From time to time, listed companies unbundle shares to their shareholders. It is important for the shareholders to understand the tax implications which may arise upon the receipt of the shares.
Absent any relief which may apply in terms of section 46 of the Income Tax Act (the “Act”) (which deals with unbundling transactions), the general principles are:
- If a South African tax resident company makes a distribution of an asset in specie to a person in respect of a share, and the distribution (1) does not result in the reduction of contributed tax capital (“CTC”), (2) does not constitute shares issued by the company making the distribution, or (3) does not constitute a general repurchase based on the relevant exchange’s rules (in the context of listed shares), then the receipt of the distribution constitutes a receipt of a dividend for purposes of the Act.
- The receipt or accrual of an amount as a dividend is included in “gross income” in terms of paragraph (k) of the definition in section 1 of the Act. The dividend may be exempt from income tax but the exemption is subject to one of the provisos to the exemption not applying. If one of the provisos to the exemption were to apply then the dividend will be subject to income tax.
- In addition, a dividend is subject to dividends tax at the rate of 20%. However, in the context of a dividend that constitutes a distribution of an asset in specie, the liability for the dividends tax is on the company declaring and paying the dividend which would be the unbundling company. Various exemptions from dividends tax may apply. For example, if the beneficial owner of the dividend is a South African tax resident company, then the dividend is exempt from dividends tax.
- If a company makes a distribution of an asset in specie to a person in respect of a share and the distribution results in a reduction of CTC, then it will constitute a return of capital. CTC is defined in relation to a class of shares issued by a company, inter alia as the consideration received by or accrued to a company on or after 1 January 2011 and reduced by so much as the company has transferred on or after 1 January 2011, for the benefit of any person holding a share in that company of that class in respect of that share.
- Paragraph 76B(2) of the Eighth Schedule to the Income Tax Act (the “Eighth Schedule”) provides that where a return of capital by way of a distribution of cash or an asset in specie is received on or after 1 April 2012 and prior to the disposal of the share, the holder of the share must reduce its expenditure incurred in respect of the share with the amount of that cash or the market value of the asset on the date the asset or the cash is received. If the cash or the market value of the asset exceeds the expenditure incurred in respect of the share, then the excess is treated as a capital gain in the year of assessment in which the return of capital is received.
Based on the above, if a South African tax resident company unbundles shares (“unbundling company”) that it holds in a subsidiary (“unbundled company”) by distributing those shares to the unbundling company’s shareholders (the “shareholders”), the receipt of the shares by the shareholders would constitute a dividend (if the distribution does not result in the reduction of CTC by the unbundling company) or a return of capital (to the extent that it reduces the CTC of the unbundling company).
Section 46 of the Act contains specific provisions for an unbundling transaction and broadly deals with the following:
- the tax consequences for the unbundling company distributing the shares. The unbundling company is required to disregard the distribution in determining its taxable income (any capital or revenue gain is not taxed);
- the expenditure of the shareholder receiving the shares. The shareholder is required to allocate a portion of the expenditure incurred in acquiring the shares in the unbundling company to the shares it received in the unbundled company in accordance with a specified ratio;
- the CTC of the unbundling company and the unbundled company immediately after the distribution. The CTC of the unbundling company is effectively proportionately split between the unbundling company and the unbundled company in accordance with a specified ratio;
- the dividends tax implications for the unbundling company. The distribution of the shares must be disregarded in determining any liability for dividends tax;
- the impact of paragraph 76B of the Eighth Schedule for the shareholder. It provides that paragraph 76B of the Eighth Schedule does not apply.
Section 46 of the Act does not deal with the tax implications arising for the shareholder upon receipt of the shares which are unbundled other than stating that paragraph 76B of the Eighth Schedule does not apply.
It is therefore important to determine if the receipt is a return of capital or a dividend. If it is a return of capital then paragraph 76B of the Eighth Schedule does not apply.
If the receipt does not result in the reduction of CTC, then it would constitute a dividend. As noted above, dividends are exempt from tax in terms of section 10(1)(k)(i) of the Act. However, section 10(1)(k)(i) contains various provisos which, if applicable, would result in the exemption not applying to the dividend. By way of example, if the shareholder borrowed the shares in the unbundling company and receives the shares being unbundled as a dividend, then that dividend is not exempt from income tax.
Based on the above, shareholders in listed companies that receive shares by way of a distribution should, inter alia, check whether they are receiving the shares as a return of capital or as a dividend in order to ensure that they understand the tax implications.