Safe and sound again

Still not a bad in­vest­ment – de­spite tax on div­i­dends

Finweek English Edition - - Companies & markets - VIC DE KLERK

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.

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