A proposed amendment in the 2017 South African Taxation Laws Amendment Bill (TLAB) which has a lot of people talking, is the amendment to regulations around share buy-back transactions.
The share buy-back process typically involves a new shareholder subscribing for shares in one company, after which that company buys back the shares, structured as a tax exempt dividend, from another shareholder, and as a result no Capital Gains Tax (CGT) is paid. Ordinarily if these shares were sold, it would have triggered CGT, and the share buy-back process is thus a way to get around paying CGT.
In the 2017 Budget Speech, mention was made that legislation would be drafted to close this tax avoidance loophole. The new legislation addresses the loophole by changing the dividend stripping rules. The entire section on dividend stripping rules in the TLAB is to be replaced, and three tests have been imposed.
The first test is the disposal test - a company must be disposing of its shares in another company. Notably, this refers to any disposal and not just share buy-backs.
The second test is the qualifying interest test - the disposer must at any time during 18 months prior to the disposal, held either (1) 50% of equity shares or voting rights or (2) 20% of equity shares or voting rights if no other person holds the majority of the equity or voting rights in that other company.
The third test is the dividend test and looks for a dividend accruing to the disposer, either within eighteen months before that disposal or as a result of that disposal. This is the only part of the draft legislation where you see the share buy-back terminology coming into play.
What this means is that the proposed legislation is about much more than a subscription or buy-back transaction. If, for example, a company holds more than 50% of the shares in another company and it sells its shares, and within eighteen months before that sale dividends were declared, then those dividends could, in terms of the proposed legislation, be interpreted to be part of the proceeds of that sale and, thus, increasing the CGT liability. Similarly, you get companies where you have one shareholder who would like to reduce its shareholding through a buy-back and that will now, as a result of this provision, automatically be deemed to be capital proceeds and subject to CGT. This was not intended by what was said in the 2017 Budget Speech. We believe that what National Treasury said and what is reflected in these changes are two different things, and there needs to be some sort of narrowing of this legislation to ensure that it's correctly applied.
Another controversial section of the TLAB is that from the first of March 2017, an ongoing, and annual donation tax liability is triggered whenever interest-free loans are advanced directly or indirectly by a natural person to a connected trust. It has been suggested that taxpayers are avoiding the deemed annual donation tax by either advancing interest-free loans to companies whose shares are held by trusts, as opposed to advancing the interest-free loan directly to the trust, or by entering into an arrangement whereby the loan claim of the natural person is transferred to another natural person, arguably breaking the link between the natural person and the loan advanced.
To curb these suspected anti-avoidance schemes, it has been proposed that interest-free loans that are made to a company that is a connected person to a trust will fall within the anti-avoidance measure and be regarded as a deemed annual donation. Furthermore, if a connected person in relation to a trust acquires a loan claim to an amount owing by the trust, the person who acquired the claim will be deemed to have advanced the amount of that claim as a loan on the date such person acquired the claim.
These additional measures will be implemented to counter the perceived abuse, and I think that the intention behind the legislation is valid. However, this provision could have unintended consequences for legitimate transactions involving trusts.
However, if you scrutinise these provisions it is clear they will not only apply to connected persons but to anyone - a much wider application than I think is intended. It points to a mismatch between what is intended and the proposed legislation, which should be addressed.