Draft Tax Amendment Bill 2011– The focus on preference shares as a means of funding

Next Moves?

The Draft Taxation Laws  Amendment Bill, 2011  proposes in essence that if a share is classified as debt in terms of financial accounting rules it should also be classified as debt for tax purposes. This is particularly evident in the treatment of preference shares.

These Anti-avoidance amendments are proposed in clauses 20 and 21.. Dividends on preference shares are generally not subject to income tax, but the proposed amendments will result in preference shares redeemable within ten years now becoming taxable as income, without a subsequent deduction. Treasury is of the opinion that guaranteed preference shares are ‘disguised’ as debt and so the dividends should be taxed.

Preference shares have often been  favoured with new companies as a convenient financing tool, and are often attractive to investors as well. Black Empowerment entities in particular, who are generally more reliant on preference shares as a means of funding are would be detrimentally affected if this amendment is passed into law in this form.

Deloitte holds the view that it is incorrect to equate preference shares funding with debt funding. Fundamentally a preference share is different to a debt instrument because of the rights and obligations it creates. Our tax law is rife with examples where accounting and tax diverge. It is highly inequitable to treat a dividend payment as a non-deductable expense from the perspective of the taxpayer, but as taxable interest in the hands of the preference shareholder.

Ordinary treatment for third-party backed shares and closure of various dividend schemes Further anti-avoidance proposals relate to dividends received  from shares, where the shares are ‘backed’ by third parties, through put or call options (including contingent puts). If the proposals become law, dividends from these transactions may be treated as ordinary revenue (with possible exemptions). These proposals suggest that  a shareholder should  hold a preference share for no less than  ten years if the form of the share is to be respected.

This proposal could potentially result in double taxation for the individual taxpayer. Deloitterecommends that if this proposal is to be pursued that a method be introduced that would allow the taxpayer to claim the dividend tax as a credit against the normal income tax payable. Deloitte suggests that a share only be a third party backed share if the right of disposal or guarantee is in place at the time the share is acquired by the taxpayer, or forms part of the acquisition.

Nazrien Kader is the Service Line Leader of Taxation Services  and  Lead Director of Financial Services Taxation at Deloitte South Africa.

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