In terms of section 8E of the South African Income Tax Act, 1962 (the “Act”), dividends received by or accrued to a person in respect of certain shares and “equity instruments”, as defined, must be deemed in relation to that person to be an amount of income if that share or equity instrument constitutes a “hybrid equity instrument” at any time during that year of assessment.
The term “hybrid equity instrument” is defined in section 8E, inter alia, as:
(a) “any share, other than an equity share, if –
i. the issuer of that share is obliged to redeem that share in whole or in part; or
ii. that share may at the option of the holder be redeemed in whole or in part,
within a period of three years from the date of issue of that share.”
Paragraph (b) of the definition deals with shares other than those contemplated in paragraph (a) (and thus, broadly speaking, equity shares), contains similar provisions, but with an additional requirement should paragraph (i) or (ii) above be met.
(a) “Date of issue” is defined in section 8E of the Act, in relation to a share in a company, as the date on which:
(b) “the share is issued by the company;
(c) the company at any time after the share has been issued undertakes the obligation to redeem that share in whole or in part; or
the holder of the share at any time after the share has been issued obtains that right to require that share to be redeemed in whole or in part, otherwise than as a result of the acquisition of that share by that holder.”
It is submitted that the object of paragraphs (b) and (c) is to ensure that shares, the terms of which when issued did not result in that share qualifying as a hybrid equity instrument, will qualify as such if there is a subsequent undertaking by the issuer to redeem, or acquisition of a right by the holder to require the redemption of that share within a period of three years from the date of issue.
In practice, to ensure that a share does not qualify as a “hybrid equity share”, the redemption date is typically more than three years from the date on which the share is issued by the company.
Where a share is issued with a scheduled redemption date more than three years after the date of issue, and the term of that share is subsequently varied to extend such redemption date, the question arises whether such variation of the terms of the share (other than a variation that introduces an obligation or right to redeem the share as contemplated in paragraph (b) or (c) of the definition of “date of issue”) after the date on which the share was issued will constitute a new “date of issue” for purposes of section 8E of the Act.
By way of example, if shares are issued on 31 January 2017 and the terms provide for a scheduled redemption date of 1 February 2020, such shares should not constitute a hybrid equity instrument as there is no obligation or right to redeem the shares within a period of three years from the date of issue (assuming any “redemption events” which may trigger an earlier redemption are objectively defined and outside of the control of the issuer).
However, should the terms of the shares be varied before the redemption date, say on 20 January 2020, to extend the redemption date of the shares by one year, ie the shares are only redeemable on 1 February 2021, and thus within three years from the date of change of the rights and obligations attaching to the share, the question is whether that variation constitutes a new “date of issue”.
If the date of the variation constitutes a new date of issue, such share should constitute a hybrid equity instrument from 20 January 2020, as the issuer would be obliged and the holder would have a right to require the redemption of such shares within three years from the new “date of issue”.
To constitute a new “date of issue”, the company must, after the share has been issued, undertake the obligation to redeem that share or the holder of the share must, after the share has been issued, obtain the right to require that share to be redeemed.
The question is therefore when the obligation or right to redeem the shares come into existence. Does such obligation or right arise when the shares are first issued and carry forward to the extended period of the shares, or does a new right or obligation come into existence when the period is extended?
In terms of the original agreement between the parties, there was a right or obligation to redeem the shares more than three years from the date of issue (at the scheduled redemption date, the company would be obliged and the holder would have the right to require the shares to be redeemed). These terms are then varied to provide that the right or obligation to redeem is extended for a further period. In our view, this is distinguishable from the issues that paragraph (b) and (c) of the definition of “date of issue” attempt to address, a situation where there is no obligation or right to redeem, and such obligation or right is subsequently introduced.
The South African Revenue Service has previously stated that the “date of issue” is defined not with reference to a fixed date, but with reference to the date on which an obligation or right to redeem come into existence. Further, the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2004 provides that: “Importance is placed on the redemption features added after the initial date of issue of the share. For instance, a company originally issued a non-redeemable preference share and subsequent to the original date of issue the terms of the share are altered to make the share redeemable within three years.”
While an explanatory memorandum does not have the force of law, it provides an indication of the legislature’s intention with regard to the legislation in question. Therefore, in our view, where a share has been issued and the issuer has an obligation or the holder a right to redeem after more than three years, and the parties subsequently agree to extend such redemption date (and such extended redemption date is within three years from the date of the variation), the obligation or right to redeem arises on the date that the shares were originally issued and no new “date of issue” should arise upon this variation of the terms.
Written by Carmen Gers, tax director and Chris de Bruyn, a candidate attorney in ENSafrica’s tax department.
This article was first published by ENSafrica.
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