The South African Revenue Service (SARS) released Binding Class Ruling 42 on February 7 2014. The factual circumstances in respect of which the ruling was made are as follows:
- 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 a wholly owned subsidiary of Company Y.
- Company X is to be listed on the JSE Limited.
- Company X’s 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 equally 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 (58/1962) provides that foreign dividends are exempt from normal tax in certain circumstances. Specifically, in terms of Section 10B(2)(d) of the act, a foreign dividend will be exempt to the extent that it 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 Section 1 of the act as any share that is listed on a licensed exchange in terms of the Financial Markets Act (19/2012). The JSE Limited constitutes such a licensed exchange.
SARS ruled that:
- the preferred securities in question would constitute listed shares for the purposes of Section 10B(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 Section 10B(2) of the act.
Interestingly, SARS made no ruling in respect of whether the dividend income in the hands of the South African investors would be recharacterised as ordinary income in terms of Section 8E and 8EA of the act.