A Purposive Interpretation of the ‘Qualifying Purpose’ Exemption in Sections 8E and 8EA of the Income Tax Act

• Published date: 01 March 2022
• Date: 01 March 2022
• Author: Milton Seligson SC
• Pages: 7-15
• DOI: 10.10520/ejc-btclq_v13_n1_a3

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A Purposive Interpretation

of the ‘Qualifying Purpose’

Exemption in Sections 8E and

8EA of the Income Tax Act

MILTON SELIGSON SC*

ABSTRACT

The issue of preference shares as a means of f‌inancing the acquisition of equity

shares in a company is well established in South Africa, particularly in connec-

tion with BEE projects involving employee share ownership plans. The issuer

of the preference shares is usually a special purpose vehicle (‘SPV’) which may

itself acquire the equity shares, or the acquirer may be a trust which holds all

the shares in the SPV and acquires the equity shares in the employer company

using a capital contribution made to the Trust by the SPV, thus applying the

funding derived from the issue of preference shares by the SPV.

From a tax perspective, the issue of preference shares always runs the risk

of falling foul of the anti-avoidance provisions of section 8E and 8EA of the

Income Tax Act. Section 8E is aimed at preference shares that are ‘hybrid

equity instruments’, while section 8EA targets such shares that are ‘third-party

backed shares’. If the preference shares meet the requirements of these provi-

sions, any dividends declared and paid to their holders are deemed to be

income.

This article investigates the scope and proper interpretation of the exemp-

tion provided for in both sections for preference shares that are issued for

a ‘qualifying purpose’. The def‌inition of ‘hybrid equity instrument’ includes

in paragraph (c) any preference share, if that share is secured by a f‌inancial

instrument, unless that share was issued for a qualifying purpose. Section 8EA(3)

(a) provides that where the funds derived from the issue of a preference share

were applied for a ‘qualifying purpose’, in determining whether there is an

enforcement right exercisable by the holder in respect of that share (which

would otherwise make the preference share a ‘third-party backed share’),

any right that is exercisable against the counterparties mentioned in section

8EA(3)(b) must be disregarded.

The article discusses the def‌inition of ‘qualifying purpose’ in section 8EA

and investigates the proper interpretation of the relevant exemptions in the

context of two hypothetical scenarios, which may well occur in practice.

The f‌irst scenario involves the question whether the qualifying purpose

exemption applies, where the party that acquired the equity shares using

the preference share funding has disposed of them at the time dividends are

declared and paid to the holder of the preference shares. The second scenario

involves the acquisition of the shares by a Trust using a capital contribution

to it by a SPV, its wholly-owned subsidiary, comprising the proceeds of the

preference share issue by the SPV.

* Honorary Member, Cape Bar.