Refinancing Preference-share Transactions

• DOI: 10.10520/ejc-btclq_v12_n3_a2
• Author: Milton Seligson SC
• Published date: 01 September 2021
• Pages: 1-7
• Date: 01 September 2021

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Refinancing Preference-share

Transactions:

ESCAPING THE PERILS OF SECTIONS 8E AND

8EA OF THE INCOME TAX ACT

MILTON SELIGSON SC*

AbstrAct

The issue of preference shares by companies as a means of raising funding is

well established in South Africa. It is typically used to provide financing in BEE

transactions and in a variety of other corporate situations where substantial

funding is required.

From an income tax perspective, relatively short-term funding derived

from preference shares is discouraged, being treated like an ordinary loan by

taxing dividends received on the preference shares as income in the hands

of the recipient.

This is achieved by a complex tax regime which, in section 8E of the Income

Tax Act, targets preference shares (as well as equity shares) that are redeem-

able or may be disposed of, within a period of three years from the date of

issue. Such shares are treated as ‘hybrid equity instruments’, the dividends on

which are taxed as income. An extended definition of ‘date of issue’ widens

the ambit of this provision. It applies to the date on which after the issue of

the shares, the issuer undertakes the obligation to redeem the shares in whole

or in part, or the holder obtains the right to require such redemption.

Section 8EA, which must be read with section 8E, targets ‘third-party

backed’ preference shares by deeming dividends thereon to be income in

relation to the recipient, where there is an ‘enforcement right’ exercisable by

the holder of the share to require any person other than the issuer to acquire

it, or to make any payment in respect of that share in terms of a guarantee,

indemnity or similar arrangement.

The article explores the question whether and in what circumstances the

refinancing of the usual type of medium- to long-term corporate preference-

share transaction will escape the perils of sections 8E and 8EA. The relevant

definitions in these provisions are explained and their application to the refi-

nancing of such a transaction is discussed. The article also reviews BPR 191

in which SARS considered the refinancing of loan debt through preference-

share funding and ruled that the provisions of sections 8E and 8EA were not

implicated.

There is further analysis of the provisions of section 8EA and their applica-

tion in circumstances where, notwithstanding the existence of enforcement

rights which would satisfy the definition of ‘third-party backed share’, the

issue of the shares for a ‘qualifying purpose’ would exclude the application

of section 8EA. The definition of ‘qualifying purpose’ and its scope are also

explored.

* Honorary Member, Cape Bar.