Section 8EA of the Income Tax Act, No 58 of 1962 (Act) constitutes an anti-avoidance provision which, if applicable, has the effect that the amount of any dividend or foreign dividend received or accrued to the holder of a preference share, is deemed to be an amount of income as opposed to exempt income for tax purposes. In order for the provisions of s8EA of the Act to apply, the preference share in question must be regarded as a ‘third-party backed share’.
A third-party backed share means any preference share in respect of which an enforcement right is exercisable by the holder of that preference share or an enforcement obligation is enforceable as a result of any amount of any specified dividend, foreign dividend, return of capital or foreign return of capital attributable to that share not being received by, or accruing to the person entitled thereto.
Sections 8EA(1) and (3) should be read together to fully understand the requirements and proviso.
Section 8EA(1)
A ‘qualifying purpose’ is defined in section 8EA(1) of the Act in relation to the application of the funds derived from the issue of a preference share, as one or more of the following purposes:
a) The direct or indirect acquisition of an equity share by any person in a company that is an operating company at the time of the receipt or accrual of any dividend or foreign dividend in respect of that preference share…
b) the partial or full settlement by any person of any:
i. debt incurred for one or more of the following purposes:
(aa) The direct or indirect acquisition of an equity share by any person in a company that is an operating company at the time of the receipt or accrual of any dividend or foreign dividend in respect of that preference share…
(bb) a direct or indirect acquisition or a redemption contemplated in paragraph (c);
(cc) …; orc) the direct or indirect acquisition by any person or a redemption by any person of any other preference share if –
ii. that other preference share was issued for any purpose contemplated in this definition; and…
d)…
Section 8EA(3)
The Taxation Laws Amendment Act 17 of 2023 (“TLAA”) which was promulgated on 22 December 2023 amended section 8EA by the addition to subsection (3) of the following proviso:
“Provided that where an equity share in an operating company is acquired by any person as contemplated in paragraph (a) or (b) of the definition of ‘‘qualifying purpose’’ and the share so acquired is no longer held directly or indirectly by that person at the time of the receipt or accrual of that dividend or foreign dividend in respect of the preference share, this subsection must not apply, unless …”
It is now a requirement that the equity shares in the operating company which underpin the qualifying purpose requirement, must be held by the person that acquired same at the time that each dividend is received or accrue in respect of the relevant preference share.
Given the above information, SARS recently dealt with a request to provide a ruling on Section 8EA(3) of the Income Tax Act and the proviso contained therein in Private Binding Ruling BPR413 of 18 November 2024.
Summary
This Binding Private Ruling from SARS determines that the proviso to section 8EA(3) will apply where equity shares in an operating company acquired by a person through the direct or direct application of preference share funding are no longer directly or indirectly held by that person.
Relevant tax laws
In this ruling references to sections are to sections of the Act applicable as at 13 November 2024. Unless the context indicates otherwise any word or expression in this ruling bears the meaning ascribed to it in the Act.
This is a ruling on the interpretation and application of section 8EA.
Parties to the proposed transaction
The Applicant: A resident company
The Co-Applicants: Institutions that provide funding to the Applicants group of companies
Company A: A resident company and a wholly-owned subsidiary of the Applicant
Company B: A resident company and a wholly-owned subsidiary of the Applicant
Company C: A resident company and a wholly-owned subsidiary of the Applicant
Company D: A resident company and a wholly-owned subsidiary of the Applicant
Company E: A resident company and a wholly-owned subsidiary of the Applicant
Company F: A non-resident company
Company G: A resident company and a wholly-owned subsidiary of Company B
Company H: A resident company and a wholly-owned subsidiary of Company B
Company I: A resident company partly held by Company D
Company J: A resident company
Description of the proposed transaction
The Applicant is an intermediary holding company of a group of companies comprising, among others, Company A to Company E.
The Applicant makes and directs the investment and funding decisions of the group.
The Co-Applicants provide funding to the group of companies by way of, among others, preference share funding. The preference share funding for the group is raised by Company A and on-advanced directly or indirectly to the company that requires funding in the group.
The Co-Applicants have in the past subscribed for preference shares in Company A. The Applicant has provided guarantees to the Co-Applicants for the due compliance with the obligations of Company A in respect of the preference share funding in addition to guarantees provided by the subsidiary companies of the Applicant which provide the Co-Applicants with direct access to their underlying assets in the event of the execution of security rights.
The proceeds from the previous issue of tranches preference shares by Company A to the Co-Applicants mentioned above and relevant to this ruling has been applied as follows:
- Preference Shares 1
The Preference Shares 1 subscription proceeds were used by Company A to redeem other previously issued tranches preference shares the proceeds from which subscription were applied by Company A to advance a loan to Company C, which in turn advanced a loan to Company B to acquire equity shares in Company F. X portion of the equity shares acquired by Company B in Company F were subsequently disposed of by Company B to Company G and Company H, both companies being wholly-owned subsidiaries of Company B. The remaining Y portion of equity shares in Company F remain held by Company B.
- Preference Shares 2
The Preference Shares 2 subscription proceeds were used by Company A to redeem other previously issued tranches of preference shares the proceeds from which subscription were applied to advance a loan to Company D to acquire equity shares in Company I.
- Preference Shares 3
The Preference Shares 3 subscription proceeds were applied by Company A to advance a loan to the Applicant to acquire equity shares in Company J.
The Applicant and some of its subsidiary companies propose to enter into the transactions detailed below, with the consent of the Co-Applicants. The proposed steps to implement transaction are as follows:
- Company B will dispose of the shares it holds in Company G and Company H to the Applicant whereafter Company G and Company H will be liquidated, resulting in the Applicant holding the shares in Company F that were previously held by Company G and Company H.
- Company D will dispose of the shares it holds in Company I to the Company E.
- The Applicant will dispose of X portion of shares that it holds in Company J.
The funding raised will not be applied to redeem any of the Preference Shares but will be used for business operations purposes. The Applicant will continue to hold Y portion of shares in Company J.
Conditions and assumptions
This binding private ruling is subject to the following additional conditions and assumptions:
a) Each one of the Preference Shares 1, 2 and 3 constitutes a “preference share” as defined in section 8EA(1).
b) An “enforcement right” as defined in section 8EA(1) read with section 8EA(3)(b) is present in respect of the Preference Shares 1, 2 and 3 as a result of the guarantee provided by the Applicant which is a person contemplated in section 8EA(3)(b).
c) At the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 1, 2 and 3, Company F, Company I and Company J will be “operating companies” as defined in section 8EA(1).
Ruling
The ruling below in connection with the proposed transaction applies in respect of dividends received by or accrued to the Co-Applicants in respect of Preference Shares 1, 2 and 3 in their respective years of assessment commencing on or after 01 January 2024 as follows:
a) As Company B will no longer directly or indirectly hold X portion of the equity shares in Company F at the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 1, the proviso to section 8EA(3) will apply, with the effect that section 8EA(3) will not apply to the X portion of the Preference Shares 1 on which the dividend was received or accrued and therefore the X portion of any dividend in respect of those Preference Shares 1 must be deemed, in relation to each Co-Applicant, to be an amount of income received or accrued.
b) As Company B will still directly hold Y portion of the equity shares in Company F at the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 1, the proviso to section 8EA(3) will not apply, with the effect that section 8EA(3) will apply to the Y portion of the Preference Shares 1 on which the dividend was received or accrued and therefore the Y portion of any dividend in respect of those Preference Shares 1must not be deemed, in relation to each Co-Applicant, to be an amount of income received or accrued, provided that the requirements of section 8EA(3) are satisfied at the time of the receipt by or accrual to each Co-Applicant of such dividend.
c) As Company D will no longer directly or indirectly hold equity shares in Company I at the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 2, the proviso to section 8EA(3) will apply, with the effect that section 8EA(3) will not apply to the Preference Shares 2 on which the dividend was received or accrued and therefore any dividend in respect of those Preference Shares 2 must be deemed, in relation to each Co-Applicant, to be an amount of income received or accrued.
d) As the Applicant will no longer directly or indirectly hold X portion of the equity shares in Company J at the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 3, the proviso to section 8EA(3) will apply, with the effect that section 8EA(3) will not apply to the X portion of the Preference Shares 3 on which the dividend was received or accrued and therefore the X portion of any dividend in respect of those Preference Shares 3 must be deemed in relation to each Co-Applicant to be an amount of income received or accrued.
e) As the Applicant will still directly hold Y portion of the equity shares in Company J at the time of the receipt by or accrual to the Co-Applicants of any dividend in respect of the Preference Shares 3, the proviso to section 8EA(3) will not apply, with the effect that section 8EA(3) will apply to the Y portion of the Preference Shares 3 on which the dividend was received or accrued and therefore the Y portion of any dividend in respect of those Preference Shares 3 must not be deemed, in relation to each Co-Applicant, to be an amount of income received or accrued, provided that the requirements of section 8EA(3) are satisfied at the time of the receipt by or accrual to each Co-Applicant of such dividend.
In short, the operating company shares must be directly or indirectly held by the original purchaser of such shares.
This binding private ruling is valid for a period of five years from 13 November 2024.
A future article will discuss Preference Share Funding Structures and Income Tax Act provisions.