|Peter Dachs, ENS Taxand|
To avoid the re-characterisation of dividends as income in the hands of the shareholder it is important:
- that there is no obligation on the issuer of the shares to redeem the shares within three years; and
- that there is no option of the shareholder to redeem the shares within three years.
It is also necessary to ensure that the shares are not secured by a financial instrument and are also not subject to an arrangement in terms of which a financial instrument may not be disposed of by the issuer. It should therefore be ensured that there is no negative pledge in relation to any financial instrument held by the issuer.
Even if the relevant triggers are met, the dividends will still not be re-characterised as taxable income provided the shares are issued by the issuer for the purpose of acquiring equity shares in an operating company.
In terms of the new section 8EA, any dividend received by or accrued to a person during any year of assessment in respect of a share must be deemed in relation to that person to be an amount of income (and not a tax exempt dividend) if that share constitutes a "third-party backed share" at any time during that year of assessment.
A "third-party backed share" is defined in section 8EA(1) as any share in respect of which an enforcement right is exercisable or an enforcement obligation is enforceable as a result of any amount of any specified dividend or return of capital attributable to that share not being received by or accruing to the person holding the share.
An "enforcement obligation" is defined in section 8EA(1) as, in relation to a share, any obligation, whether fixed or contingent, of any person other than the issuer of the share to:
(i) acquire the share from the holder of that share;
(ii) make any payment in respect of that share in terms of a guarantee, indemnity or similar arrangement; or
(iii) procure, facilitate or assist with any acquisition or the making of any payment contemplated in (i) or (ii) above.
An "enforcement right" has similar wording to the concept of an "enforcement obligation".
In terms of the proviso to the definition of a "third-party backed share", where the purpose of the issuer in issuing the preference shares is to acquire equity shares in an operating company, then the re-characterisation of dividends as taxable income does not take place. This is provided that the enforcement right or enforcement obligation may be exercised against any company that forms part of the same group of companies as the issuer and operating company respectively.
It can therefore be seen that there are fairly complex rules relating to the re-characterisation of tax exempt dividend income to taxable income in respect of certain shares. These rules apply in respect of existing shares and therefore it should be ensured that, at the relevant effective dates, the above-mentioned triggers are not in place in respect of all such shares.
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