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Buyback tax rules: a sledgehammer, where a scalpel would do better

29 July 2017   (0 Comments)
Posted by: Author: Amanda Visser
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Author: Amanda Visser (Business Live)

Experts say plans to do away with tax breaks on share buybacks will affect transactions done for legitimate commercial reasons

Treasury plans to do away with tax breaks for corporate share buybacks, in a move described as "overly zealous" and "too far-reaching".

Treasury has proposed changes in the draft Taxation Laws Amendment Bill, saying tax planning using share buybacks has become prevalent due to the fact that company-to-company dividends are exempt from dividend tax.

Clive Sharwood, tax consultant at Deloitte, says listed companies will often use share buybacks when they feel their shares are undervalued.

"The shares can be housed in a subsidiary (maximum of 10% of the shares) or if they are bought back by the company the shares are cancelled."

He explains that share transactions are treated either as a return of "contributed tax capital" — in which case it is called a buyout — or as a dividend, when it is called a buyback.

A return of contributed tax capital would be proceeds on a sale and attract capital gains tax of 22.4%, whereas a dividend is exempt from tax.

"If a company is selling shares by entering into a share buyback, it would receive exempt dividends rather than proceeds that could be subject to capital gains tax."

A buyback occurs when the transaction is between related parties.

Patricia Williams, partner at law firm Bowman, says in terms of the proposal, if a company with a "qualifying interest" (holding 50% of the shares) disposes of shares, any exempt dividend received at any time on the shares in the preceding 18 months, must be treated as proceeds attracting capital gains tax.

She says a key problem with proposal is that the anti-avoidance measure would apply to all disposals, and not only share buyback transactions.

"Even for normal dividends received within 18 months before a share disposal, there would be a very significant increase in tax."

Brian Dennehy, member of the South African Institute of Tax Professionals (SAIT) business tax work group, says share buybacks have been identified as a "loophole" to avoid capital gains tax.

It must be noted that Treasury created a flexible means of structuring one’s affairs, he says.

There has been a natural tension; the South African Revenue Service and Treasury dislikes the structure, but companies argue that the tools have been made available for them to structure their affairs as efficiently as possible, as long as the transaction is commercially driven.

"It is similar to saying you can have your cake, but you cannot eat it," says Dennehy, who is also a director at Webber Wentzel.

General anti-avoidance measures to counter abuse of share buybacks have been around for some time in the current tax laws, he says.

The test is that the overall transaction must be implemented solely for non-tax reasons. The onus is effectively on the taxpayer to prove this.

Dennehy says the new rules, which relate to subscription buybacks, have not been brought through general anti-avoidance but through specific anti-avoidance measures.

"Even if the company does the share buyback for bona fide commercial purposes, the transaction will still be caught and recharacterised so that dividends are treated as capital gain proceeds (taxable at 22.4%)."

Dennehy says Treasury wants to take the structuring opportunity off the table. It wants to level the playing field between "buyback" and "buyout".

"Unfortunately with a lot of these draft anti-avoidance measures, my personal view is that Treasury takes a sledgehammer to the rules where they could have taken a scalpel."

Dennehy says in the current format the measures are just too far-reaching. They will inadvertently affect a lot more transactions that should not necessarily be affected.

He also raises concern about the retrospective nature of the proposal, even if the amendment states that the effective date is 19 July in respect of any disposal on or after that date.

If the share buyback happens tomorrow, and shareholders have received dividends in the past 18 months leading up to the transaction, the dividend will be recharacterised as proceeds and will be subject to capital gains tax.

"It certainly is not a tenable position at all, but it has unfortunately become a common theme in effective date language and policy change."

The changes look prospective in nature but taxpayers can be affected retrospectively, warns Dennehy.

Erika de Villiers, head of policy at SAIT, says the retrospectivity is not unexpected given the potentially significant loss to the fiscus. These proposals were also foreshadowed in the budget.

In a recent case between Pienaar Brothers, SARS and the finance minister, the court found that it was not necessary that exceptional circumstances must exist for Parliament to pass retrospective legislation.

Beric Croome, tax executive at ENSafrica, wrote in an article on the case that the court decided there was no overriding duty to give notice of intended legislation.

In the Pienaar case the court found there was sufficient notice of general impact and that there is no overriding duty to give notice that indicates precisely what the intended legislation will encompass, he wrote.

This article first appeared on businesslive.co.za.


 

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