The plot thickens

Finweek English Edition - - Communication & Technology -

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!

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