In 2017 the Income Tax Act (58/1962) was amended to strengthen the anti-avoidance rules regarding dividend stripping. The Explanatory Memorandum on the Taxation Laws Amendment Bill states that these anti-avoidance rules were initially introduced in 2009 to curb the use of dividend stripping structures, whereby a resident shareholder company could avoid income tax (including capital gains tax) on the sale of shares by ensuring that the target declared a large pre-sale dividend to it. This dividend would be exempt from dividends tax and would result in the shares being sold at a lower price.
Following the 2017 amendments, exempt dividends that arise in the manner above can now constitute extraordinary dividends if the resident shareholder company sells the shares in respect of which it received the dividends within 18 months. To the extent that the exempt dividends constitute 'extraordinary dividends' – as defined in Section 22B of the act and Paragraph 43A of the Eighth Schedule thereto – such dividends are treated as income or proceeds received from the disposal of those shares.
In addition, amendments were made so that the corporate reorganisation rules in the act are now subject to these anti-avoidance rules regarding dividend stripping.
The Explanatory Memorandum on the Taxation Laws Amendment Bill notes that it has come to the government's attention that the 2017 amendments providing that the anti-avoidance rules on dividend stripping override the corporate reorganisation rules may affect some legitimate transactions. As such, a number of amendments have been proposed to remedy this issue.
Corporate reorganisation rules no longer overridden
To ensure that the anti-avoidance rules regarding dividend stripping do not affect legitimate transactions, the National Treasury has proposed that they should no longer override the corporate reorganisation rules. Instead, the anti-avoidance rules should be triggered only when the corporate reorganisation rules are abused by taxpayers to subsequently dispose of their shares to unrelated purchasers, outside the realm of the reorganisation rules.
Introduction of deferral transaction
To address instances in which taxpayers use the corporate reorganisation rules to subsequently dispose of their shares to unrelated purchasers outside the realm of the rules, amendments have been proposed to clarify the timing of the trigger of the anti-avoidance rules regarding dividend stripping. To achieve this, it has been proposed that the term 'deferral transaction' be introduced under the anti-avoidance rules regarding dividend stripping. This term will be defined to mean transactions in respect of which the corporate reorganisation provisions in the act apply.
Where a disposal does not take place as part of a deferral transaction and a resident company receives an extraordinary dividend within 18 months or as a consequence of that disposal, the extraordinary dividend amount must be added to the income or proceeds from the disposal in the disposal's assessment year. However, if the dividend that qualifies as an extraordinary dividend is received by or accrues to the resident company in a subsequent assessment year, it must be considered to determine the resident company's tax liability in that subsequent assessment year.
Application of dividend stripping rules
As stated above, where a resident company disposes of shares that it holds in another company as part of a deferral transaction, the anti-avoidance rules regarding dividend stripping will not immediately be triggered. However, the Explanatory Memorandum on the Taxation Laws Amendment Bill states that specific clawback rules should apply to exempt dividends received or accrued in respect of those shares or others acquired in exchange for those shares in respect of which such exempt dividends were received or accrued within 18 months of their acquisition. The purpose is for these clawback rules to apply at the time when such shares are subsequently disposed of in a transaction that is not a deferral transaction within 18 months of their acquisition. Without going into detail, the memorandum sets out two scenarios in this regard.
Scenario 1 In the first scenario, exempt dividends are received by or accrued to a resident company in respect of certain shares 18 months before a deferral transaction and those shares are disposed of to another resident company as part of the deferral transaction.
In such scenario, if these companies were connected persons immediately after the deferral transaction and the other resident company disposes of the shares within 18 months thereafter, outside of a deferral transaction, the other resident company will be deemed to have received or accrued the exempt dividends that were received by or accrued to the resident company from these shares.
Scenario 2 In the second scenario, exempt dividends are received by or accrued to a resident company in respect of certain shares 18 months before the deferral transaction and a company acquires other shares in exchange for shares disposed of as part of the deferral transaction.
In such scenario, if a company disposes of the other shares within 18 months of the deferral transaction, the exempt dividends that were previously received by or accrued to the resident company for shares disposed of under the deferral transaction will be deemed to have been received by or accrued to that company.
The proposed clawback rules apply only for the purposes of determining whether the anti-avoidance rules on dividend stripping apply to the subsequent deferral transaction.
Other proposals regarding anti-avoidance rules
In addition to the above, the Explanatory Memorandum on the Taxation Laws Amendment Bill states that there are proposals to prevent connected persons that form part of the same group of companies from using deferral transactions to split exempt dividends among themselves. The purpose of splitting an exempt dividend is to ensure that no one connected person or a group company receives an extraordinary dividend.
There is also a proposal to prevent taxpayers from stripping the value of a company after entering into a deferral transaction and avoiding the application of the extraordinary dividend by using a company with high-value shares to distribute an exempt dividend.
For further information on this topic please contact Louis Botha at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email ([email protected]). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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