Executive summary

South Africa’s Minister of Finance introduced the Taxation Laws Amendment Bill¹ (2018 TLAB) into Parliament on 24 October 2018.² The 2018 TLAB sets out various amendments to the Income Tax Act including, inter alia, amendments to the interaction between the anti-dividend stripping rules and the corporate reorganization rules.

Based on the amendments, the dividend stripping rules will no longer override the corporate reorganization rules as of 1 January 2019. However, as summarized below, there is a period from 18 December 2017 through 31 December 2018 when this override remains in effect.

Detailed discussion

Background

Dividend stripping occurs when a resident shareholder company (that intends selling its shares in a target company) avoids tax by ensuring the target company declares a dividend (to that resident shareholder) prior to the sale of the target shares, thereby driving down the value of the target company. The dividend is exempt from income tax and dividends tax in the hands of the resident shareholder and any gain subject to capital gains tax (CGT) is reduced.

Section 22B of the Income Tax Act (in the case of shares held on revenue account) and paragraph 43A of the Eighth Schedule to the Income Tax Act (in the case of shares held on capital account) aim to discourage dividend stripping and are collectively referred to as the “anti-dividend stripping rules.”

In 2017, various amendments (effective 19 July 2017) were made to the Income Tax Act which strengthened the anti-dividend stripping rules.

Currently, the anti-dividend stripping rules apply where, inter alia:

• The person disposing of the shares is a company;
• The company held a “qualifying interest” in the other company at any time during the 18 months preceding the disposal of the shares; and
• An exempt dividend that constitutes an “extraordinary dividend” was received or accrued in respect of the shares disposed of.

A “qualifying interest” is defined as an interest held by a company in another company (whether alone or together with any connected persons in relation to that company) where:

• If that other company is not listed, it held at least 50% of the equity shares or voting rights in that other company, or it held at least 20% of the equity shares or voting rights if no other person (alone or together with any connected person) holds the majority of the equity shares or voting rights in that other company; or
• If that other company is listed, it held at least 10% of the equity shares or voting rights in that other company.

“Extraordinary dividend” means:

• In relation to a preference share where dividends are determined with reference to a rate of interest, so much of the amount of any dividend as exceeds an amount determined at a rate of 15%; and
• In relation to any other share, so much of any dividend received or accrued within a period of 18 months prior to the disposal of that share or in respect of, by reason of or in consequence of that disposal, as exceeds 15% of the higher of the market value of that share as at the beginning of the period of 18 months and as at the date of  the disposal of that share.

To the extent the exempt dividend constitutes an “extraordinary dividend,” that dividend must be taken into account as income (in accordance with Section 22B) or proceeds for capital gains tax (in accordance with paragraph 43A) arising from the disposal of the shares in the year of assessment that the shares are disposed of, or where the dividend is received or accrued after the year in which the shares are disposed of, in the year of assessment in which that dividend is received or accrues as part of the proceeds from the disposal of those shares.

In 2017, amendments (also effective 19 July 2017) were also made to the Income Tax Act which resulted in these anti-dividend stripping rules overriding the corporate reorganization rules (as contemplated in Section 41 to Section 47 of the Income Tax Act). As a result, legitimate corporate reorganization transactions have been adversely affected by these 2017 amendments.

Proposed amendments

The amendments to the Income Tax Act, as set out in the 2018 TLAB, include, inter alia, the reversal of the 2017 amendment which resulted in the anti-dividend stripping rules overriding the corporate reorganization rules.

The anti-dividend stripping rules will, however, still be triggered where the corporate reorganization rules are “abused” by taxpayers who use them with the intention of subsequently disposing of the shares (within 18 months of the corporate reorganization transaction) to unrelated purchasers outside of the realm of the corporate reorganization rules. In such a case, dividends received in respect of those shares (within a period of 18 months prior to the corporate reorganization transaction) by persons that are connected parties in relation to that company, will in terms of the new “claw-back” provisions inserted into Section 22B and paragraph 43A, be subject to the anti-dividend stripping rules. In summary, these “claw-back” provisions aim to prevent taxpayers interposing a corporate reorganization transaction to effectively strip dividends from a company whose shares are intended for disposal to an unrelated party.

It is important to note that the 2017 amendment which lead to the anti-dividend stripping rules overriding the corporate reorganization rules was made effective from 18 December 2017. The reversal of this amendment has, however, only been made effective from 1 January 2019. There is therefore approximately a resultant 12 months (i.e., 18 December 2017 to 31 December 2018) in which the anti-dividend stripping rules still in fact override the corporate reorganization rules. And, while this has been brought to the attention of Treasury, Treasury has stated³ that “At the time when these rules were proposed in 2017, it was intended that the anti-dividend stripping rules should override the corporate re-organisation rules. The 2018 proposed amendments are a change to the 2017 policy position and will as such have a future effective date of 1 January 2019.”

Consequently, taxpayers that have implemented or intend to implement corporate reorganization transactions during the affected period (i.e., 18 December 2017 to 31 December 2018) should be aware of the negative impact that the anti-dividend stripping rules may have on these transactions.

Endnotes

1. B38 -2018.

2. See EY Global Tax Alert, South Africa introduces tax amendment bills, dated 26 October 2018.

3. Refer to the “Draft Response Document on Taxation Laws Amendment Bill, 2018 and Tax Administration Laws Amendment Bill, 2018.”

For additional information with respect to this Alert, please contact the following:

Ernst & Young Advisory Services (Pty) Limited, Johannesburg

• Brigitte Keirby-Smith | brigitte.keirbysmith@za.ey.com

Ernst & Young Advisory Services (Pty) Limited, Durban

• Candice Van Den Berg | candice.vandenberg@za.ey.com

Ernst & Young LLP (United Kingdom), Pan African Tax Desk, London

• Rendani Neluvhalani | rendani.mabel.neluvhalani@uk.ey.com
• Byron Thomas | bthomas4@uk.ey.com

Ernst & Young LLP, Pan African Tax Desk, New York

• Dele A. Olaogun | dele.olaogun@ey.com

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