The company’s Act
The Companies Act No. 71 of 2008, provides that a company may acquire its own shares to the extent that it is solvent and liquid, as more fully described in Section 4 of the Act. The number of shares that have to be serviced by the company, is reduced permanently and, from then on, distributions are made between fewer shareholders.
Definition of a Dividend
The definition of a dividend in Section 1 of the Income Tax Act No. 58 of 1962 (“ITA”). This definition provides that the proceeds from a share buy-back will be deemed to be a dividend to the extent that it is not funded out of so-called share capital or contributed tax capital (“CTC”).
A company’s CTC constitutes its stated capital or share capital and share premium immediately prior to 1 January 2011, less so much of the stated capital, share capital or share premium as would have constituted a dividend under the previous dividend definition had it been distributed by the company before that date, plus the consideration received or accrued to the company for the issue of shares on or after 1 January 2011. In other words, a company must determine its CTC on 1 January 2011 as the total of its share capital and share premium account on that date, excluding any amounts thereof which would have constituted a dividend had they been distributed prior to that date. After 1 January 2011, the CTC will be increased by any consideration received by the company in respect of the subsequent issue of shares.
If a company had issued several classes of shares, CTC must be maintained separately on a per class basis. Therefore, CTC created by virtue of an ordinary share issue cannot be allocated or re-allocated to preference shares. Similarly, distributions in respect of preference shares cannot be utilised to reduce the CTC associated with ordinary shares. If a company makes a distribution out of CTC in respect of a given class of shares, the CTC distributed will be pro rata allocated to the shareholders of that class of shares.5
To the extent that the selling shareholder is a company, as opposed to an individual, such dividend would also not be subject to dividends tax at a rate of 20% due to the fact that a dividend paid to a resident company is exempt from dividends tax and instead capital gains tax (“CGT”) at the normal company rate of 22.4% is paid.
The directors of the company or some other person or body of persons with comparable authority must determine the amount that will reduce the contributed tax capital.
Capital Gains Tax
To the extent that the distribution does not constitute a dividend, the potential CGT implications require consideration since the amount so received would constitute a “capital distribution” for CGT purposes. “Capital distribution” is defined in paragraph 74 of the Eighth Schedule to the Act as “any distribution (or portion thereof) by a company that does not constitute a dividend.”
In terms of paragraph 76 of the Eighth Schedule, where a capital contribution of cash or an asset in specie is received by or accrues to a shareholder in respect of a share, the shareholder must treat the amount of cash or the market value of the asset in specie as “proceeds” when the share is disposed of. In other words, should the capital distribution received in consequence of the share buy-back, exceed the base cost of the share in the shareholder’s hands, a taxable capital gain would arise.
Such distribution is deemed to be a disposal resulting in an immediate CGT liability. Paragraph 76A of the Eighth Schedule provides that the shareholder must be treated as having disposed of part of the share on the date of receipt or accrual of a capital distribution of cash or an asset in specie received by or accrued to the shareholder. The shareholder would therefore be deemed to have disposed of its shares in the company buying back its shares on the date of the share buy-back.
The term “proceeds” is defined in the Eighth Schedule to the Act and under the current circumstances would be regarded as the amount received by the shareholder as consideration for the shares. Paragraph 35(3)(a) of the Eighth Schedule provides that the proceeds from the disposal of an asset must be reduced by any amount of the proceeds which have been included in the gross income of that person before the inclusion of any taxable capital gain.
As dividends constitute “gross income”, to the extent that the share buy-back consideration constitutes a dividend, the amount of proceeds derived by the shareholder would therefore be reduced. The non-dividend portion would, however, constitute proceeds for CGT purposes.
The amount paid to the shareholder by the company to acquire the share(s) would therefore constitute a dividend for tax purposes, except to the extent that the payment results in a reduction of contributed tax capital. The proceeds for CGT purposes would be reduced by this amount.
It is suggested that companies engage the services of an expert in this field to assist in navigating the complex terrain of share buy-backs.
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