shareholder – Rust Gold

The 2019 tax legislation amendment cycle commenced on 25 June, when National Treasury issued the initial batch of the Draft Taxation Laws Amendment Bill which covers specific provisions that require further consultation. National Treasury will be publishing the full text of the 2019 Draft Taxation Laws Amendment Bill for public comment in mid-July 2019. One of the topics for amendment in the first batch deals with apparent abusive arrangements aimed at avoiding the anti-dividend stripping provisions.

Anti-avoidance rules dealing with dividend stripping were first introduced in 2009. Dividend stripping occurs when a shareholder company intending to divest from a target company avoids capital gains tax that would ordinarily arise on the sale of shares. This is achieved by the target company declaring a large dividend (to the shareholder company) before the sale of its shares to a prospective purchaser. This pre-sale dividend (normally exempt from dividends tax in the case of a company-to-company declaration) decreases the value of shares in the target company. As a result, the shareholder company sells the shares at a lower amount, avoiding the burden of capital gains tax in respect of the sale of shares.

In 2017 and 2018, several amendments were made to strengthen the anti-avoidance rules dealing with dividend stripping. Currently, certain exempt dividends (called extra-ordinary dividends), received by a shareholder company are treated as taxable proceeds in the hands of the shareholder company, as long as the shares in respect of which extra-ordinary dividends are received, are disposed of within a certain period, thereby eliminating the planning opportunities that dividend stripping presented.

National Treasury has indicated that it has come to Government’s attention that specific alleged abusive tax schemes aimed at circumventing the anti-avoidance rules dealing with dividend stripping arrangements are currently in the market. Essentially, a substantial dividend distribution by the target company to the shareholder company is done, combined with the issuance (by the target company) of its shares to the purchaser. The result is a dilution of the shareholder company’s effective interest in the shares of the target company that does not involve the disposal of those shares by the shareholder company. The shareholder company retains a negligible stake in the shares of the target company without triggering the current anti-avoidance rules.

In terms of the proposed amendments, the anti-avoidance rules will no longer apply only at the time when a shareholder company disposes of shares in a target company, as is currently the case. Furthermore, if a target company issues shares to another party and the market value of the shares held by the (current) shareholder company in the target company are reduced by reason of the shares issued by the target company, the shareholder company will be deemed to have disposed of and immediately reacquired its shares in the target company, thus creating value-shifting. This happens despite actual disposal not taking place, which could lead to adverse capital gains tax consequences.

It is expected that the proposed amendments, currently open for public comment, will be met with some severe criticism from the industry, especially since several legitimate BEE schemes could be impacted if the proposals are accepted as currently proposed.

This article is a general information sheet and should not be used or relied on as legal or other professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

We are often approached by clients to advise on the most tax efficient manner in which a shareholder can sell an investment in a private company. Typically, the parties involve a majority shareholder of a company that is interested in buying out the minority shareholders in the company and which will ensure that that majority shareholder becomes the single remaining shareholder of that company.

In essence, two options are available through which a shareholder may dispose of a share in a company to achieve the above goal: it could either sell its shares to the purchasing shareholder, or it could sell the shares owned back to the company (i.e. a so-called “share buyback”). These two different options have varying tax consequences, and taxpayers should take care that these (often material) transactions are structured in the most tax appropriate manner possible.

Where a share is sold to another shareholder, the selling shareholder will simply pay a capital gains tax related cost. For companies, such capital gains tax related cost will effectively be 22.4% of the gains realised, whereas the rate for trusts is 36% (if gains are not distributed to beneficiaries), or up to 18% if the seller is an individual.

Where shares are however sold back to the company whose shares are being traded, that share buyback constitutes a dividend for tax purposes (to the extent that contributed tax capital is not used to fund that repurchase). Capital gains tax is therefore no longer relevant, but rather the dividends tax. Dividends would typically attract dividends tax (levied at 20%), rather than capital gains taxes.

It may therefore be beneficial for an existing shareholder (that is itself a company) to opt for its shares to be sold back to the company whose shares are held (and which shares are therefore effectively cancelled), rather than to sell these to the remaining shareholders and pay capital gains tax. This is because if the shares are sold to the remaining shareholders, a 22.4% capital gains tax related cost arises. However, where the shares are bought back, the “dividend” received by the company will be exempt from dividends tax and therefore no dividends tax should arise, since SA resident companies are exempt from the dividends tax altogether. A company selling its shares back to the entity in which it held the shares may therefore dispose of its investment without paying any tax whatsoever: no capital gains are realised since the shareholder receives a “dividend” for tax purposes, and the dividend itself is also exempt from dividends tax.

Share buybacks have become a hot topic recently and National Treasury has now moved to introduce certain specific anti-avoidance measures and reporting requirements that apply in certain circumstances. Still, there are perfectly legitimate ways in which to structure many corporate restructures where a buyout of shareholders takes place, and taxpayers will be well-advised to seek professional advice to ensure that such transactions are structured in as tax effective manner as possible.

The 2019 Tax legislative amendment cycle kicks-off

Buying out shareholders