In the 2013 Budget Review, which was released on 27 February 2013, specific mention was made that a research project is underway in which consideration is being given to a unified treatment of dividend cessions and manufactured dividends. As part of this project it noted that consideration will be given to anti-avoidance rules to eliminate the shift in the income from taxable parties to exempt parties. The Budget Review states that the tax impact of a dividend transfer depends on whether the transfer is a cession or a dividend compensation payment. It notes that in the case of a cession, the dividend generally retains its nature while in the case of a dividend compensation payment, the payment is largely deductible by the payor and largely includable by the payee. It further states that both sets of rules continually give rise to tax avoidance or mismatches that reduce the ultimate tax due on the economic profit.
This announcement comes after the Income Tax Act 58 of 1962 (“Act”) has recently been amended to address the taxation of these types of income both from an income tax and dividends tax perspective.
In terms of the current rules, taxpayers are required to specifically include dividends in their gross income. Although certain exemptions apply to dividends, in the case of a dividend which has been received or accrued to a company in consequence of any cession of the right to that dividend, this exemption would not apply unless that cession or exercise is part of the disposal of all of the rights attaching to a share. Therefore, any dividend which a company currently receives as a result of a cession which is not part of the disposal of all the rights attaching to a share, that is, the typical dividend cessions, is included in a taxpayer’s gross income and subject to income tax. Similarly, to the extent that a manufactured dividend is received or accrued by a taxpayer, it would be included in the taxpayer’s gross income and be subject to tax. As such, broadly speaking, from an income tax perspective, the receipt of dividends by a company as a result of a cession of such dividend to the taxpayer and the receipt of a manufactured dividend are both taxable receipts.
In addition, currently specific anti-avoidance measures exist under the dividends tax provisions which apply to dividend cessions and the receipt of manufactured dividends in certain circumstances.
In particular, section 64EB(1) of the Act provides that where a person that is a beneficial owner contemplated in section 64F (i.e. beneficial owners who are exempt from dividends tax) acquires the right to a dividend by way of a cession and that dividend is either announced or declared before that acquisition, that dividend is deemed to be a dividend paid for the benefit of a person ceding that right. This sub-section does not apply to any cession in respect of a share if the right to that dividend is ceded together with all the rights attaching to that share.
In addition, section 64EB(2) provides that for dividends tax purposes, where a person that is a beneficial owner contemplated in section 64F (that is, beneficial owners who are exempt from the dividends tax) borrows a share in a listed company from another person and a dividend is either announced or declared before that share is borrowed, so much of any amount paid by the person in respect of that borrowed share does not exceed the amount of the dividend is deemed to be a dividend paid for the benefit of that other person.
The provisions in section 64EB were introduced with effect from 1 September 2012 and are applicable in respect of transactions entered into on or after that date and amounts paid on or after 1 October 2012 in respect of transactions entered into before 1 September 2012.
Based on the explanatory memorandum to the Taxation Laws Amendment Bill of 2012, these rules were introduced to close tax schemes which emerged for the benefit of foreign shareholders that reduces the dividends tax rate to zero (without any reliance on a tax treaty) by converting the taxable payment of dividends into exempt compensation, gains or income upon disposal.
Notwithstanding the introduction of these specific anti-tax avoidance rules, based on the announcement in the Budget Review, it appears that further changes are to be expected and such changes will seek to align the tax treatment of the different income streams. It remains to be seen what these changes will look like and the impact they will have on the dividend cessions and the payment of manufactured dividends. In the meantime, the current provisions remain on the statute book and provide specific rules dealing with dividend cessions and manufactured dividends.