Safe and sound again
Still not a bad investment – despite tax on dividends
A MODICUM OF PEACE has once again descended on the preference share market. The fall in the prices of these shares after the Budget, in which the planned downscaling of secondary tax on companies (STC) and the introduction of 10% dividend tax was announced, has largely been wiped out. However, the reasons for the large and sudden 10%-15% decline in the prices of these shares in August last year remain a mystery.
Three of the big banks that make considerable use of preference shares for their primary capital requirements made special announcements during the past week about the future dividends and tax on the shares. Though all three had to leave the back door slightly ajar regarding how they were interpreting the draft legislation, the statement by Standard Bank, in particular, made it clear it was not intending to exploit the loopholes that could arise between STC and dividend tax to the detriment of investors.
The bank says: “It’s believed that an increase in the dividend rate on Standard Bank’s non-redeemable, non-cumulative preference shares to compensate for the new dividend tax would be consistent with the intention of the existing income tax adjustment clause in the company’s articles of association.”
What it’s saying is that it will be saving 10% on STC from October 2008, and that you, as an investor in the bank’s preference shares, will pay 10% tax on dividends. According to the existing prospectus of the preference shares, such a step is perhaps possible in technically legal terms.
However, the spirit of the agreement is that any saving to the benefit of the bank from the elimination of STC will be passed on to investors in preference shares. With this underwriting of the spirit of the agreement, rather than the technical terms, Standard has probably placed a moral obligation on all 13 other issuers of listed preference shares, and all will have to follow the same practice.
In brief, from October 2008 the issuer saves 10% in tax, and the investor pays 10% dividend tax. To correct this, the dividend will simply be increased 10% in rand, and the issuer will, in terms of the legislation, simply deduct 10% from it.
The future after-tax dividend on a preference share with a nominal value of R100 that pays 75% of prime will, at the current prime rate of 12,5%, still be 0,75 x 12,5 = 93,75, or R9,375, on your investment.
These shares are currently trading between R93 and R100, depending on the quality of the issuer. So it’s still possible to earn as much as 10% on these shares after all taxes, while it’s not very likely that the value of the shares will fall at all in the future. An after-tax return of 10% with an almost guaranteed capital is not a bad investment.