Preference shares constituting equity shares
16 May 2013
Posted by: Author: Andrew Lewis
Source: Andrew Lewis
A very interesting binding private ruling was released by the South African Revenue Service (SARS) on 2 May
Binding Private Ruling 143 (BPR 143) dealt with the question of whether preference shares would qualify as 'equity shares' for purposes of applying the definition of 'headquarter company' in s1 of the Income Tax Act, No 58 of 1962 (Act).
The 'equity share' definition has been subject to a number of amendments in recent years. The current 'equity share' definition, which is similar to that applicable in BPR 143, provides that an 'equity share' is:
The 'equity share' definition thus excludes any share that 'neither as respects dividends nor as respects returns of capital', carries any right to participate beyond a specified amount in a distribution. In other words, any share that both in respect of dividends and returns of capital does not carry a right to participate beyond a specified amount in distribution will not constitute an 'equity share'.
"any share in a company, excluding any share that, neither as respects dividends nor as respects returns of capital, carries any right to participate beyond a specified amount in a distribution."
It follows, that if a share either as respects dividends or as respects returns of capital has an unlimited right to participate in distributions of the company, one still has an 'equity share'. Many of the provisions in the Act are only applicable to 'equity shares' and many consultants have used the above interpretation to structure transactions to fall within the 'equity share' definition.
South Africa’s headquarter company regime provides a number of tax and other benefits, which include inter alia:
- exemptions from withholding taxes;
- controlled foreign company rules;
- transfer pricing provisions; and
- exchange control regulations
A requirement to qualify for the headquarter company regime is that 80% or more of the cost of the total assets of the company was attributable to inter alia an interest in 'equity shares' (see s9I(1)(b) of the Act). Thus, in BPR 143, the applicant was concerned that if the preference shares it held in the offshore
company did not constitute 'equity shares', it would not satisfy the aforementioned provision. The salient terms of the preference shares were that:
- the holder has the right to participate in a return of capital only to the extent of the subscription price, as well as any arrear dividends;
- the right to participate in dividends, although expressed in the articles of association as a rate on the subscription price, is effectively unlimited and unrestricted to a pre-determined amount or coupon; and
- in effect, the directors are entitled to declare the same dividend on preference shares as on ordinary shares and thus the right to participate in dividends is not restricted.
SARS confirmed in BPR 143 that the preference shares in question, subject to the rights and limitations mentioned above, would be regarded as 'equity shares' for purposes of the Act. This ruling will give some comfort to consultants and taxpayers who have sought to implement transactions using shares with similar features and the Act specifically requires the use of 'equity shares'.
The other interesting aspect of BPR 143 is that the applicant, should it qualify as a 'headquarter company' and the attendant tax relief afforded by the regime applies, intends to list a certain percentage of its shares on an international stock exchange. This may be an indication that taxpayers are starting to consider using South Africa’s headquarter company regime as a preferred headquarter company for investments into Africa over other jurisdictions.