The antecedent divestment of a right to a dividend has been a feature of our tax law for longer than I have been in practice. See Hiddingh v CIR 1941 AD 111.
The Government are obviously concerned that the cession of this right is the foundation of what Government perceives as commercial abuse in modern law. Moreover, in as such as tax lawyers see a dividend as having a particular character because it is a distribution of after tax profits, the Revenue see the recipient of a ceded dividend as merely receiving another form of income distinct from the distribution of the underlying dividend.
The advent of the dividends tax will further complicate matters: there should be withholding if a natural person is the shareholder. But if he cedes his dividend right to a company, the company would be exempt; but only if the company is the “beneficial owner” of the dividend. The question arises if this is really the beneficial owner of the share or the dividend?
While the writer’s opinion is that the right to a dividend is something you should be entitled to sell if you wish, the Revenue are obviously seeing this principle abused as well. In the Explanatory Memorandum they say those transactions are only motivated by tax arbitrage. What appears to rub salt in the wound is that many of these cessions seem to be financed by tax deductible money.
We are about to embark on a new route in the life of dividend taxation, which will be achieved by extensive additions to the exclusionary provisions of Section 10 (1)(k)(i) (that is lots more reasons why a domestic dividend will not be exempt). The basic principle now underlying the receipt of an exempt dividend is that the company or trust that is a shareholder must be exposed to the risk of profit and loss associated with the share (a variation on the “at risk” principle). Natural persons are not exposed to this new avenue of thought so that for instance an heir of a testamentary trust can still be dividend recipient.
The first exclusion from exemption then is where the company or trust fails to hold the relevant shares from the date on which the dividend was declared until the close of the date on which it is received or accrued (subitem (ee)(A)). In the context of this legislation, one needs to note that dividends tax will be triggered on actual payment of the dividend, or if the amount due is set aside or made unconditionally available to be dealt with at the direction of the beneficial holder of the share (Section 64E(2)).
The second is where the relevant share is held as trading stock and is disposed of by the holder within 45 days after the date of receipt or accrual; but the law will not take into account days if the holder has an option to sell the share or has entered into a short sale or is the grantor of an option to buy the same share or has hedged its risk of loss by holding a contrary position on the same share (subitem (ee)(B)). The trader must be at risk on that share for the duration of the 45 days.
Then (ff) and (gg) provides that exempt status for dividends on borrowed shares shall no longer be enjoyed. The aim with this legislation is to deny exempt status to the dividends where the borrower has a corresponding obligation to make up the dividend where he is short the identical share (ie pay the manufactured dividend). Effectively the legislation is seeing the company with corresponding long and short positions not being “at risk” on the underlying share. The writer has struggled to understand if the mischief is the fact that the borrower is not “at risk”; or that his obligation to pay the manufactured dividend is frequently a tax deductible cost in running his business. The legislation does not require the linkage between long and short positions to apply – any dividends on borrowed shares will be treated as ordinary income in subitem (gg).
Where foreign companies receive or accrue domestic dividends, these dividends will firstly be subject to dividends tax from 1 April 2012. They may now also be taxed as income because they no longer enjoy exemption under these provisions. These foreign companies will be eligible for a tax credit against the dividends tax in terms of a new proposed section 6 sex.
DLA Cliffe Dekker Hofmeyr
Alastair Morphet