Review of “qualifying purpose” in the context of third-party backed shares
At a glance
- Binding Private Ruling 379 addressed the classification of preference shares as "hybrid equity instruments" or "third-party backed shares" for tax purposes.
- The ruling determined that preference dividends would not be deemed income if the shares were initially issued or applied for a qualifying purpose, such as acquiring shares in operating companies.
- The Budget indicates that SARS is reconsidering the rules regarding "qualifying purpose" in the context of third-party backed shares, particularly when the shares in the operating company are no longer held by the original acquirer, suggesting a potential change in the ruling or legislative amendments.
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.
The information and material published on this website is provided for general purposes only and does not constitute legal advice. We make every effort to ensure that the content is updated regularly and to offer the most current and accurate information. Please consult one of our lawyers on any specific legal problem or matter. We accept no responsibility for any loss or damage, whether direct or consequential, which may arise from reliance on the information contained in these pages. Please refer to our full terms and conditions. Copyright © 2023 Cliffe Dekker Hofmeyr. All rights reserved. For permission to reproduce an article or publication, please contact us firstname.lastname@example.org.
We support our clients’ strategic and operational needs by offering innovative, integrated and high quality thought leadership. To stay up to date on the latest legal developments that may potentially impact your business, subscribe to our alerts, seminar and webinar invitations.Subscribe