February 24 2016 was Budget Day. This update summarises some of the key budget proposals.

Recharacterisation of proceeds in case of share buyback

The budget included a proposal for the National Treasury to recharacterise the proceeds that are received by a shareholder company which disposes of its shares through a share buyback instead of selling them outright to a third party.

Disposal of shares

A choice frequently arises where a shareholder in a company has two ways to dispose of its shares:

  • outright sale of the shares to a third party, which will result in capital gains tax on the profits made (22.4%); or
  • sale of the shares to the company in which the shares are held through a specific repurchase of shares, which will result in an exempt dividend if the purchase price is not funded out of contributed tax capital.

The benefit that arises from the repurchase of shares is that a dividend declared by one company to another is exempt from dividends tax. It is also exempt from income tax. Further, the purchase price is not only exempt in the hands of the seller company, but also not subject to dividends tax, provided that:

  • the shares are repurchased through a specific share buyback of shares; and
  • the purchase price is not funded from share capital (contributed tax capital), but from reserves.

Tax avoidance

The budget announcement indicated that one scheme for avoiding the tax consequences of share disposals involves "the company buying back the shares from the seller company and issuing new shares to the buyer". Apart from the benefit that the seller company may derive, there is an additional benefit in that the purchaser subscribes for new shares in the company, the proceeds of which are used to fund the buyback of the shares. In particular, the share subscription will result in the contributed share capital of the company being increased.

It was announced that this type of transaction is in substance a share sale that should be subject to tax. The question arises as to whether these transactions will be recharacterised so that capital gains tax is payable even though the shares are, strictly speaking, a dividend. Alternatively, it is possible that the dividend will no longer be exempt in the hands of the seller of the shares, even though the seller is a company.


Whatever the coming developments, these types of transaction are not automatically without risk. There should always be a commercial rationale for embarking on a share buyback as opposed to the sale of shares – for instance, where the purchaser does not have the cash to pay for the shares and the company in which the shares are held does. Great care should thus be taken in implementing share buyback transactions where the parties rely on the fact that the proceeds are exempt in the hands of the seller company over and above the fact that no dividends tax is payable.

Interest deemed as dividends

Sections 8F and 8FA of the Income Tax Act (58/1962) provide for the convertion of interest into dividends. These sections deal with a scenario where the debt instrument displays a number of equity characteristics – for instance, if amounts are payable only if the issuer's assets exceed its liabilities or interest is not calculated with reference to the time value of money.


A number of transactions have been implemented which make use of the intentional recharacterisation of interest into dividends. This is especially common where the issuer is a non-resident, in which event the non-resident issuer is treated as having paid dividends instead of interest to the South African holder.

Non-residents excluded

As of February 24 2016, interest will no longer be reclassified as a dividend where the issuer is a non-resident. The reason is that a non-resident cannot suffer negative tax consequences in a South African context – not only is the dividend exempt, the issuer can potentially claim an interest deduction in its country of origin. Going forward, the interest will no longer be recharacterised as a dividend and will thus be taxable in the hands of the South African holder if the issuer is a non-resident of South Africa.

Submission date of estimate for second provisional tax payment

Provisional tax is not a separate tax payable by certain parties. Instead, it is merely a method used to collect normal tax that will ultimately be payable for the year of assessment concerned during the year. Essentially, provisional tax is an advance payment of a taxpayer's normal tax liability.

A provisional taxpayer must generally make two provisional tax payments – six months into the year of assessment and at the end of the year of assessment – but can make a third top-up payment after the end of the year of assessment. Provisional tax payments are calculated on estimated taxable income (including taxable capital gains) for the year of assessment.

Late submission

Certain rules must be adhered to when making estimates of taxable income for provisional tax purposes. Penalties and interest will be imposed if the estimates are inaccurate or if the submission of the estimates or the payment of provisional tax is late.

Regarding the second provisional tax payment period, a provisional taxpayer must submit a return to the commissioner of the South African Revenue Service (SARS) which includes an estimate of the total taxable income that will be derived by the taxpayer in the year of assessment (ie, a second period estimate). Because the second period estimate is made at or close to the end of the year of assessment, a taxpayer can often make a relatively accurate estimate of the taxable income.

An underpayment penalty may be levied for the second period if the actual taxable income as finally determined is more than the taxable income estimated on the second provisional tax return. The underpayment penalty is a percentage-based penalty imposed under Chapter 15 of the Tax Administration Act (28/2011). The calculation of the potential penalty depends on whether actual taxable income is more than R1 million. Further, under Paragraph 19(3) of the Income Tax Act, the penalty may be levied even if the commissioner of SARS has increased the estimate.

Notwithstanding this, a provisional taxpayer is not presently subject to the underpayment penalty if an estimate for the second provisional tax period is submitted before the due date of the subsequent provisional tax payment.

Grace period closure

The budget includes a proposal to close this grace period on the date of assessment of the relevant year. The proposal contains limited information. However, it appears to limit the time between the submission of the provisional tax returns and the actual payment of the provisional tax for the second period. More clarity will be obtained once the draft legislation has been published.

Withdrawal of withholding tax on service fees

The withholding tax on service fees provided for in Sections 51A to 51H of the Income Tax Act was expected to commence on January 1 2017.

It was envisaged that the local recipient of services would generally have to withhold 15% of the fee payable to the non-resident service provider (subject to the application of a relevant international tax treaty). Section 51B of the Income Tax Act, previously intended to be effective from January 1 2017, provides for a final withholding tax on service fees calculated at the rate of 15% of the amount of service fee that is paid to or for the benefit of a foreign party, provided that it has been received or accrued from a source within South Africa.


The budget proposes withdrawing the withholding tax on service fees from the Income Tax Act. The reason for the concession is that the introduction of the withholding tax has resulted in uncertainty regarding the application of domestic tax law and taxing rights under tax treaties. Accordingly, it is proposed that the withholding tax be included in the reportable arrangements provisions in the Tax Administration Act.

Interestingly, the proposal accords with Notice 140 in Government Gazette 39650, published by SARS on February 3 2016 regarding Section 35(2) of the Tax Administration Act (Notice), which lists an additional reportable arrangement that was not included in previous notices. The notice is largely aimed at non-resident service providers that physically provide services in South Africa to residents (or permanent establishments of non-residents), via individual non-residents sent to South Africa.

Foreign companies and collective investment schemes

Collective investment schemes (CISs), regulated by the CIS Control Act (45/2002), are schemes under which two or more investors pool their resources by investing in a company or trust for their joint benefit while sharing the risk and benefit of investment in proportion to their participatory interest in a portfolio.

In terms of the definition of 'person' in Section 1 of the Income Tax Act, each portfolio in a CIS is defined as a separate person for tax purposes. As such, CISs may hold shares in other companies, including foreign companies.

Anti-avoidance provision

Section 9D of the Income Tax Act is the anti-avoidance provision aimed at preventing South African residents from excluding tainted forms of taxable income from the South African tax net through investment into controlled foreign companies (CFCs). Specifically, Section 9D(2) of the Income Tax Act provides for an amount equal to the net income of a CFC to be included in the South African resident's income in proportion with the resident's participation rights in the total.

Since Section 9D of the Income Tax Act taxes South African owners of foreign-owned entities on amounts equal to those entities' earned income, it results in adverse consequences for CISs that hold shares in foreign CISs.

Proposed exclusion

As it is uncertain whether the local fund or the investor in the local fund should be considered to be the holder of the participation rights in the foreign CIS, the budget includes a proposal that CISs be excluded from applying Section 9D of the Income Tax Act to investments made in foreign companies.

For further information on this topic please contact Emil Brincker, Gigi Nyanin or Nicole Paulsen at Cliffe Dekker Hofmeyr by telephone (+27 11 290 7000) or email (emil.brincker@dlacdh.com, gigi.nyanin@cdhlegal.com or nicole.paulsen@cdhlegal.com). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.

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