The Future of Preference Shares in South Africa: Will they work for your own company?

Published: 9 September 2025

For decades, preference shares have been a staple funding instrument in South Africa’s corporate finance landscape. Their hybrid nature—legally equity but economically similar to debt—has made them attractive to both issuers and investors. Yet, the future of preference share funding structures is now under serious scrutiny.

Why Preference Shares Became Popular

At their core, preference shares involve a financier subscribing for shares that carry:

• A pre-agreed dividend rate, often mimicking an interest coupon.

• A redemption profile, which outlines when and how capital is returned.

  
  

From the investor’s perspective, the major attraction has been that dividends are exempt from income tax in many cases—unlike interest, which is fully taxable. For issuers, preference share funding has often provided cheaper after-tax capital than traditional debt.

Key Features of Preference Shares

Traditional preference share terms vary:

• Cumulative or non-cumulative dividends

• Participating rights in excess profits

• Convertible rights into ordinary equity

• Redeemable features that provide certainty on capital return

  
  

These features are usually embedded in a company’s Memorandum of Incorporation (MOI), approved by shareholders, and lodged with CIPC before issuance.

The Draft 2025 TLAB Proposal

On 16 August 2025, National Treasury and SARS published the Draft Taxation Laws Amendment Bill (2025 Draft TLAB). A key focus is section 8E of the Income Tax Act, which already targets “hybrid equity instruments” that are essentially debt in disguise.

Currently, section 8E applies mainly to preference shares with a redemption period of three years or less. Market participants have long avoided this trigger by designing shares redeemable after “three years and one day.”

Changes Proposed in the Draft TLAB

The Draft TLAB would remove the three-year test entirely, instead tying classification to International Financial Reporting Standards (IFRS). In other words:

• If the instrument is shown as a financial liability in the issuer’s financial statements,

• Then it becomes a hybrid equity instrument for tax purposes,

• Meaning dividends are deemed ordinary income in the hands of investors.

  
  

Treasury’s rationale is based on economic substance over legal form. Preference shares structured to look like debt in IFRS should also be taxed like debt.

Impact on Existing and Future Issuances

Crucially, the proposal would apply to all preference shares in issue, not just new issuances. From 1 January 2026, dividends paid to investors would be taxable as income—regardless of when the shares were originally issued.

This means banks, private equity funds, and corporate investors holding preference shares would suddenly face a material after-tax yield reduction.

The “Adjustment Event” Trap

Most preference share agreements anticipate tax changes. They include adjustment event clauses, which trigger a tax gross-up if dividends become taxable.

The math is punishing:

• On a R100 dividend, the gross-up pushes the payout to R136.99 just to leave investors whole after tax.

• For issuers, this makes preference share funding far more expensive than straightforward debt, where no gross-up applies.

  
  

In effect, the gross-up clauses could accelerate the demise of preference share funding, as issuers opt for cleaner, cheaper debt alternatives.

Market Response and Next Steps

Treasury has invited public comments until 12 September 2025. Market pushback is likely to be strong, given the reliance on preference shares in M&A, BEE funding structures, and balance sheet management.

Possible Outcomes

• Revision: Narrower application, carve-outs, or phased implementation.

• Delay: Extended timelines to allow transition.

• Withdrawal (less likely): A full retreat from the IFRS approach.

  
  

Still, the policy direction is unmistakable: SARS and Treasury aim to close tax arbitrage and ensure consistency between accounting and tax treatment.

Strategic Considerations for Issuers and Investors

1. Scenario Modelling

   Recalculate IRRs and cash flows assuming dividends are taxable and gross-ups apply. Compare preference share funding against senior and mezzanine debt.

   
   

2. Term Sheet Review

   Identify clauses that could be recharacterised as debt-like: redemption obligations, step-up coupons, convertibility, or participation features.

   
   

3. Funding Optionality

   Keep parallel debt structures ready. Don’t let deal pipelines stall if preference shares suddenly become unviable.

   
   

4. Engagement

   Submit comments to Treasury. Industry voices matter in shaping the final legislation.

   
   

Conclusion

The 2025 Draft TLAB marks a turning point. Whether or not the proposals are enacted as-is, the signal is clear: preference shares with debt-like features are under tax pressure.

For issuers and investors, the prudent course is to plan for a future where preference shares may no longer deliver their historical tax advantage. In many cases, the end of the road may be near—but those who adapt early will avoid costly surprises when policy catches up with practice.

👉 Your move: Are your funding structures resilient to these changes? Now is the time to stress-test, reprice, and renegotiate before 2026 arrives.

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