Shedding light on the concealed tax consequences of the new Companies Act
20 April 2012
Posted by: Author: Pieter van der Zwan
Shedding light on the concealed tax consequences of the new Companies Act
All companies have been affected by the Companies Act 71 of 2008 (hereafter the Act) that became effective from 1 May 2011. A number of questions have arisen regarding the tax implications of certain provisions of the Act. The purpose of this article is to investigate the tax consequences of a number of provisions in the Act that are different from the corresponding provisions in the Companies Act 61 of 1973.
Consequences of the scrapping of the par-value concept:
Section 35(2) of the Act states that a share does not have a nominal or par value. Traditionally, a company made distributions to it's shareholders from share capital, share premium or other reserves, such as retained earnings; the component of equity from which the distribution was made affected the tax treatment. The question arises whether the scrapping of the par-value and share-premium concepts had any tax consequences.
The answer to this question is relatively simple. Prior to 1 January 2011, distributions made from pure share capital and share premium did not constitute dividends for tax purposes, and were taxed as capital distributions (recently renamed to returns of capital by the Taxation Laws Amendment Act 24 of 2011). Any distribution from another component of equity constituted a dividend and was subject to Secondary Tax on Companies (STC) in the hands of the distributing company, while being exempt income in the hands of the recipient in most cases. As from 1 January 2011 the Income Tax Act has its own definition of capital for tax purposes, namely Contributed Tax Capital (CTC). In brief, CTC is calculated based on share capital and share premium balances on 1 January 2011 (before the Act became effective) and with reference to proceeds or payments in respect of shareholder transactions thereafter. Payments that are made from CTC are treated as returns of capital, while as a general rule any other distribution to a shareholder will be a dividend that could be subject to STC (or dividends tax from 1 April 2012). As a result of the introduction of the definition of CTC and the amended definition of a dividend, the scrapping of the share capital and share premium concepts should not have any tax consequences.
An unforeseen tax implication of fundamental transactions:
In terms of section 164 of the Act a company may be required to acquire any shares held by dissenting shareholders at its fair value when fundamental transactions, as contemplated in sections 112, 113 and 114, occur, as well as when the Memorandum of Incorporation (hereafter the MoI) is amended to adversely affect the rights of those shareholders. It has been noted by some commentators that this provision may have significant cash flow implications as companies would need to budget for the possible acquisition of shares from dissenting shareholders in addition to the substantial cash outflows required for fundamental transactions, such as mergers and acquisitions. When budgeting for these transactions, it should furthermore be borne in mind that the acquisition of shares from dissenting shareholders can also have tax implications for the company. The Income Tax Act defines a dividend as, amongst others, any amount transferred to the shareholders by the company as consideration for the acquisition of any shares held in the company, unless this consideration is paid from CTC. The acquisition of shares from dissenting shareholders will, therefore, result in a dividend for tax purposes to the extent that the fair value of the shares is not paid from CTC. Prior to 1 April 2012, these dividends will be subject to STC, while the payment of dividends tax by the shareholder after 1 April 2012 may impact on the value at which companies have to acquire the shares as the cash received by the shareholders will be affected.
Traditionally, a company made distributions to its shareholders from share capital, share premium or other reserves, such as retained earnings; the component of equity from which the distribution was made affected the tax treatment.
Impact on hybrid instruments:
A company’s MoI may provide that certain classes of shares issued have preferences, rights or limitations (section 37 of the Act). Section 37(6) allows for these preferences, rights and limitations to be variable in response to any objectively ascertainable external fact(s). Companies and counter parties to these shares should approach the structuring of the instruments with care as the preferences, rights or limitations of the shares may affect its tax treatment.
Section 8E of the Income Tax Act deems dividends declared on hybrid equity instruments, which are shares that display certain characteristics of debt instruments that are set out in section 8E, to be treated as interest in the hands of the recipient, as opposed to exempt dividends, while still treating it as a dividend in the hands of the distributing company. This amount paid by the company, which is still considered to be a dividend paid from the company’s perspective, could arguably be subject to dividends tax (with effect from 1 April 2012), as the trigger for withholding dividends tax is when a dividend is paid by the company (section 64E of the Income Tax Act). With effect from 1 April 2012, section 8EA has been inserted into the Income Tax Act as another anti-avoidance measure that deals with shares that display debt-like characteristics. Similarly, section 8F of the Income Tax Act deems interest paid on hybrid debt instruments to be treated as non-deductible dividends that are subject to STC (and dividends tax from 1 April 2012) in the hands of the payor. In this regard, care should be taken when allocating rights to convert debt into shares as this may trigger the provisions of section 8F.
Some frequently asked questions:
Can a company be required to have its financial statements audited, as described in section 30 of the Act and the corresponding Regulations, for tax purposes? The Act only determines that companies have to be audited based on their classification (i.e. public or state-owned companies), whether they hold assets in a fiduciary capacity or based on their public interest score. There is no requirement in the Act that imposes an obligation on a company to have its annual financial statements audited for tax purposes. SARS may, however, perform an audit or investigation for tax purposes in terms of section 74B of the Income Tax Act or Chapter 5 of the proposed Tax Administration Bill, but this is not a statutory audit of the company’s annual financial statements. Will the liquidity and solvency requirements of the Act have any tax effects?
These requirements should not have any direct tax effect. If the terms or amounts of liabilities are, however, altered to meet these requirements, which are different from the requirements of the Companies Act 61 of 1973, it may have tax consequences. An example of this would be that a loan written off to improve the assets to debt ratio of a company may have capital gains tax implications for the borrower.
Concluding thoughts on the tax impact of the new Companies Act:
This article attempted to clarify some tax-related questions that may stem from the Act. It is anticipated that there could be many other tax-related debates arising from the application of the Act. From the discussion in this article, it appears as if the new Companies Act is likely to affect the taxation of various specific transactions rather than company taxation in general.
Source: By Pieter van der Zwan (Tax Professional)