Overly zealous closure of share buyback ‘loophole’
By Patricia Williams, Bowmans, member of SAICA Tax Administration Act sub-committee and SAIT Tax Administration Act sub-committee
South African companies disposing of shares may feel the pain of overly zealous tax proposals released on 19 July 2017. These proposals are for shares held as capital assets.
SARS became concerned about a perceived “loophole” in relation to share buyback and issue transactions, identifying certain share buyback and issue transactions as “reportable arrangements” for tax purposes in 2015.
This structure was potentially tax advantageous for South African companies exiting or reducing investment in another South African company. In the case of a share sale, the seller would ordinarily be subject to capital gains tax (CGT), currently at 22.4% for companies. A share buyback, on the other hand, could be done as a dividend for tax purposes, resulting in an exempt dividend if the recipient is a South African company. Share buybacks have become a common transaction mechanism in South Africa.
In the 2016 Budget Review, the Minister of Finance indicated that “the wide-spread use of [share buyback] arrangements merits a review to determine if additional countermeasures are required”. The 2017 Budget then proposed that specific legislative countermeasures be introduced to curb the use of share buyback arrangements.
The 2017 Draft Taxation Laws Amendment Bill, issued on 19 July 2017, introduces tax proposals for “addressing circumvention of anti-avoidance rules dealing with share buybacks and dividend stripping”. However, these proposals extend far beyond share buyback and issue transactions. As such, South African companies disposing of shares (in any manner) may feel the pain.
Who isn’t affected?
The proposals deal with a taxpayer that is a company with a direct or indirect interest (individually or with connected persons) in another company, of at least 50% of the equity shares or voting rights, or 20% of the equity shares or voting rights if no other person holds majority equity shares or voting rights. This means that minority shareholders below this threshold, and non-corporate entities, would not be directly affected.
The proposal in brief
If a shareholder that is a company disposes of shares, and held the necessary qualifying interest (discussed above) at any time in the preceding 18 months, then any exempt dividend received by the shareholder in relation to the shares disposed of, at any time in the preceding 18 months, or in respect of, by reason or in consequence of that disposal, must be treated as CGT proceeds.
What are the key problems with the proposal?
- This anti-avoidance proposal would apply to all disposals, and not only share buyback transactions. In many instances, companies declare cash dividends regularly, from after-tax profits, for example every six months. In this type of scenario, an exiting shareholder selling its shares as a normal share sale, would be subject to CGT on the last three dividends received, even though these were declared out of after-tax profits, in the normal course of events, and were entirely unrelated to the later share sale. This shareholder would then still be subject to dividends tax on the net (after tax) proceeds from the share disposal. The income tax on the underlying company, CGT on the shareholder and the dividends tax on distributing the sales proceeds, would result in an effective tax rate of 55.3% on the affected dividend amounts. In the normal course of events, the effective tax rate should be 42.4% (recently increased from 38.8% when the dividends tax rate was increased from 15% to 20% in February 2017). This represents a massive increase in tax, where the underlying taxpayer was not engaging in any “mischief” that needs addressing.
- Retrospective effect of proposals. The proposed effective date given in the Draft Taxation Laws Amendment Bill is 19 July 2017, “in respect of any disposal on or after that date”. This means that, where a legal agreement has already been concluded, but the relevant conditions precedent have not yet been fulfilled, the “disposal” would only occur after 19 July 2017, and the transaction would be “caught” by the new provisions. This is the case notwithstanding the fact that the relevant taxpayer is already legally bound by a signed agreement, and had no knowledge of what the proposals would have been, nor any opportunity to consider the impact on the transaction. It is a well-known fact that various transactions in South Africa would be subject to conditions precedent such as exchange control approval or competition commission approval. The wording of the effective date therefore necessarily results in retrospective effect, which undermines tax certainty.
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