An analysis of the tax implications pertaining to share buy-backs require the detailed consideration of various provisions of the Income Tax Act No. 58 of 1962 ("the Act"), including the capital gains tax (“CGT”) provisions that may apply in the event of a company acquiring its own shares. In addition, the provisions of the Companies Act must be borne in mind.
Section 85 of the previous Companies Act, No 61 of 1973 permitted companies to acquire their own shares from shareholders by way of special resolution and subject to meeting the solvency and liquidity requirements.
In terms of the new Companies Act, No 71 of 2008 (“the Companies Act”), share buy-backs are governed by section 46 thereof, which sets out the circumstances in which a company’s board of directors may authorise a distribution by such company. The most noteworthy requirement is contained in section 46(1)(b) which provides that a distribution may not be made unless the company will satisfy the solvency and liquidity test immediately following such distribution.
Section 48 of the Companies Act contains further pertinent requirements relating to share buy-backs, mainly that the acquisition of its own shares by a company, or the acquisition by a subsidiary of that company’s shares is prohibited if, as a result of that acquisition, there would no longer be shares of the company in issue other than shares held by subsidiaries of the company or convertible or redeemable shares.
For tax purposes, a new definition of “dividend” became effective on 1 January 2011. “Dividend” is now defined as any amount transferred or applied by a company for the benefit of any shareholder in relation to that company by virtue of any share held by that shareholder in that company, whether by distribution or as consideration for the acquisition of any share in that company. Specifically excluded from the definition of “dividend” is, inter alia, an amount transferred or applied by the company to the extent that the amount so transferred or applied constitutes an acquisition by a company of its own shares by a company listed on the Johannesburg Stock Exchange (“JSE”) in accordance with the JSE Listings Requirements.
Also effective 1 January 2011 is the concept of so-called “contributed tax capital” (“CTC”). A company’s CTC constitutes its stated capital or share capital and share premium immediately prior to 1 January 2011, less so much of the stated capital, share capital or share premium as would have constituted a dividend under the previous dividend definition had it been distributed by the company before that date, plus the consideration received or accrued to the company for the issue of shares on or after 1 January 2011. In other words, a company must determine its CTC on 1 January 2011 as the total of its share capital and share premium account on that date, excluding any amounts thereof which would have constituted a dividend had they been distributed prior to that date. After 1 January 2011, the CTC will be increased by any consideration received by the company in respect of the subsequent issue of shares.
If a company had issued several classes of shares, CTC must be maintained separately on a per class basis. Therefore, CTC created by virtue of an ordinary share issue cannot be allocated or re-allocated to preference shares. Similarly, distributions in respect of preference shares cannot be utilised to reduce the CTC associated with ordinary shares. If a company makes a distribution out of CTC in respect of a given class of shares, the CTC distributed will be pro rata allocated to the shareholders of that class of shares.
An amount paid by a company to a shareholder in consequence of a share buy-back transaction would therefore not constitute a dividend for tax purposes if –
- the acquisition was by a listed company in accordance with the JSE requirements; or
- in the event of a non-listed company buying back its own shares, the amount paid for the acquisition of the relevant shares to the extent that it results in a reduction of CTC.
To the extent the consideration paid to the shareholder constitutes a “dividend”, the company acquiring the shares will incur a liability to pay secondary tax on companies (“STC”) at a rate of 10% of the net amount of the dividend declared. The amount distributed to shareholders as consideration for their shares, less any reduction in the company’s CTC would therefore constitute a dividend on which STC is payable.
In terms of section 64B(4)(c) of the Act, such dividend would be deemed to have been declared by the company and to have accrued to the shareholders on the date on which the shareholders become entitled to the cash or assets distributed to them.
From the recipient’s perspective, to the extent that the consideration for the shares constitutes a “dividend”, paragraph (k) of the definition of “gross income” in section 1 of the Act provides that any amount received or accrued to a shareholder by way of a dividend is included in that shareholder’s gross income. Section 10(1)(k)(i) of the Act exempts from tax in the hands of the shareholder, dividends received from South African companies. This exemption does not, however, apply to a dividend that forms part of the consideration payable to the shareholder in respect of a share buy-back where the shares bought back were held as trading stock.
To the extent that the distribution does not constitute a dividend, the potential CGT implications require consideration since the amount so received would constitute a “capital distribution” for CGT purposes. “Capital distribution” is defined in paragraph 74 of the Eighth Schedule to the Act as “any distribution (or portion thereof) by a company that does not constitute a dividend.”
In terms of paragraph 76 of the Eighth Schedule, where a capital contribution of cash or an asset in specie is received by or accrues to a shareholder in respect of a share, the shareholder must treat the amount of cash or the market value of the asset in specie as “proceeds” when the share is disposed of. In other words, should the capital distribution received in consequence of the share buy-back, exceed the base cost of the share in the shareholder’s hands, a taxable capital gain would arise.
Such distribution is deemed to be a disposal resulting in an immediate CGT liability. Paragraph 76A of the Eighth Schedule provides that the shareholder must be treated as having disposed of part of the share on the date of receipt or accrual of a capital distribution of cash or an asset in specie received by or accrued to the shareholder. The shareholder would therefore be deemed to have disposed of its shares in the company buying back its shares on the date of the share buy-back.
The term “proceeds” is defined in the Eighth Schedule to the Act and under the current circumstances would be regarded as the amount received by the shareholder as consideration for the shares. Paragraph 35(3)(a) of the Eighth Schedule provides that the proceeds from the disposal of an asset must be reduced by any amount of the proceeds which have been included in the gross income of that person before the inclusion of any taxable capital gain.
As dividends constitute “gross income” (albeit exempt) to the extent that the share buy-back consideration constitutes a dividend, the amount of proceeds derived by the shareholder would therefore be reduced. The non-dividend portion would, however, constitute proceeds for CGT purposes.
A new tax on dividends, the shareholders dividends tax will replace STC with effect from 1 April 2012. Dividends tax will be levied at a rate of 10% on the amount of any dividend paid by a company. The recipient of the dividend will be liable for the dividend tax, but subject to certain exemptions, the company declaring and paying the dividend is obliged to withhold the tax from the amount of the dividend paid and pay the tax to SARS by the last day of the month succeeding the date of payment. There are certain persons which are exempt from the dividends tax, the most noteworthy being a South African resident company.