Closing a targeted scheme abusing the tax implications inherent to contributed tax capital

The “contributed tax capital” (CTC) of a company is a notional tax concept that denotes an amount derived from the value of any contribution (typically a subscription price) made to a company as consideration for the issue of a specific class of shares. CTC is reduced by any part that is allocated by the company in a subsequent transfer to one or more shareholders if the board specifically resolves that a distribution will give rise to a reduction of CTC.

1 Mar 2023 2 min read Special Edition Budget Speech Alert Article

At a glance

  • Contributed tax capital (CTC) represents the value of contributions made to a company for specific shares and is reduced by distributions allocated by the company, resulting in a reduction of CTC.
  • CTC distributions do not have the same tax implications as dividends because they are excluded from the definition of "dividend" in the ITA.
  • National Treasury aims to address the misuse of CTC provisions in schemes involving the interposition of a foreign company to avoid dividends tax. Legislative amendments are proposed to prevent such schemes and address the conversion of foreign currency to rands by foreign entities changing tax residency to South Africa.

A key feature of CTC is that although, like a dividend, it amounts to a distribution to a shareholder by a company in respect of a share, because the definition of “dividend” contained in the ITA excludes amounts resulting in the reduction of CTC, CTC distributions do not attract the tax implications which a “dividend”, for tax purposes, would typically attract.

National Treasury has identified of the misuse of the CTC provision in schemes involving the interposition of a foreign company which becomes South African tax resident, between a South African company desiring to effect a dividend distribution to its foreign shareholder.

Under the recognised arrangement:

  • A distribution is to be affected by a South African company (SA issuer) to a foreign company (foreign beneficial owner).
  • Prior to such distribution another foreign company is interposed between the SA issuer and the foreign beneficial owner (intermediary company).
  • The intermediary company becomes South African tax resident. When this takes place, in terms of the definition of “contributed tax capital” contained in section 1 of the ITA, the CTC recognised as an amount equal to the market value of the shares in the intermediary company.
  • The SA issuer will thereafter proceed to affect the dividend distribution to the intermediary company, and such dividends are exempt from dividends tax under the SA tax resident-company-to-company exemption contained in section 64F(1)(a) of the ITA.
  • When the intermediary company on-distributes the funds to the foreign beneficial owner, the distribution is affected out of CTC and is therefore not subject to dividends tax by virtue of the “dividend” definition which excludes amounts resulting in the reduction of CTC.

To prevent these schemes from being implemented to avoid dividends tax, National Treasury proposes introducing legislation. Amendments are also intended to be introduced to deal with the conversion of amounts denominated in foreign currency to rands by foreign entities which change their tax residency to South African i.e. presumably the intermediary company, in the context, of the arrangement outlined above.

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