Author: Heinrich Louw (Cliff Dekker Hofmeyer)
The South African Revenue Service (SARS) released Binding Class Ruling No 42 on 7 February 2014. The factual circumstances in respect of which the ruling was made are as follow:
Company Y is a company incorporated and resident in foreign country Y. Company X is a company incorporated and resident in country X. Company X is also a wholly-owned subsidiary of Company Y. Company X is to be listed on the JSE Limited. Its business is investment in foreign debt instruments, on which it will receive interest returns.
Company X intends to raise funds for its business by issuing certain preferred securities. The preferred securities will be issued through its branch in country Y.
The preferred securities would:
- be redeemable after five years or more at the same amount paid for them;
- confer preferred rights to dividends;
- generally not carry any voting rights;
- rank pari passu with all other preferred securities; and
- rank in preference to ordinary shares.
The dividends payable in respect of the preferred securities would be:
- calculated with reference to a rate derived from the underlying foreign debt instruments;
- limited to the net revenue derived from the underlying debt instruments; and
- paid in cash.
Certain South African investors (the class of persons concerned) would be beneficial owners of dividends paid by Company X in respect of the preferred securities.
Section 10B(2) of the Income Tax Act, No 58 of 1962 (Act) provides that foreign dividends are exempt from normal tax in certain circumstances. Specifically, in terms of s10B(2)(d) of the Act, a foreign dividend will be exempt to the extent that the dividend is paid in respect of a ‘listed share’ and does not constitute a distribution of an asset in specie.
The issue that arises in these circumstances is whether the preferred securities constitute ‘listed shares’ and whether the South African investors would be able to rely on the foreign dividend exemption in respect of dividends paid on these securities.
A ‘listed share’ is simply defined in s1 of the Act as any share that is listed on a licensed exchange in terms of the Financial Markets Act, No 19 of 2012. The JSE Limited constitutes such a licensed exchange.
SARS ruled that:
- the preferred securities in question would constitute ‘listed shares’ for purposes of s10B(2)(6) of the Act;
- the dividends paid in respect of the securities would constitute ‘foreign dividends’; and
- the dividends would not constitute a distribution of an asset in specie.
By implication, SARS ruled that the South African investors would in principle be able to rely on the foreign dividend exemption in s10B(2) of the Act.
Interestingly, SARS did not make any ruling in respect of whether the dividend income in the hands of the South African investors would be re-characterised as ordinary income in terms of s8E and 8EA of the Act.