Companies that have been contemplating corporate restructuring or even black economic empowerment (BEE) transactions have been wary of proceeding because of looming anti-avoidance rules.
Proposed amendments to the rules regulating dividend stripping arrangements were announced in the February budget, with effect from budget day, with no further guidance.
Previously, when Treasury wanted to prevent avoidance with immediate effect, draft legislation was generally released with the announcement.
The current budget announcement is completely open-ended, creating risk for a number of otherwise probably innocent transactions, warns the South African Institute of Tax Professionals (Sait).
National Treasury has not responded to questions sent to it by Moneyweb on the matter. The practice Treasury has been trying to curb relates to dividend stripping in order to avoid taxation on share disposals.
Companies have achieved this by declaring large dividends to corporate shareholders prior to the sale of their shares, thereby diluting the value of the shares.
Last year’s changes introduced the concept of an “extraordinary dividend”.
This dividend must have been received within 18 months prior or as part of a share disposal arrangement. If the dividend exceeds 15% of the market value of the shares, the excess amount will be added to the proceeds for capital gains tax or income tax purposes when the share is sold.
However, Treasury is of the view that these adjusted rules are being undermined by some taxpayers.
In essence, Treasury has repeatedly wanted to target arrangements where a company (Company A) wants to sell its shares in an underlying company (Company B). The underlying company then declares a large dividend to the company holding its shares, and subsequently issue shares to third parties.
Adjustment not triggered
The effect is that the value of the shares of the underlying company is severely diluted, and is not disposed of immediately. Therefore it does not trigger the anti-avoidance adjustment.
David Warneke, head of tax technical at BDO, says it appears the wording in Annexure C of the Budget Review refers to arrangements where there is not an immediate disposal of the shares.
This is where BEE transactions may be affected. “Often BEE transactions rely on the declaration of a dividend by a company to extract the pre-existing value in the company in favour of the current corporate shareholders.”
This dilutes the value of the shares in the company and BEE shareholders can be introduced into the company, he says.
“This seems to be one of the transactions that can be hit by the proposal, and I do not know whether that was the intention,” says Warneke.
Introducing anti-avoidance measures to curb these transactions can interfere with BEE structuring in a fundamental way, he adds.
Mike Benetello, a tax executive at ENS Africa, says in the past mechanisms were legitimately used to reduce values in companies to allow for the entrance of BEE participants at full value.
Getting around the rule
Instances where the purchaser bought into a company after a large dividend was paid to the existing shareholder, with a percentage of the shares kept for 18 months, was obviously an arrangement to get around the 18-month disposal rule.
Contrast that with a BEE transaction where there is a 100% shareholder who wants to introduce a BEE partner at 30%. The options are to either reduce the value of the company and let the BEE partner come in at full value, or give the shares away for free. Needless to say, not everybody is willing to do that.
“When stripping the value in these transactions, it was not to avoid paying tax, but to introduce a BEE partner,” says Benetello. “I do think logic will prevail and when the draft legislation is put forward there may be a carve-out for BEE-type transactions. However, it will be difficult to do.”
Tertius Troost, senior tax consultant at Mazars, says the uncertainty about which transactions will be affected impacts on tax professionals’ ability to advise clients on transactions.
He gives the example of the owner of a small business who wants to bring a BEE partner into the business. The arrangement used quite often in the past was for the underlying company to declare a dividend equal to the value of the business to its corporate shareholder – this is done tax-free since a dividend between South African resident companies is exempt from dividend-withholding tax.
The dividend usually remains outstanding on loan account.
The new shareholder (BEE partner) can subsequently subscribe for shares in the company for a nominal amount, since the assets of the company will be equal to its liabilities.
Warneke says while it is understandable that Treasury wants to curb tax avoidance, it is unclear how it is going to draft legislation to give effect to the policy issue.
Sait CEO Keith Engel says the real problem is that many technical ‘tax’ dividends are, in reality, capital distributions.
“The current elective system means that taxpayers can freely choose the desired outcome even if that outcome does not comport with reality.”
Other legislation, such as BEE, pushes taxpayers into transactions that lack normal commercial reality solely to satisfy other non-tax regulatory objectives.
“While it is widely accepted that Treasury should not provide incentives for BEE, tax should not be imposed as an added hurdle,” says Engel.