Treasury softens sledgehammer approach to taxing share buybacks
BUSINESSLIVE / 28 OCTOBER 2017 - 08:38 / AMANDA VISSER
Provisions to curb the abuse of corporate share buyback transactions to avoid paying capital gains tax have been relaxed.
However, the days of tax-free share buyback arrangements largely remain a thing of the past. These transactions by South African companies will in future attract the same tax treatment as ordinary share sales to third parties.
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The initial provisions in the draft Taxation Laws Amendment Bill, published in July, were described as "overzealous and "too far-reaching".
Following the initial publication, Treasury has invited comments and held workshops on the issue. Many of the comments have been taken into account in the drafting of the latest set of proposals.
In the initial draft all dividends received by a company within 18 months prior to the sale of shares would have been re-characterised as proceeds for capital gains tax purposes. There was no distinction between ordinary dividends and dividends relating to a sale. This sledgehammer approach has now been softened.
Emil Brincker, head of Cliffe Dekker Hofmeyr’s tax practice, explains where all of this started.
He says concerns about the abuse of corporate share buyback arrangements were raised when there was a notable increase in these types of arrangements.
It became common practice when the dividend tax rate increased from 15% to 20%.
In a normal transaction, where a company sells its shares in another company to a third party, the selling company will pay capital gains tax of 22.4% on the proceeds of the sale.
"Instead of entering into a direct sale agreement with the buyer, the parties restructure the transaction so that the buyer subscribes for shares in the company (in which the seller has shares). The subscription price of the shares is equal to the purchase price he would have paid."
This means the seller and buyer are now both shareholders in the company. The seller of the shares sells its own shares back to the company rather than directly to the buyer.
In this scenario the proceeds from the sale constitute a dividend, which is exempt from tax. So the seller has avoided paying capital gains tax on the proceeds.
The provisions specifically target resident South African companies, because of the dividend exemption.
The abuse did not involve the sale of shares by individuals.
In terms of the new relaxed rules, Treasury has built in some "threshold tests" to ensure "innocent shareholders" are not caught in the net.
Brian Dennehy, a member of the South African Institute of Tax Professionals (SAIT) business tax work group, says Treasury has now considered an "extraordinary dividend" concept.
It has built in a 15% threshold rule. If the dividend received in a share buyback arrangement exceeds 15% of the market value of the shares at specified dates, that amount will be added to the proceeds for capital gains tax.
"That is a more equitable position. It is quite unusual to have a dividend yield on any share over and above that percentage. Most listed shares are nowhere near a 15% yield," says Dennehy, who is also a director at Webber Wentzel.
In the initial draft the dividend would have been reclassified as proceeds and taxed in full at 22.4%.
Treasury has also considered concerns about preference shares inadvertently caught in the share buyback avoidance proposals. These shares entitle the holder to a fixed dividend.
Treasury accepted that "bank-funded preference shares" should not be included in these provisions.
Brincker says a second test has also been built in to ensure that real minority interests (especially black economic empowerment shareholders) will be excluded from the provisions.
If a company holds less than 10% of the shares in a listed company, the provisions will not apply. In unlisted companies (private or public) the provisions will apply if the company holds a minimum of 50% of the shares in the company, or 20% if no one has a majority stake.
The bottom line is that whether a company enters into a share buyback or a direct sale, the tax consequence will in future be exactly the same. Share buybacks will be much less attractive since the tax benefit by restructuring the transaction will now fall away.
A positive amendment since the initial draft is that the provisions will not apply retrospectively. If the share buyback agreement was concluded before July 19, but there are still some regulatory approvals necessary, the provisions will not apply.
Only transactions concluded after July 19 will be caught in the net.
Dennehy expressed disappointed, though, that distributions in specie have not been carved out.
If a company distributes a dividend in specie to its corporate shareholders, it may lead to double taxation. The same economic value will be taxed twice — once in the shareholder’s hands and once in the company’s hands.
LINK - https://www.businesslive.co.za/bd/business-and-economy/2017-10-28-treasury-softens-sledgehammer-approach-to-taxing-share-buybacks/
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