However, it seems like the future of preference share funding structures is no longer certain. On Saturday, 16 August 2025, National Treasury and the South African Revenue Service (SARS) published the 2025 Draft Taxation Laws Amendment Bill (2025 Draft TLAB). One of the sections of the Income Tax Act 58 of 1962 (ITA) that SARS intends to amend with the 2025 Draft TLAB is section 8E, an anti-avoidance provision that targets shares that have debt-like features.

Hybrid equity instruments

A key feature of section 8E is that it targets shares with a redemption period of three years or less. These shares are known as “hybrid equity instruments”. Should this section be applicable, the dividends derived from those shares will be deemed to be income in the hands of the recipient(s) thereof; in other words, such dividends are not exempt from income tax. Preference share funding structures avoid triggering section 8E by providing for a redemption period that exceeds three years.

The 2025 Draft TLAB proposes amending section 8E by refining the definition of a “hybrid equity instrument” to include any share or financial arrangement that is or would be classified as a financial liability in the annual financial statements of the issuer (in accordance with International Financial Reporting Standards (IFRS)), and by removing the three-year requirement. This means that any instrument with an obligation on the issuer to redeem that instrument, such as a funding preference share, regardless of the duration of the redemption period, would qualify as a “hybrid equity instrument”, and section 8E would apply.

In the explanatory memorandum accompanying the 2025 Draft TLAB, National Treasury set out its rationale for these amendments, explaining that, while the economic substance of preference shares allows the holders to recognise them as debt for financial reporting purposes under IFRS, their legal form as preference shares allows for “potential tax arbitrage”. National Treasury specifically referred to the fact that preference share funding structures are intentionally designed with redemption periods exceeding three years in order to circumvent the application of section 8E. Referring to the importance that IFRS place on substance over form when classifying financial instruments, National Treasury concluded that the contractual terms of preference share funding structures, when subjected to a rigorous analysis under IFRS, lead to a financial liability classification and, accordingly, should be treated as debt for tax purposes.

Existing preference shares also affected by the amendments

The proposed amendments, as set out above, will come into operation on 1 January 2026 and apply in respect of years of assessment commencing on or after that date. This means that, if a bank, for example, is a preference shareholder and has a year of assessment commencing on 1 April, all dividends payable on or after 1 April 2026 in respect of those preference shares, including preference shares that were issued in 2025 (or in any previous year), will be deemed to be income and, therefore, subject to income tax.

The reason the 2025 Draft TLAB also captures dividends on existing preference shares (and not only preference shares issued on or after 1 January 2026) is because section 8E(2) of the ITA, as amended, provides that any dividend received by a person during any year of assessment in respect of a share or financial instrument must be deemed in relation to that person to be an amount of income accrued to that person if that share or financial instrument constitutes a hybrid equity instrument at any time during that year of assessment. Considering that preference shares will now constitute a hybrid equity instrument in any year of assessment commencing after 1 January 2026, any dividend on a preference share received by the holder thereof will be taxable in that year of assessment.

Adjustment events

Preference share funding structures usually include terms dealing with the consequences of the occurrence of an “adjustment event”, which includes an event in terms of which the holder of preference shares becomes liable to pay tax on, or in respect of, those preference shares (as is contemplated in the 2025 Draft TLAB). If such an adjustment event occurs, the preference shareholder is usually entitled to claim a tax gross-up, being an additional dividend in such an amount as is necessary to place the holder in the same after-tax position that it would have been in, had the relevant adjustment event not occurred.

When one considers these tax gross-up provisions, it is clear that preference share funding structures will become too expensive to be used as funding instruments. This is because the company issuing the preference shares will be obliged to pay the dividends (at the agreed rate) plus a tax gross-up in an amount equal to the dividend divided by 0.73.¹ For example, the dividends plus the tax gross-up on a dividend of R100 will be R136,99. This means that a preference share funding structure will be much more expensive than a debt funding structure, where no such tax gross-up amounts (relating to dividends) are payable. It is, accordingly, difficult to see preference shares being used as funding instruments going forward.

Open for comments

It is important to note that National Treasury and SARS have invited comments on the 2025 Draft TLAB, with the due date for comments being 12 September 2025. This means that National Treasury and SARS may still decide to revise or (less likely) remove the amendments relating to section 8E. However, if the amendments as set out in the current 2025 Draft TLAB come into operation, it will probably entail the end of the road for preference shares as a funding instrument.

¹ This number (0.73) is calculated by subtracting 0.27 (the corporate tax rate) from 1.