The facts were briefly as follows. A certain company, Company A, had issued redeemable preference shares to another company in order to raise funds. The purpose of raising the funds were for Company A to make a loan to its holding company, which would in turn acquire shares in a locally listed company.

It was accepted that the preference shares could constitute “hybrid equity instruments” for purposes of section 8E of the ITA, or “third-party backed shares” for purposes of section 8EA of the ITA.

Sections 8E and 8EA are anti-avoidance provisions which effectively deem any dividends received on certain instruments to be income in the hands of the recipient, unless in certain circumstances the shares were issued for or applied for a qualifying purpose.

A qualifying purpose generally refers to the direct or indirect acquisition of shares in operating companies (and other relevant permutations involving re-financing of such acquisitions).

It appears that in this particular case, the preference shares were initially issued or applied for a qualifying purpose because the listed company was assumed to be an operating company.

Preference dividends paid would therefore not have been deemed to be income.

However, the holding company subsequently disposed of the shares due to unfavourable market conditions.

After this disposal event, Company A wanted to pay a dividend in respect of the preference shares. The question that arose was whether one would still be dealing with a qualifying purpose after the shares had been disposed of. If not, the preference dividend would be deemed to be income for the recipient.

The South African Revenue Service (SARS) ruled that sections 8E and 8EA would not apply, and would not recharacterize the preference dividends as income.

In the Budget, it was indicated that SARS will be reconsidering the rules in relation to “qualifying purpose” in the context of third-party backed shares, and specifically in circumstances where the shares in the operating company are no longer held by the person who initially acquired them.

It appears therefore that SARS is either backtracking on the ruling or will be making legislative amendments that would make the ruling redundant.