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In terms of section 8E of the Income Tax Act, 58 of 1962
("the Act"), dividends declared in respect of shares with
certain characteristics are deemed to be interest in the hands of
the recipient. The effect of the provisions of section 8E is that,
while the recipient is taxed on the deemed interest received, the
company may not deduct the payment of the dividend from its taxable
income. This section is essentially an anti-avoidance section,
which was introduced to ensure that debt is not disguised as
equity.
Section 8E provides that any dividend declared by a company on a
"hybrid equity instrument" will be deemed, in
relation to the recipient only, to be an amount of interest
received by him from a source within South Africa.
The term "hybrid equity instrument" is
defined in section 8E as:
any redeemable preference share where:
the company is obliged to redeem the share in whole or in part
within a period of three years from the date of issue; or
the holder has an option to require the company to redeem the
share in whole or in part within a period of three years from the
date of issue; or
the holder has a right of disposal which may be exercised
within three years from the date of issue;
any other share if:
the holder has a right of disposal in respect of such share
which may be exercised within a period of three years from the date
of issue of such share or, at the time of issue the issuing company
will be or is likely to be terminated within three years, and:
such share does not rank pari passu as regards its
participation in dividends with all other ordinary shares in the
capital of the company, or where the ordinary shares are divided
into two or more classes, with the shares of at least one of such
classes; or any dividend payable on such share is to be calculated
by reference to:
any specified rate of interest; or
the amount of capital subscribed for such share, or
the amount of any loan or advance made directly or indirectly
by the shareholder or any connected person in relation to the
shareholder.
The Taxation Laws Amendment Bill No. 19 of 2011 ("the
TLAB") which was released by National Treasury on 25 October
2011 contained a change to the definition of "hybrid
equity instrument" in section 8E, in terms of which the
definition of "hybrid equity instrument", is
expanded, with effect from 1 April 2012, to include:
any share if:
any dividend or foreign dividend payable on such share is to be
calculated directly or indirectly with reference to any specified
rate of interest or the amount of capital subscribed for such
share; and
such share is directly or indirectly secured by a financial
instrument other than an equity share.
This new definition of a hybrid equity instrument will apply
without regard to the three-year period and accordingly, where any
share meets the requirements set out above, such share will be
regarded as a hybrid equity instrument and the dividends received
by the holder of such share on or after 1 April 2012 will be
regarded as interest.
In terms of the Explanatory Memorandum to the TLAB, the reason
for the expansion of the current "hybrid equity
instrument" definition is because the current tax
legislation which seeks to avoid equity funding operating like debt
has largely been ineffective.
In terms of the current legislation, the key impermissible debt
features, such as the compulsory redemption by the company and the
optional redemption by the redeemable preference shareholders
within a period of three years from the date of issue of the
redeemable preference shares, can be avoided by simply extending
the period for the compulsory/optional redemption beyond a three
year period.
Accordingly it is important for companies which have issued
shares to evaluate as to whether the shares issued meet the
requirements of the new definition of a hybrid equity instrument
set out above, in order to avoid its shareholders becoming subject
to tax on any dividends received on or after 1 April 2012.
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