When raising finance by way of preference shares, taxpayers are well aware of the risks posed by the anti-avoidance provisions of sections 8E and 8EA of the Income Tax Act ("the Act") and care is taken to ensure that preference shares which are typically issued to fund the purchase of share investments, do not fall foul of these provisions.

Section 8E is aimed at preference shares that are 'hybrid equity instruments', while section 8EA targets shares that are 'third-party backed shares'. If the preference shares meet the requirements of either of these provisions, any dividends declared and paid to their holders are deemed to be income for the full year of assessment in which they are so characterised (even if that status only applies for a portion of that year).

In relation to section 8EA, a 'third-party backed share' is in essence a preference share in respect of which, inter alia, an enforcement right is exercisable by the holder of the preference share as a result of any dividends or foreign dividends attributable to the shares not being received by or accruing to the person entitled thereto. An enforcement right includes any fixed or contingent right to require any person other than the issuer of the preference share to acquire the shares from the holder or to make any payment in respect of the share in terms of a guarantee, indemnity or similar arrangement or to procure, facilitate or assist with the aforegoing.

There is an important carve-out in section 8EA(3) of the Act which provides that where funds derived from the issue of a preference share were applied for a 'qualifying purpose', in determining whether an enforcement right is exercisable in respect of that share, no regard must be had to any arrangement in terms of which the enforcement right is exercisable, against certain specified persons.

A 'qualifying purpose' is defined in section 8EA(1) of the Act in relation to the application of the funds derived from the issue of a preference share, as one or more of the following purposes:

a) The direct or indirect acquisition of an equity share by any person in a company that is an operating company at the time of the receipt or accrual of any dividend or foreign dividend in respect of that preference share...

b) the partial or full settlement by any person of any—

i. debt incurred for one or more of the following purposes:

(aa) The direct or indirect acquisition of an equity share by any person in a company that is an operating company at the time of the receipt or accrual of any dividend or foreign dividend in respect of that preference share...

(bb) a direct or indirect acquisition or a redemption contemplated in paragraph (c);

(cc) ...; or

c) the direct or indirect acquisition by any person or a redemption by any person of any other preference share if –

ii. that other preference share was issued for any purpose contemplated in this definition; and...


The Taxation Laws Amendment Act 17 of 2023 ("TLAA") which was promulgated on 22 December 2023 amended section 8EA by the addition to subsection (3) of the following proviso:

"Provided that where an equity share in an operating company is acquired by any person as contemplated in paragraph (a) or (b) of the definition of ''qualifying purpose'' and the share so acquired is no longer held directly or indirectly by that person at the time of the receipt or accrual of that dividend or foreign dividend in respect of the preference share, this subsection must not apply, unless ..."

Therefore, in essence, it is now a requirement that the equity shares in the operating company which underpin the qualifying purpose requirement, must be held by the person that acquired same at the time that each dividend is received or accrue in respect of the relevant preference share.

It is important to note that this amendment came into operation on 1 January 2024 and applies in respect of any dividend or foreign dividend received or accrued during years of assessment commencing on or after the date. Specifically, the amendment does not only apply to 'new' preference shares issued after such date, but also applies to existing preference shares in issue.

One submission made in the Draft Response Document in respect of 2023 Draft Taxation Laws Amendment Bill, 2023 (which preceded the TLAA) was that "this new ownership requirement will affect many commercially driven transactions which is not intended to undermine the fiscus.... as there are various legitimate commercial reasons why a disposal or substitution of the equity shares held in an operating company should be allowed". This comment was only partially accepted and the final draft of the legislation now excludes from the new proviso two scenarios with limited application.

In particular, the application of this amendment to 'equity shares held in an operating company' which have been or are transferred between companies within the same group (for example in terms of a group rationalisation) will need to be carefully considered with reference to the wording of the proviso which requires that the operating company shares must be directly or indirectly held by the original purchaser of such shares.

Given the above, it is recommended that corporates that have existing preference share funding in place and which have in the past or intend to restructure the group's shareholding in the 'operating company', should consider how this amendment may impact such existing preference shares before implementing any such restructures. It should be noted that the preference share arrangements with financial institutions generally require the preference share issuer to gross up dividend payments where such dividends are re-characterised as income in terms of section 8EA, resulting in a potential increase in the funding costs for the issuer.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.