Share buybacks have gone from obscurity to an everyday occurrence in the past decade, says Carmen Westermeyer, tax partner at Maitland and Associates. Several legislative changes have been introduced over the years, limiting the tax planning opportunities somewhat.
Companies may at times be obliged to buy back their shares from shareholders because of an agreed redemption date for preference shares, or where individual shareholders cannot afford to buy the shares of other shareholders.
Law firm Bowmans said in an earlier analysis that share buybacks became a “very common mechanism” for exiting an investment in a South African company since the introduction of dividends tax in 2012.
Dividends are exempt from normal tax (income tax) but may be subject to dividends tax in the hand of individual shareholders. Dividends paid to South African resident companies are exempt from dividends tax.
“This makes share buybacks particularly attractive in circumstances where the disinvesting shareholder is a South African company,” the analysis states.
Westermeyer says under the old regime a share buyback was essentially viewed as the equivalent of a capital gain event. It gave rise to proceeds and capital gains tax. With the legislative changes, a share buyback gave rise to a dividend and an amount of proceeds.
Different outcomes
BDO tax directors Bruce Russell and Chris Smith remarked in a tax insight that the income tax treatment of dividends may vary depending on the circumstances and the nature of a shareholder.
A shareholder who is not a South African resident company would ordinarily pay dividends tax on a dividend paid to him. A dividend paid to a South African resident company should not attract dividends tax, but may, in certain circumstances, be re-characterised to attract CGT.
However, the return of contributed tax capital (CTC) to a shareholder, depending on the shareholder’s specific circumstances, may not attract income tax.
“The rationale for a return of CTC not attracting income tax is that CTC represents the shareholder’s capital originally invested and therefore when this invested capital is returned to the shareholder, no income tax should arise,” they note.
When a portion of the consideration for the buyback from a shareholder is paid out as CTC, the amount received by the shareholder is income tax-free.
The tax effect
Westermeyer illustrates the tax effects before the legislative change and after by way of an example. Company A (the shareholder) bought shares in Company B for R150 (base cost). The share capital (CTC) component was R50. Company B then offered Company A R350 to buy back its shares.
Under the old regime, this would have constituted a disposal of shares, subject to CGT. The shareholder would pay CGT equal to R350 – R150 = R200. At an inclusion rate of 80% and a tax rate of 27%, this would result in tax payable of R43.20.
Under the new regime, the amount received would be split into two parts, presuming a part of the consideration was paid from the CTC. The difference between the return of capital (R50) and the amount received (R350) is a R300 dividend. Dividends paid to a South African resident company is exempt from dividends withholding tax; therefore, no tax would be payable.
Company B would have had a disposal of the Company A shares. The CGT would be calculated as follows: proceeds = R350 – R300 (the tax-exempt dividend) = R50. Since the base cost was R150, the transaction resulted in a capital loss of R100.
“So, in a nutshell, due to the change in legislation, companies went from having tax payable of R43.20 to a capital loss accrued to them of R100,” Westermeyer says.
Not lying down
Westermeyer says the South African Revenue Service did not take some of the tax planning happening in the market “lying down”. Several measures have been introduced to prevent abuse. “It well behoves a taxpayer to be aware of these provisions prior to entering into a share buyback agreement, as they are now all subject to these requirements.”
One such change is that any share buyback arrangement of more than R10 million and in which shares are issued by the same company within 12 months is defined as a reportable arrangement.
“This has no real tax impact, other than a potential penalty of R100 000 per month for non-disclosure,” warns Westermeyer.
The real teeth, however, come with the introduction and revamping of a new provision in the Income Tax Act. This provision essentially requires that any dividend in excess of 15% of the market value of the shares, received over the past 18 months, is deemed either gross income or proceeds when the shares are disposed of.
The provision applies only where the shareholder owns 50% or more of an unlisted company, leaving some tax planning opportunities for shareholders.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law and regulatory issues.
Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article does not constitute financial planning, legal or tax advice that is appropriate to every individual’s needs and circumstances.
