(c) South Africa Institute of Chartered Accountants. Contact SAICA for permission to reproduce this article., Tax

South Africa updates its tax anti-dividend stripping rules relating to share issues to third parties

South Africa updates its tax anti-dividend stripping rules relating to share issues to third parties − but does the introduction of the wording ‘effective interest’ in the drafting of this legislation achieve its purpose?

By Madelein Grobler (Senior Tax Manager at EY), Shaheed Patel (Associate Tax Director at EY), Candice Van Den Berg CA (SA) (Tax Partner at EY) and Mohammed Y Jada CA (SA) (member of the SAICA National Tax Committee and Tax Partner at EY)

Effective and efficient design of a country’s tax system is ever changing – largely due to the state of the respective economy and its spending requirements, and also in part due to the innovation that taxpayers seem to apply to not being in a position where they are being subject to tax!

You may have heard of the 17th-century ‘window’ tax on inhabited houses in England and in Scotland where a tax was levied based on the number of windows a house had. The more windows, the more tax they had to pay. So, while it was easy to administer (as the windows would be clearly visible from the street), the downside was that this tax revenue declined over the years due to houses being built with fewer windows and existing houses having had some of its windows boarded up! It also had an unintended negative impact on the demand for glass and the glassmaking industry suffered due to low demand for windows! Not a very healthy (pun intended) situation for the home residents as you can imagine and after an outcry, this tax was finally repealed, albeit more than 150 years later, in 1851.

Another more recent example of a tax design with surprising consequences is the tax on swimming pools in Greece where you have to declare a minimum income of about R200 000 (at last exchange rate) for tax purposes if you own a swimming pool of over 25 square metres! Aimed at combating tax evasion and fraud, the Greek authorities have had to resort to using helicopters and google maps to identify tax delinquents and (ahem) widen the collection pool! A by-product of tax fueled innovation is an increased demand for ‘floating’ tiles and pool nets that conceal the pool.

Tax design, and the required efficiency for collecting the tax sought, needs to be optimally balanced and carefully thought through. This applies even more so when drafting the wording of tax legislation and often this is an area that leaves much to be desired − which brings us to the main topic of this article – the current tax bill contains changes to the anti-dividend stripping tax laws that at first glance seeks to limit abuse but upon a careful reading thereof will reveal that the resultant tax penalty is far from what may have been intended when designing and drafting the tax legislation.

We set out below the background to the new anti-dividend avoidance rules that came into operation on 20 February 2019 and analyse whether National Treasury (NT) achieved its purpose in introducing additional refinements to this constantly changing area of tax law.

New tax anti-dividend stripping rules relating to share issues to third parties

Companies should consider the new proposed tax anti-dividend stripping rules when declaring a substantial dividend followed by the issue of shares to third parties. The dividend may lead to additional taxation for shareholders corresponding to the reduction in their effective interest of their shareholding in the company.

The anti-avoidance rules are contained in section 22B (from an income tax perspective) of the Income Tax Act58 of 1962 as amended (the Act) and paragraph 43A (from a capital gains perspective) of the Eighth Schedule to the Act.


In 2012 we saw the new dividends tax regime being implemented, specifically allowing dividends declared between South African tax resident companies to be exempt from the dividends tax. Some companies subsequently took advantage of the opportunity to extract value from subsidiary (target) companies through receiving large tax-exempt dividends. The target company shares would then be subsequently sold at a significantly lower value (as the net asset value would be stripped of the pre-sale dividend), thus reducing the tax applicable to the shareholder on the sale of the target company’s shares.  

During 2017 National Treasury introduced anti-avoidance measures that targeted these dividend stripping schemes and extended the anti-avoidance rules to also include share buy-back avoidance schemes. These rules unfortunately caught legitimate corporate reorganisation transactions and NT then introduced legislation during 2018 that reversed the impact on legitimate corporate reorganisation transactions.

In essence, the anti-avoidance rules curb schemes where:

  • A shareholder company (having a qualifying interest[1]) sells the target company shares held, and
  • Within 18-month period prior to such sale received/accrued an exempt dividend constituting an extraordinary dividend (basically a dividend that exceeds 15% of the share market value)

The effect of the anti-avoidance rules is that the extraordinary dividend is deemed to be proceeds from the sale of the target company shares, which will either be included in the shareholder’s company tax computation as:

  • Income, if the shares were held as trading stock, or
  • a capital gain, if the shares were held as capital assets

New proposed anti-dividend rules – focus on ‘effective interest’ wording in the legislation   

During the Budget speech on 20 February 2019[2] it was announced that NT was aware of schemes that had been devised to circumvent the current anti-avoidance rules, and we saw the release of the 2019 Draft Taxation Laws Amendment Bill (2019 DTLAB) containing, inter alia, the current proposedrules setting the requirements to capture schemes that involve:

  • Value extraction (reducing the market value of the shares) by the declaration of a large dividend by a target company to a shareholder company that constitutes an extraordinary dividend[3]
  • Dilution of the shareholder company’s effective interest through the target company issuing new shares to a third party
  • Prior to the share issue, the shareholder company had a qualifying interest, and
  • The extraordinary dividend occurs within 18 months of the share issue

In essence, the shareholder company is deemed to have disposed of a percentage of its shares held in the target company equal to the reduction of its effective interest in that target company. The determination of how one would evaluate the reduction of the effective interest, remains to be tested given that no clarity has been provided by NT neither in terms of a definition in the draft legislation nor when specifically alerted to this during the submission of comments to NT on the draft legislation and neither again during the workshops conducted by NT during September 2019.

It is submitted that the current wording (which is unchanged in the Tax Bill[4]) may result in only the portion of the dividend relating to the deemed disposed shares (and to the extent that it constitutes an extraordinary dividend) that will be taxed in the hands of the shareholder company – and not the 85% portion of the dividend (which one would expect to be the subject of anti-avoidance tax rules).  

Practical example

The above is best illustrated by way of a practical example:

  • T-Co is an unlisted company and in 2015 T-Co had 100 available shares. S-Co subscribed for T-Co shares (ie base cost) in 2015 at 20 cents per share for all 100 shares (R20 consideration was paid in total). 
  • The value per T-Co share on 1 January 2018 was 100 cents. T-Co distributed a dividend on 31 January 2019 at 80 cents per share. Post distribution on 31 January 2019 the value per T-Co share is 20 cents per share.
  • A BBBEEE Transaction was concluded wherein B-Co subscribed for 34 T-Co shares at 20 cents each (ie base cost) on 30 June 2019. As a result, B-Co held 25% (34/134) of the shareholding in T-Co, while S-Co’s shareholding reduced from 100% (100/100) to 75% (100/134).  

Applying the legislation as currently in the Tax Bill, the transaction would fall within the ambit of the new anti-dividend stripping tax rules in that:

  • S-Co holds a qualifying interest in T-Co (a minimum 50% shareholding in the equity and voting rights in T-Co)
  • The declaration of the dividend on 31 January 2019 is within the 18-month period before the issue of the new shares to B-Co
  • The effective interest of S-Co in T-Co is reduced by 25%(on a shareholding basis)

[that is it now holds 100 of the total 134 shares (75%, compared to its
previous 100%]

, and

  • The dividend would constitute an extraordinary dividend –
    • Dividend of 80 cents/share declared for each share (within an 18-month period before new shares issued)
    • Exceeds 15% of the higher of the market value of a share:
      • At the beginning of the 18-month period (15% of R1/per share value on 1 January 2018 = 15 cents/per share), or
      • at the date of deemed disposal (15% of 20 cents/share = 3 cents/share)
    • Hence the extraordinary dividend would be 65 cents/share (being 80 cents/share less 15 cents/share) equating to R65 based on 100 shares being held.

The result of the current proposed anti-dividend stripping rules is that S-Co would be deemed to have disposed of 25% of its effective interest in T-Co (without having actually disposed of its’ shares) creating a tax liability of:

  • R4,55: being a R65 extraordinary dividend @ 25% (effective interest reduction) @ 28% (corporate tax rate), assuming the shares were held on revenue account, or
  • R3,64: being R65 extraordinary dividend @ 25% (effective interest reduction) @ 80% inclusion rate for CGT without any base cost adjustment) @ 28% (corporate tax rate), assuming the shares were held on capital account.

Analysing the current proposed rules, S-Co still qualifies for a tax-free benefit of three-quarters (it only reduced its effective shareholding by 25%) of the value extraction in T-Co, representing the remainder of the exempt dividend.

The current proposed rules do not seem to capture the full value extraction by way of the dividend received by S-Co, but only captures the proportionate dilution (being the 25% effective interest reduction portion in the above example). 

Conclusion – yet more refinements expected in the grand design

The new tax anti-dividend stripping rules seem to have missed the mark when considering the effect of applying the law as is currently contained in the Tax Bill, as only a portion of the value extracted through a prior substantial dividend would be subject to tax in the latest iteration of these anti-tax avoidance rules.

Was this intended by the legislature? Perhaps not. On the other hand, this was brought to the attention of NT through written submissions, yet no changes were made to the tax rules when the Tax Bill was tabled in Parliament on 30 October 2019 – so perhaps there is an argument that this may have indeed been the intention of the legislature! Our view, however, is that like all grand designs, we should not be surprised if yet another iteration or ‘refinement’ to these tax anti-dividend stripping rules in the coming year.

What this means though for companies is that precaution should be applied before effecting any substantial dividend as well as any shareholding dilution transactions. Consult your tax advisor before committing to any tax position.  


[1] Directly/indirectly held, at least 50% (or 20% if no majority shareholders’) of the shares or voting rights in an unlisted company (or if a listed company, directly/indirectly held at least 10%).

[2] As part of the 2019 Budget Annexure C tax policy proposals.

[3] Dividend that exceeds 15% of the higher of the share market value at the time of the deemed disposal or 18 months earlier.

[4] The Taxation Law Amendment Bill 18 of 2019 (the Tax Bill) was tabled in Parliament on 30 October 2019 by the South African Minister of Finance.

This article was originally published in ASA.