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More clarity on dividend-stripping rules expected in July

Tax institute says ‘open-ended’ amendments create risk for innocent transactions.

The exact scope of proposed changes to the rules regulating dividend-stripping arrangements will be included in the Draft Taxation Laws Amendment Bill in mid-July.

However, the amendments will be effective retrospectively from February 20, the date the proposed changes were announced in the annual budget, according to National Treasury.

In response to concerns about the lack of clarity surrounding the proposed retrospective amendments, Treasury said they are aimed at structures that are currently undermining the existing tax rules that were strengthened in 2017 and in 2018.

Read: Legitimate transactions caught in anti-avoidance rules

These rules were “aimed at curbing the abuse in respect of arrangements that involve the target company distributing a substantial dividend to its current company shareholder and subsequently issuing shares to a third party”.

“As a result, the value of the current company shareholder’s holding in the shares of the target company is diluted and these shares are not immediately disposed of.”

This response echoes the wording of the proposal in Annexure C of the 2019 Budget Review.

The South African Institute of Tax Professionals (Sait) calls it “completely open-ended”, which creates risks for a number of probably innocent transactions.

Kyle Mandy, head of tax technical at PwC, says that if transactions are caught it will be costlier than expected because of the deemed tax event, and there may – in principle – even be interest because of the late payment of the tax.

He says there are currently ways of diluting shareholding without attracting tax. “I assume this is what is of concern to treasury,” he says.

However, to “curb” this will require substantial changes to the existing rules since there will have to be a deemed tax event, which is not currently catered for in the legislation.

Public comments

Treasury says that once the Draft Taxation Laws Amendment Bill has been published, there will be time for public comments and the standing committee on finance will convene public hearings before the bill is introduced in parliament.

Treasury and the South African Revenue Service (Sars) will also invite written comments on the draft bill and hold workshops in August – and in September a response document will be presented to the standing committee.

The bill will be revised (to take public comments into account) before going through the parliamentary process.

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.

Exploitation

“Despite government’s efforts to curb the avoidance schemes, some aggressive taxpayers and tax advisors are exploiting the manner in which these new rules – developed in 2017 and 2018 – apply,” Treasury said. 

“The minister of finance reserves the right to take urgent steps to close down this new form of abuse.”

David Warneke, head of tax technical at BDO, said it is standard practice for legislation to undergo a public consultation process.

The announcement in the budget speech in February that the amendments would be effective from the same day without a clear statement as to the exact scope of the proposals is “unsatisfactory” as a result of the uncertainty it has created.

Announcement without clarity 

“In my view, if amendments are to be effective from the date of the announcement, a draft of the proposed amendments should be released at the same time.”

He says there is no clarity on whether the proposed amendments will not apply if shares in the company are subsequently issued to a “connected person” instead of a third party.

Warneke says it is also unclear whether the wording “not immediately disposed of” implies that shares in the company must be disposed of in order to trigger the new provisions. It is also unclear whether the provisions on black economic empowerment (BEE) transactions have been considered.

“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 arrangement seems to be one of the transactions that can be hit by the proposal.

Mandy cautions companies to be aware of the risk that their transactions might be impacted by these retrospective amendments.

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