The South African Revenue Service (SARS) recently released an interesting binding class ruling (BCR 44) dealing with the tax consequences of the repurchase of certain non-redeemable, non-participating preference shares.
The applicant was a public company listed on the Johannesburg Stock Exchange (JSE). The applicant issued preference shares to certain persons (the class members).
- The shares:
- were issued at a par value;
- were not redeemable;
- were non-participating; and
- confer the right on members to a return of capital on the winding up of the applicant equal to the issue price of the shares.
The applicant decided to repurchase the shares at their current market value (as traded on the JSE).
The purchase price would be less than the issue price. SARS made various rulings in respect of the transaction.
Hybrid equity instruments
Firstly, it was ruled that the preference shares do not constitute 'equity shares' as defined in s1 of the Income Tax Act, No 58 of 1962 (Act).
For a share to be an equity share the holder must have the right to either:
participate in the profits of the company (by way of dividend) in an unlimited manner; or
participate in the capital of the company (by way of return of capital eg at winding up) in an unlimited manner.
That is, the share must carry the right to fully participate in either dividends or capital. If the share is restricted in respect of only one, it can still be an equity share. Technically then, a preference share can be an equity share if it is a participating preference share – that is, if the holder either participates in the profits (by way of dividends) in an unlimited manner, or participates in the capital (at liquidation) in an unlimited manner.
In the current instance it appears that the shares were non-participating and on winding up the right to capital is limited to the issue price. They therefore could not constitute 'equity shares'.
Secondly it was ruled that the preference shares would not constitute 'hybrid equity instruments' for purposes of s8E of the Act merely because of the repurchase.
In terms of paragraph (a) of the definition of 'hybrid equity instrument' in s8E(1) of the Act, a 'hybrid equity instrument' includes any share, other than an equity share, if within a period of three years from the date of issue:
- the issuer of that share is obliged to redeem that share in whole or in part; or
- that share may at the option of the holder be redeemed in whole or in part.
The concern seems to be that, where the repurchase took place within 3 years of the date of issue, the repurchase could be seen as a right or obligation in respect of the redemption of the shares. However, SARS made it clear that such a repurchase alone would not be sufficient.
Thirdly, SARS ruled that any power of the applicant to repurchase the preference shares in terms of the Takeover Regulation Panel requirements or s164 of the Companies Act, No 71 of 2008 (concerning the appraisal rights of dissenting shareholders) will not be seen as an 'obligation' to repurchase or redeem the preference shares for purposes of s8E of the Act.
Capital gains tax
SARS ruled that the repurchase (and subsequent cancellation) of the preference shares would not constitute a disposal of an asset by the applicant for capital gains tax purposes.
It seems clear however that there would be a disposal by the class members, and that a potential capital loss could arise to the extent that the payment in respect of the repurchase does not constitute a dividend but a return of capital.
Securities transfer tax
SARS ruled that the repurchase would constitute a 'transfer' for purposes of the Securities Transfer Tax Act, No 25 of 2007 and that securities transfer tax would be payable by the applicant on the repurchase price.
SARS also ruled that, to the extent that the repurchase constitutes a dividend (as opposed to a return of capital that reduces the applicant’s contributed tax capital), dividends tax may have to be accounted for.