Introduction

The introduction of capital gains tax (CGT) with effect from 1 October 2001 brought about many additional administrative changes. In addition, CGT had to be integrated with a variety of different sections in the main body of the Income Tax Act, 58 of 1962 (the Income Tax Act). The topic of dividends was no exception.

Taxpayers are now obliged to keep more records than before, and for longer in respect of capital transactions, i.e. from acquisition to disposal. The recent proposed changes that will in time lead to the shift in tax burden from the company to the shareholder in respect of dividends declared has more difficulties than meet the eye. Historical treatment of dividends will have to be integrated into the new treatment, including the capital gains tax treatment.

Whenever a tax is introduced or amended, initial teething problems are discovered. CGT is not without its difficulties; some administrative, some procedural, legislative etc. The new withholdings tax on dividends (as proposed) is expected also to introduce further complications.

This paper aims to address one of the current difficulties, namely the CGT implications resulting from capital distributions by companies. Part 1 covers the background issues and the CGT aspects in broad terms. Part 2 explores more fully the changes to the treatment of capital distributions for CGT purposes contained in the Revenue Laws Amendment Act, No. 35 of 2007.

Capital gains tax implications of capital distributions

Prior to the introduction of CGT, the tax treatment of dividends was fairly straightforward. Dividends received from South African companies were largely exempt from taxation and the capital profit made on disposal of the shares had no taxation consequences. Record-keeping, in these circumstances, would not feature in the mind of the investing taxpayer.

Subsequent to the introduction of CGT, the disposal of shares by an investor required the taxpayer to take account of any capital distribution made prior to 1 October 2001 in determining the base cost of a share and any capital distribution made subsequent to that date would impact ‘proceeds’.

In essence, the capital distribution is defined as any distribution that is not a dividend. The determination of the amount of the dividend as defined in the Income Tax Act therefore grew in importance for the investor. Paragraph 76 of the Eighth Schedule to the Income Tax Act (the Eighth Schedule) (before considering the amendments contained in the Revenue Laws Amendment Act, No. 35 of 2007) requires that the effect of capital distributions received or accrued prior to the disposal of any share (but subsequent to 1 October 2001) must be deferred until the disposal of that share. Therein lie the potential problems: (1) Are shareholders even aware of amounts that constitute a capital distribution? (2) Are the shareholders aware of the need to keep a record of such capital distributions received until disposal of the shares? (3) Where companies are making distributions to shareholders – is the split between the ‘dividend’ and the ‘capital distribution’ adequately disclosed?

How capital distributions arise prior to the disposal of a share – return of share capital or premium

In terms of section 90 of the Companies Act, payments to shareholders are permitted if certain requirements are complied with, principally that such payments must be authorised by the company’s articles of association, and that the directors must be satisfied as to the company’s ability to meet its financial obligations. Share buy-backs, which appear to fall into the category of payments to shareholders, are subject to approval by special resolution – either a general authority, which lasts until the next annual general meeting, or a specific authority relating to a specific buy-back.

The term ‘payments to shareholders’ is not defined in the Companies Act, and no specific limitations or qualifications are contained in respect of the term. Hence it seems to be generally accepted that the term permits the payment of share capital or share premium to shareholders, subject to the compliance mentioned above.

Returning to the Income Tax Act, assuming that the proviso to the dividend definition was not applicable; distributions by companies from share premium would not constitute a dividend as defined in that Act. While repayments of capital (including share premium) above the nominal value of the share are dividends (paragraph (c) of the dividend definition), the repayment of share premium is specifically excluded (paragraph (f) of the dividend definition).

Where such a repayment of share premium is made by a company, and assuming that the provisos to the dividend definition are not applicable to this case, the net effect for such a company making such a distribution is no liability for secondary tax on companies (STC). For the shareholder, none of the amount is a dividend as defined. Assuming the shareholder holds the share with a capital intention (i.e. for investment purposes); the amount is not a dividend as defined and is therefore a capital distribution. Since repayments of share premium are not necessarily accompanied by the disposal of the shares, this distribution would qualify as a deferred capital distribution (i.e. the CGT effect would have to be deferred until such time as the shareholder disposes of the shares). Shareholders are generally pleased to receive distributions, and many might be unaware of the consequence of receiving a ‘distribution’ instead of a ‘dividend’.

The responsibility lies with the shareholder to maintain records related to any capital distribution received that was not related to the disposal of any shares. It is submitted that this requirement may not always have received the necessary attention, either by the company making a distribution or by the shareholder receiving such distribution.

Payments to shareholders out of share premium as a substitute for regular dividend payments

A number of companies have made payments to shareholders using the share premium account, as a substitute for making dividend payments out of profits. Presumably this has been done in order to effect a saving of STC by those companies. For the reasons discussed above, this leads to the company avoiding STC, but has CGT implications for shareholders.

This leads to the question of whether disclosure by the companies adopting this approach have been adequate to ensure that their shareholders are fully aware of the potential cash flow implications of such a policy, as well as the need to maintain records of those capital distributions indefinitely.

Another potential problem is the extent to which shareholders that are companies might have inadvertently treated these capital distributions as if they were regular dividend distributions, thereby reducing the amount of their net dividends declared for STC purposes. Moreover, the question arises as to whether companies receiving capital distributions have properly accounted for the deferred tax arising from the deferred capital gains.

(Table 1 highlights a table of the companies that have made capital distributions to shareholders between 2000 and 2006. The table comprises only the companies listed on the JSE that made capital distributions during the relevant years. It does not include companies that were unlisted at the time of making capital distributions. It is a guide only and should not be relied on for purposes of determining any taxpayer’s obligations to
the fiscus.)

The Revenue Laws Amendment Act, No. 35 of 2007

In terms of the Revenue Laws Amendment Act, No. 35 of 2007 (the Amendment Act) nothing changes with respect to capital distributions that were made prior to 1 October 2001. In terms of paragraph 76 of the Eighth Schedule, these are treated as a reduction of the expenditure allowed by paragraph 20, and are thus taken into account in determining the base cost of a share. It is questionable as to how many shareholders would actually have such information to hand. Prior to the amendments discussed below, those capital payments received by shareholders between 1 October 2001 and 1 October 2007 represented proceeds deferred until the eventual disposal of the shares.

The proposed amendments to the Income Tax Act, embodied in the Amendment Act, introduce an unexpected twist and will require that shareholders deal with capital distributions from a CGT perspective a lot earlier than had been anticipated. In essence, the amendments to paragraphs 76 and the insertion of paragraph 76A by the Amendment Act provide that capital distributions received between 1 October 2001 and 1 October 2007 will continue to be added to proceeds on disposal of the relevant shares. However, where the relevant shares are still held at 1 July 2011, shareholders will have to account for a capital gain by treating the capital distributions during that period as part disposals of the shares in the 2012 tax year. Similarly, any capital distributions received after 1 October 2007 will be treated as a part disposal of the shares, and a capital gain will be included in taxable income in the year the capital distribution is received or accrued.

Relevant disclosure

In general, institutional shareholders and shareholders with dematerialised holdings that receive comprehensive statements from their CSDPs (Central Securities Depository Participants) or from asset management companies will have the level of detail necessary to deal with the CGT implications of capital distributions (provided that the statements from these agents are properly retained by the shareholders). However many smaller shareholders, including natural persons, trusts and small companies, and especially those that do  not have dematerialised holdings, would tend to rely on direct communication from the companies in which they invest. Such communication might not always be as clear as it could be.

Woolworths Holdings Ltd is an example. In its 2006 annual report it discloses a ‘distribution per share’ of 63 cents for the year, which is partially reflected as a reduction of share premium of R176.4m in the statement of changes in equity (the balance being charged against retained profit, due presumably to the amount of share premium having been depleted). The directors’ report, under the heading Distribution to Shareholders makes the appropriate distinction between the dividend and the capital portion of the distributions, but the final and interim profit announcements refer only to ‘dividend’ payments, and neither to ‘distributions’ nor to ‘capital distributions’. A less sophisticated shareholder could be forgiven for treating the capital distribution as a dividend and fail to retain the information for the length of time required.

Conclusion

In conclusion to Part 1 of this article, it is clear that shareholders need to take early steps to ensure that they have the necessary information regarding capital distributions, both past and future, in order to calculate their capital gains correctly. Where the information on past capital distributions is not to hand, shareholders should take steps to obtain it, so as to avoid complications arising in the assessment of their tax liability. Shareholders who received capital distributions prior to 1 October 2007 need to be aware of the looming cash flow implications of such distributions, especially in respect of shares that are not disposed of by 1 July 2011.

In Part 2 of this article, the amendments to paragraph 76, and the new paragraph 76A, will be explored more fully, including an assessment of the effects arising where the base cost of identical shares is calculated using the weighted average method.

Craig West BCom, MCom CA(SA) and Peter Cramer BCom (Hon), BCompt, MBA, CA(SA) are both senior lecturers in the Department of Accounting at the University of Cape Town.

 

Table 1 – Listed companies that have made capital distributions to shareholders between 2000 and 2006

Source: JSE Market Information Division

 

Calendar year	2000	2001	2002	2003	2004	2005	2006
Share
AB BVT							√
ACUMEN	√
ADCORP				√	√
ADVTECH						√	√
AFGRI						√	√
AFHARV			√
AGI				√	√		√
ALEXFBS			√	√		√	√
ALLIANCE				√	√
ALLIANCE
ALLIANCE -N				√	√
AMAP							√
AMAPROP -LS	√
ANGLO – NAMIBIA			√
ANGLOVAAL IND						√
APN						√	√
AQUILA	√				√
ASPEN						√	√
AVIS			√	√
AVMIN	√
BIDVEST			√	√	√	√	√
BILLBOARD		√
BOE	√
BOE CORPORATION	√
BOLTON FOOTWEAR	√
BONATLA					√
BRANDCO					√
BVT						√	√
C G SMITH	√
CADIZ					√		√
CADSWEP	√
CAXTON				√
CLIENTLE LIFE	√
CLIENTLE LIFE				√
CLINICS	√	√
CML						√	√
CML
COMPAREX					√
COMPCLEAR							√
CONGELLA FED 6% P				√
CONLOG	√
CORONATION HLDGS				√
CORPCAP				√	√
CRN-B				√
CST-B	√	√
DATACENTRIX					√
DATATEC							√
DAWN	√			√		√	√
DELCORP	√
DELFOOD	√
DELHOLD	√
DORBYL			√
ELLERINE
ENVIROSEV HOLDINGS			√	√	√	√	√
FAMBRANDS							√
FORIM				√	√
FORIM
FORTUNE			√
FRAME	√
GEM	√
GENSEC	√
GFSA	√
GLOHOLD	√
GLOHOLD
GOODCAP				√
GRAY	√
HOWDEN							√
HUDACO	√
I & J -CD	√
IDION							√
IMPERIAL			√	√	√	√	√
INDFIN						√
INFOWAVE			√
INTRADING			√
IPL						√	√
KAP INTERNATIONAL							√
KELGRAN							√
KPM		√
KTL		√
LAGO					√
LGL NB IB 3100 10/06							√
LIBERTY		√					√
LIBERTY
LOGOPT		√
LONRHO			√
MAC-B	√
MASSMART					√
MCUBED						√
MEDI-CLINIC			√	√	√	√
METLIFE						√	√
METMAR							√
MINACO	√
MMWTECH		√
MNET/SS				√
MOBILE
MONEYWEB					√
MR PRICE						√	√
MVELA GROUP							√
NAIL					√
NAIL -N					√
NAMPAK							√
NAMPAK
NETCARE	√	√	√	√	√	√	√
NEW CPA						√	√
NEW CPA
NEW WITS	√
NORTHAM PLATINUM				√	√
NPK							√
NUCLICKS							√
NU-WORLD
OTK Limited	√	√
OZZ				√
PALS HOLDINGS			√
PARACON					√	√	√
PETMIN				√
PGH	√	√		√
PHUMELELA						√	√
POWTECH			√
PRIMEDIA				√	√	√	√
PRIMEDIA – N				√	√	√	√
PSG	√			√
PSGOLD			√
RAHOLD				√		√	√
REAL AFRICA			√
REBSERVE HOLDINGS				√
REMBRANDT BEH	√
RMB HOLDINGS						√
RMH						√
SAAMBOU	not a OS ( IP)			√	√
SAAMBOU
SANTAM						√
SATRIX FINI				√
SEAHARV	√
SEARDEL	√	√
SEARDEL-N	√	√
SEARTEC		√
SFT-B				√
SOL IB CBD R123 11/6							√
SOLUTIONS			√
SOVEREIGN					√	√	√
SPR-B	√
SPURCORP	√	√	√	√	√	√	√
STEINHOFF	not a OS ( IP)					√	√
TEGKOR	√
TIB	√
TIWHEEL						√	√
UNIFER	√
UNITRAN						√	√
VALUE							√
VOGELS	√
VOLTEX		√
WAC-B	√
WBHOVCO	√	√	√	√
WESCO			√
WESTERN AREAS	√
WETHLYS				√
WOOLIES				√	√	√
WPH-B	√
WPH-B			√
YABENG		√
ZARARA				√