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Third-party backed shares

Thursday, 20 March 2014   (0 Comments)
Posted by: Author: Webber Wentzel
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Author: Webber Wentzel

Third-party backed shares

While Section 8EA of the Income Tax Act contains certain exceptions from what constitutes a third-party backed share (the primary being third-party backed shares used to acquire shares in an operating company where the third-party backed share is backed by a permitted person), it appears per this Budget that the exceptions will be expanded.

Section 8EA was introduced into the Act and is effective in the case of dividends or foreign dividends received in cash by any person on or after 1 January 2013.

Section 8EA deems both local and foreign dividends derived from certain third-party backed shares to be income in the hands of the recipient.

SARS' intention at the time of the introduction of Section 8EA was "to eliminate special purpose vehicles and other outside guarantee mechanisms that allow the holder of preference shares to rely on parties other than the issuer of the preference shares ". SARS' concern was that such structures allowed for tax avoidance and that the holder of the preference shares was not taking on the appropriate degree of risk for it to be effectively treated as an equity instrument.

The imposition of Section 8EA has had a number of unintended consequences ranging from:

- the need to refinance black economic empowerment transactions, because the required indirect percentage shareholding in the operating company has not been met; to

- increasing the effective cost of funding in instances where the operating company requirements have not been met (eg exploration companies)

While Section 8EA contains certain exceptions from what constitutes a third-party backed share, it appears per this Budget that the exemptions from preference shares constituting third party backed shares will be extended by:

- permitting the refinancing of third-party backed shares originally used to fund equity acquisitions in operating companies;

- including the definition of "exploration company" within the definition of "operating company", as exploration companies previously did not fall within the definition of operating company as defined; and

- permitting preference share funders to obtain limited pledges over the shares associated with the deal, from shareholders who own less than 20% of the shares in such company, without triggering further enforcement rights or obligations;

In our view, these proposed amendments are most welcome and should assist in eliminating situations where preference shares are eliminated as a financing mechanism for a legitimate commercial purpose, due to the current restrictive provisions of Sections 8E and 8EA.

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