The plot thickens
I WELCOMED the replacement (from late 2009) of the current secondary tax on companies (STC) regime with a dividend withholding tax (DWT) in the Finweek issue of 19 September this year. Under current law a company distributing a dividend will ordinarily have to pay STC at a rate of 10%. Under the new law STC will be replaced with a DWT tax, also at a rate of 10%.
One reason I welcomed the change was that it’s to be accompanied by a simpler definition of what does, or does not, constitute a “dividend” for tax purposes. The current definition of a “dividend” in South Africa’s Income Tax Act is horrendously complex. The problem is that what is or is not a “dividend” for tax purposes is at odds with the notion of a dividend under company law.
Establishing whether a distribution made by a company to its shareholders is a dividend is simplicity itself under company law. A distribution made by a company out of profits (whether revenue or capital profits) will be a dividend, save to the extent it represents a distribution of share capital or share premium reserves.
The simple approach adopted under company law is to be contrasted with the approach under the Income Tax Act. First, the Income Tax Act complicates matters by sometimes treating a distribution of share premium as a dividend. That happens if share premium reserves are distributed to shareholders who hold shares of a class different to the class of shares in respect of which the premium had been raised. It will also do so where the premium is distributed to shareholders holding shares in respect of which the premium was raised but the distri- butions aren’t made in ratio to the premium raised in respect of each of the shares.
That complication – sometimes treating a distribution of share premium as a dividend – is to be perpetuated under the new DWT system. What will hopefully not be perpetuated is another, and more wayward, aspect of the current STC regime, where a partial exemption from STC may be claimed where a company makes a distribution in contemplation of its deregistration or liquidation. If the distribution is attributable to a disposal on or after 1 October 2001of assets acquired before that date,the exempt amount will tally with the market value of such assets on 1 October 2001.
So much for the good news: a partial exemption from STC. The bad news is that there’s an awkward interaction between the STC exemption and capital gains tax (CGT). Notwithstanding, the STC exemption was extended in respect of a dividend, for CGT purposes the STC-exempt amount will be treated as a “capital distribution”.
Beyond that point the plot thickens. That capital distribution will, under the CGT regime, be taken to be “proceeds” in respect of a deemed disposal of the shares in the company that effected the STCexempt distribution. The shareholders may, accordingly, face CGT liabilities.
There’s something wayward in a system that treats a dividend (which is income) as capital, he says.
But that isn’t the most wayward aspect of the current STC regime. There’s a more sophisticated trap buried in the current definition of a “dividend”. If a company succeeds in taking over another company, a subsequent distribution by the “target” company to the “raider” (in the same group) may be treated not as a dividend but as a capital distribution. That will happen if the target company effects a distribution of profits to the raider and those profits were accumulated before the takeover.
Such “capital distributions” of pre-acquisition profits will also, for CGT purposes, be taken to be proceeds in respect of the deemed disposal of the shares in the target company.
Accordingly, there are marked differences between what’s treated as a dividend and what’s treated as a capital distribution for company law and tax purposes. Because those differences are counter-intuitive they represent traps not only for young players but even for veteran advisers.
The draft definition of a “dividend” that’s to apply from the inception of the new DWT regime mercifully makes no reference to a distribution of pre-acquisition profits. It also appears that none of the wide-ranging exemptions from DWT would lead to the exempt amount being treated not as a dividend but as a capital distribution with consequent CGT effects.
But watch this space!