This article delves into the National Treasury’s proposal to address abusive arrangements aimed at avoiding the anti-dividend stripping provisions in the Income Tax Act (58/1962). It first discusses the history of the amendments, followed by the anti-dividend stripping provisions and thereafter a brief discussion of the National Treasury’s proposal in the 2019 Budget.
In 2017 the National Treasury amended Section 22B of the Income Tax Act and Paragraph 43A of the Eighth Schedule to the act by completely replacing the previous Section 22B and Paragraph 43A. These amendments attempted to address the abuse whereby share buy-back transactions were concluded by companies wishing to dispose of their shares in another company. Before the introduction of Paragraph 43A and Section 22B, companies could dispose of their shares in another company (target) by having their shares bought back by the target and the target then issuing shares to the new shareholder. This would result in no dividends tax or capital gains tax being payable on the disposal.
In some instances, companies would arrange for the target to declare a tax-exempt dividend, which would reduce the value of the selling company’s shares so that when the shares were disposed of the seller’s capital gains tax liability would also be reduced.
Pursuant to the 2017 amendments, if a company sold its shares in one of the ways set out above, the portion of the dividend that exceeded 15% of the market value of the share (ie, the extraordinary dividend) would be added to the proceeds from the share sale, which would likely increase the seller’s capital gains tax liability. The only way to avoid this under Section 22B and Paragraph 43A was if the seller holds the shares for at least 18 months after the dividend has been declared.
At the time, Section 22B and Paragraph 43A were also made to trump the corporate rollover relief provisions in Section 41 to Section 47 of the act.
In 2018 the National Treasury amended Section 22B and Paragraph 43A to address the unintended consequences that arose from the 2017 amendments. In particular, where shares were disposed of in terms of the corporate rollover relief provisions after a dividend had been declared to a company, the corporate rollover relief would not assist the company disposing of the shares as intended, but would instead trigger a capital gain for the company disposing of shares in terms of a corporate rollover relief provision.
The National Treasury then decided to amend Section 22B and Paragraph 43A to address this unintended consequence so that parties could benefit from the corporate rollover relief provisions when disposing of shares after receiving a dividend by virtue of their shareholding. However, the National Treasury also inserted provisions in Section 22B and Paragraph 43A that would prevent tax avoidance so that companies making use of the corporate rollover relief provisions could not avoid the application of Section 22B or Paragraph 43A. Within the context of Section 22B and Paragraph 43A, transactions concluded in terms of the corporate rollover relief provisions are referred to as deferral transactions. One of the ways in which the National Treasury tried to prevent avoidance of Section 22B and Paragraph 43A through a deferral transaction was by inserting a provision stating that:
where a company disposes of shares in terms of a deferral transaction (disposing company), after having acquired those shares in terms of a deferral transaction, other than an unbundling transaction in terms of s46 of the Act; and within 18 months prior to the disposal, an exempt dividend in respect of those shares accrued to or was received by a person that disposed of the shares in terms of a deferral transaction, who was also a connected person in relation to the disposing company within that period.
As such, that dividend must, for purposes of Section 22B or Paragraph 43A, be treated as a dividend that accrued to or was received by the disposing company for those shares within the period during which the disposing company held those shares.
Therefore, where the disposing company acquired shares in terms of a deferral transaction, it could avoid the application of Section 22B or Paragraph 43A only if:
- it held the shares for at least 18 months after acquiring the shares; or
- the disposing company and the company from which it acquired the shares in terms of a deferral transaction were not connected persons during the 18-month period.
Proposal in 2019 Budget
In the 2019 Budget, the National Treasury notes that some taxpayers are trying to avoid the adjusted rules in Section 22B and Paragraph 43A. According to the National Treasury, some taxpayers are now putting arrangements in place whereby the target (ie, the company in which the shares are held) distributes a substantial dividend to its current company shareholder and thereafter issues shares to a third party. As a result, the value of the current company shareholder’s holding in the shares of the target is diluted and these shares are not immediately disposed of. According to the National Treasury, this differs from the previous avoidance arrangements that involved disposing of the same shares in return for a tax-exempt dividend.
This scheme appears to be similar to some of the avoidance schemes that were implemented before the 2017 amendments came into effect. The difference is that the target will not buy back the shares from its current shareholder, followed by a share issue to a new shareholder, as this would likely trigger the application of Section 22B or Paragraph 43A. Instead, the current company shareholder will receive a substantial dividend that is exempt from dividends tax, following which the new shareholder subscribes for shares in the target, which would dilute the current company shareholder’s interest in the target significantly. When the current company shareholder disposes of its remaining interest in the target more than 18 months after receiving the dividend, its capital gains tax liability will be less than it would have been had it simply sold the shares to the new shareholder. Where the transaction is implemented in this manner, Paragraph 43A and Section 22B will not apply.
The National Treasury is clearly intent on preventing tax avoidance through any scheme involving share buy-backs and dividend stripping. It will be interesting to see how the proposed amendment reads. As the proposed amendments have applied since 20 January 2019, any taxpayer implementing the schemes that the National Treasury will try to address through the proposed amendments after this date will be caught by this provision.