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South Africa: Legislation to extend dividend stripping provisions

South Africa: Legislation to extend dividend stripping

A bill—the Taxation Laws Amendment Bill—would extend “dividend stripping” provisions to situations when extraordinary dividends are declared on or after 20 February 2019 and are followed by a dilution of a corporate shareholding.

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Current requirements under dividend stripping provisions

Under current law, there are specific anti-avoidance provisions targeting transactions when corporate shareholders attempt to avoid paying income tax or capital gains tax on the sale of shares by extracting value from a target company via tax-free dividends prior to or as part of the disposal of the shares in that company.

The current dividend stripping provisions have four basic requirements:

  • Dividends, whether domestic or foreign, received by the shareholder must be exempt from both “normal” tax and dividend withholding tax (for this reason, the new provisions would primarily affect corporate shareholders of resident companies).
  • The shareholder must hold a “qualifying interest” in the target company. This interest can be held alone or in conjunction with connected persons. The threshold differs between listed companies (10%) and unlisted companies (50% or 20% if no one shareholder holds a majority interest) and can be held at any time during the 18 months prior to the disposal event. Shareholders with a qualifying interest are seen as having an element of control over the company and thus have the ability to influence the manner in which their exit is structured.
  • The shareholder must have received an extraordinary dividend from the target company.
    • In the context of preference shares, this is the dividend amount in excess of a 15% per annum coupon rate.
    • For ordinary “equity” shares, this requires a dividend received or accrued within a period of 18 months prior to disposal of the shares and is the amount of the dividend in excess of 15% of the market value of the share (calculated based on the higher of the value at the beginning of the 18-month period or on disposal date).
  • The shareholder must dispose of the shares in the target company within a period of 18 months of receiving the extraordinary dividend pursuant to a transaction that is not a tax roll-over relief transaction (unless a certain exception applies). The dividend and disposal can be structured as two separate events or can be pursuant to a share buy-back or redemption.

When all four requirements are met, the dividend stripping provisions apply with regard to the extraordinary dividend as proceeds on disposal of the share in the hands of the corporate shareholder, and tax is imposed on the amount at either the income tax or capital gains tax rates.


Proposal for deemed disposals

The bill proposes that dividend stripping provisions would be triggered when the effective interest of a shareholder in the “equity shares” of a target company is diluted through the issue of new shares by that target company to a third party. New shares in the form of convertible shares would be regarded as “equity shares.”

There are requirements of the current dividend stripping provisions that are retained—specifically, (1) the requirement that the shareholder must have held a qualifying interest prior to the event; and (2) the requirement that the shareholder must have received a tax-exempt and extraordinary dividend within 18 months prior to the event. Therefore, deemed disposal provisions would apply only in circumstances when shareholders, that have an element of control over a company, extract value via an otherwise tax-free equity share dividend and within 18 months thereof dilute their equity share interest. When triggered, the shareholders would be deemed to dispose of a percentage of the equity shares held, in an amount equivalent to the percentage reduction in the shareholders’ effective interest.

In calculating the taxable gain on the deemed disposal of the shares, no cost would be allocated to the shares deemed to have been disposed. If the shareholders actually dispose of those same shares within 18 months of the extraordinary dividend having been received, the amount of the extraordinary dividend taxed on disposal would be reduced by any amounts already taxed on account of the deemed disposal.

The amendment would affect dividends declared on or after 20 February 2019 (the date on which the intention to introduce additional anti-avoidance provisions were announced).


Dividends “in specie”

The bill also introduces a change to the definition of “extraordinary dividend.” Dividends “in specie” arising from certain tax rollover relief transactions (known as unbundling transactions and liquidation transactions) would not be regarded as extraordinary dividends.

Read an October 2019 report [PDF 129 KB] prepared by the KPMG member firm in South Africa

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