The payment of dividends out of negative reserves
09 May 2012
Posted by: SAIT Technical
By Emil Brincker (DLA Cliffe Decker Hofmeyr Tax Alert 26 April 2012)
The issue has often arisen as to whether the payment of a dividend that results in the creation of negative reserves can still be said to be a dividend or whether it is effectively funded from the share capital of a company. For instance, a company can have 100 as equity that is reflected as 100 in assets. However, the company then declares a dividend that results in it effectively having negative reserves of 100 in circumstances where the assets of 100 are used to fund the dividend. For all practical purposes one would think that the dividend is effectively paid out of capital, but no specific decision is made by the board of directors in declaring the dividend that the dividend is in fact funded from the capital account.
In a South African context, a foreign dividend is defined as an amount that is paid or payable by a foreign company in respect of a share in that foreign company where the amount is treated as a dividend or similar payment by the foreign company for the purposes of the laws relating to tax on income on companies of the country in which the foreign company has its place of effective management. It does not include any amount paid or payable that is deductible by the foreign company in the determination of any tax on income on companies of the country in which the foreign company has its place of effective management.
In the English case of HMRC v First Nationwide, the issue arose in the context of a Cayman Island company declaring dividends to its shareholder. For purposes of Cayman Island company law, the relevant dividends that were declared in respect of the preference shares constituted dividends.
The Court of Appeal in the UK (13 March 2012) indicated that the dividends in question constituted income. Given the fact that one could distribute share premium as dividends under Cayman Islands company law, the UK Courts had to give effect thereto. This is notwithstanding the fact that share premium can otherwise be seen as the "corpus" of a company.
In a South African context, the issue becomes that much more relevant given the fact that a dividend is defined in a domestic context as any amount transferred or applied by a company for the benefit of or on behalf of any person in respect of any share in the company. It excludes a reduction of contributed tax capital of the company (CTC). However, the use of CTC can only take place to the extent that it is determined to be a return of CTC by the directors of the company or by some other person or body of persons with comparable authority. If it is not determined as a return of CTC, it follows that it must of necessity be a dividend.