In the listed sector, shareholders may be presented with various elections to be made as regards the nature of distributions made by companies in which equity investments are held.
Shareholders can therefore be faced with an election to receive payment of a cash dividend, or in lieu thereof, to receive capitalisation shares from the underlying company or to partake in a dividend reinvestment plan.
Shareholders should be aware that the South African tax consequences of such distributions made by South African tax resident companies may differ materially, depending on the election made. A high level overview of certain tax aspects relating to these distributions is set out below.
Cash dividends paid by South African resident companies in the ordinary course to resident and non-resident shareholders generally qualify for the domestic income tax exemption contained in section 10(1)(k)(i) of the Income Tax Act, 1962 (the Act), and are subject to dividends tax at the rate of 20%, subject to any exemption from the dividends tax applying, or a reduction in the rate of tax by virtue of the application of a double taxation agreement (DTA).
However, where the company paying the cash dividend is a REIT (as defined in section 1 of the Act), cash dividends paid to:
- South African resident shareholders are generally subject to income tax (section 10(1)(k)(i)(aa)) and exempt from the dividends tax; and
- non-resident shareholders generally qualify for the domestic income tax exemption contained in section 10(1)(k)(i) of the Act, and are subject to dividends tax at the rate of 20%, subject to any exemptions applying or any reduction in the rate of tax by virtue of the application of a DTA.
Scrip dividends/capitalisation shares
The reference to the issue of scrip dividends or capitalisation shares indicates that the relevant company will issue new shares to its shareholders as opposed to making a cash distribution to shareholders.
Since the issue of a capitalisation share is specifically excluded from the definition of a dividend contained in section 1 of the Act, the tax implications arising in respect of receipt or accrual thereof are firstly determined with reference to the gross income definition contained in section 1 of the Act, irrespective of whether the underlying company is a REIT or not. The determination as to whether or not the amount in respect of the capitalisation shares received or accrued will result in an inclusion in the gross income of a shareholder should be made with reference to whether, inter alia, the capitalisation shares are of a capital nature or not. This is a fact-specific enquiry to be made with reference to all circumstances relevant to the shareholder in question. It seems that, in practice, SARS treats capitalisation shares as being of a capital nature.
In the event that the shareholder receiving the capitalisation share is a non-resident, the capitalisation share would need to be received or accrued from a South African source in order for an amount to be included in the gross income of the foreign shareholder. Since there are no legislative source rules pertaining to the receipt or accrual of capitalisation shares, this enquiry should be carried out with reference to case law principles.
The issue of capitalisation shares will not attract the imposition of securities transfer tax (STT).
With regard to any subsequent disposal of capitalisation shares received, section 40C of the Act provides that capitalisation shares are deemed to have been acquired for expenditure of nil. This deeming provision applies where the shares are disposed of on capital account or on revenue account.
Dividend reinvestment programme
The mechanics of a dividend reinvestment programme are such that the shareholder generally accrues a cash dividend, which is then applied towards the issue or acquisition of additional shares in the underlying company.
Although the outcome of electing to participate in a dividend reinvestment programme may be economically similar to the election to receive capitalisation shares, different tax implications arise when electing between these two options.
As a result of the mechanics of the dividend reinvestment programme, both resident and non-resident shareholders should accrue a cash dividend which, as set out above, should generally qualify for the domestic income tax exemption and be subject to dividends tax at the rate of 20%, absent any exemptions or DTA relief.
If the dividend reinvestment programme is entered into in respect of shares held in a REIT:
- South African resident shareholders will generally be subject to income tax and qualify for an exemption from the dividends tax in respect of such amount; and
- non-resident shareholders will generally qualify for the domestic income tax exemption and will be subject to dividends tax at the rate of 20%, subject to any exemptions or relief in terms of a DTA.
Should the dividend reinvestment programme entail the issue of new shares to shareholders, no STT implications should arise. However, STT implications would arise for the shareholders where existing shares are transferred to such shareholders.
With regard to any subsequent disposal of shares acquired pursuant to a dividend reinvestment programme, section 40C of the Act should not apply on the basis that the cash dividend which accrues to the shareholder is applied to subscribe for or acquire shares in the underlying company. As such, the expenditure incurred in respect of the acquisition of such shares should not be deemed to be nil.
Shareholders should therefore carefully evaluate the economic effect as well as the tax implications of the relevant options available to them before making an election in respect of a particular form of distribution.