shareholders. The nominal holdings of the existing shareholders would then be bought back at a date in the future, typically, more than 18 months into the future to avoid the application of certain anti-avoidance provisions.

These types of transactions have not gone unnoticed and the Minister of Finance in his 2019 budget speech indicated that provisions would be introduced with effect from 20 February 2019 to counter the perceived abuse associated with these types of transactions (referred to as “dividend stripping” transactions). Based on the Taxation Laws Amendment Bill 2019 [B18-2019] these provisions are broad and their application would, in very simplistic terms, result in a “deemed disposal” if there is a reduction in the effective interest of the corporate shareholders in a target company pursuant to the issue of shares by the target company. So for example, if a corporate shareholder holds 100 per cent of the equity shares in an unlisted target company and the target company issues shares to a new shareholder such that the corporate shareholder’s shareholding is diluted from 100 per cent to 70 per cent in the target company then the corporate shareholder is deemed to have disposed of 30 per cent of the equity shares in the target company. Does this mean that the provisions apply and one needs to determine a gain on the market value of the shares deemed to have been disposed? The answer to this question is no! When a deemed disposal is triggered in terms of these provisions, one still needs to consider whether the corporate shareholder held a qualifying interest in the target company in the 18 month period prior to the deemed disposal. In our example, this requirement would be met. Secondly, one needs to determine whether an extraordinary dividend was received or had accrued to the corporate shareholder in that period. If yes, then the deemed disposal would have the effect that a portion of the dividend would be included as proceeds in the determination of the capital gain arising pursuant to the deemed disposal. If no, then the deemed disposal would not result in any negative tax consequences. The provisions are, therefore, clearly aimed at addressing the dividend-stripping type transactions as discussed above. The provisions are also framed widely and could include, for example, shares issued by the target company to a share-incentive scheme where this would have the effect that the effective interest of a corporate shareholder would reduce resulting in a deemed disposal. But as mentioned, this is only cause for alarm where the other requirements, i.e. a qualifying interest and extraordinary dividend, are present.

Fortunately, where a deemed disposal has occurred and, later on, an actual disposal of the same shares occurs triggering the same provisions, then any extraordinary dividend determined on the actual disposal is only included in proceeds to the extent that it has not previously been included as proceeds in terms of the deemed disposal. The latter is to avoid double taxation!

Notwithstanding all of the above, there are still possibilities to repurchase shares and make use of the favourable tax dispensation that would not be caught by these specific anti-avoidance provisions, given that the provisions only apply to corporate shareholders that hold qualifying interests, where such shareholders received extraordinary dividends in the relevant 18 month period prior to the disposal or as part of the disposal. For example an unlisted company having a corporate shareholder holding 51 per cent of the equity shares (“A”) and another corporate shareholder holding 49 per cent of the equity shares (“B”) is still able to repurchase the 49 per cent equity shares held by B in terms of a specific share buy-back and afford B dividend treatment which means (subject to the General Anti-Avoidance Regime not applying) B will suffer no taxes on the exit of its 49 per cent shareholding.

These provisions will no doubt be amended over time as more variations of these transactions are developed by advisors and ultimately considered by the revenue authorities and National Treasury. Commercially there is still a place for share repurchase transactions, for example, the buying out of minorities and these can be structured tax effectively in the current tax dispensation notwithstanding the cumbersome anti-avoidance provisions.