Contributed tax capital in a company context

taxation 2Author: Emil Brincker (DLACliffeDekkerHofmeyr)

The creation of contributed tax capital (CTC) and the return thereof by a company to its shareholders has been the subject matter of some misconception over the years.

The CTC of a company is a notional amount that is created pursuant to the subscription of shares by holders of a specific class of shares as consideration for the issue of those shares by the company. To the extent that a company has different classes of shares, the CTC of each class is ring-fenced and cannot be used to return to the holders of another class of shares. Effectively the CTC was traditionally seen to be the share capital together with share premium that arose pursuant to the issue of shares. Pursuant to the fact that the Companies Act, No 71 of 2008 now provides for the use of no par value shares, the CTC is effectively equal to such share capital that is created less any amounts that have been returned to shareholders.

The importance of a return of CTC is that it does not constitute a dividend and is thus not subject to dividends tax. However, in order for a company to return CTC to its shareholders, a specific resolution must be taken by the board or an appropriate committee that has been designated by the board to such effect. If no such resolution has been taken by the board, one cannot argue subsequently that there has been a return of CTC.

Equally, to the extent that one returns CTC to the holders of a specific class of shares, the CTC must be used proportionately in respect of all of the holders and cannot be returned to only selected holders of a class of shares. One cannot therefore return CTC to only Shareholder X in circumstances where Shareholder Y does not participate proportionately in any such return of CTC.

In terms of the current draft amendments to the Income Tax Act, No 58 of 1962 specific provisions will be inserted dealing with the CTC attaching to so called convertible shares. For instance preference shares are often issued in circumstances where they are convertible into ordinary shares. To the extent that the preference shares are issued, these preference shares constitute a separate class even though they may be converted subsequently into ordinary shares. Should the preference shares be converted into ordinary shares, the CTC attaching to the preference shares does not automatically ‘transfer’ to the CTC of the ordinary shares.

In terms of the proposed amendments the CTC that attaches to the preference shares that are converted, will be transferred from the preference shares to the ordinary shares and deducted from the CTC reflected in respect of any remaining convertible preference shares.To the extent that the company receives any additional consideration pursuant to the conversion of the preference shares, such additional shares will also be reflected as part of the CTC in respect of the ordinary shares, ie the shares into which the preference shares have been converted.

The proposed amendment is welcomed as it provides clarity in respect of the previous uncertainty pertaining to the treatment of CTC associated with convertible shares.