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Tax Impact of a Company Buying Back Its Own Shares

But what about the tax impact of selling my shares back to the Company?


Shareholders of a private company may buy back shares held by a minority shareholder.

Introduction

The Companies Act provides that a company may acquire its own shares to the extent that it is solvent and liquid (Section 4 and 46).


Section 114 provides that the company must retain an independent expert to compile a report in line with the requirements of the section by understanding the type of arrangement proposed, evaluating the consequence of the share buy-back and assessing the effect of the arrangement on the value and rights and interests of the remaining shareholders.


A share buy-back must be approved by a special resolution of the shareholders of the company (Section 115).


The number of shares that have to be serviced by the company, is reduced permanently and, from then on, distributions are made between fewer shareholders.




Tax Treatment The definition of a ‘dividend' in section 1(1) includes: "any amount transferred or applied by a company (that is a resident) for the benefit or on behalf of any person in respect of any share in that company, whether that amount is transferred or applied...(b) as consideration for the acquisition of any share in, that company.  It does not include any amount so transferred or applied to the extent that the amount so transferred or applied ... (i) results in a reduction of contributed tax capital of the company...”


Dividends are exempt from normal tax (income tax) in terms of section 10(1)(k)(i) of the Income Tax Act, 1962 (the “Act”). In addition, dividends paid to South African resident companies are exempt from dividends tax in terms of section 64F(1)(a) of the Act (provided there is compliance with certain formalities). This makes share buy-backs particularly attractive in circumstances where the disinvesting shareholder is a South African company.

Contributed Tax Capital

A company’s CTC constitutes its stated capital or share capital and share premium immediately prior to 1 January 2011, less so much of the stated capital, share capital or share premium as would have constituted a dividend under the previous dividend definition had it been distributed by the company before that date, plus the consideration received or accrued to the company for the issue of shares on or after 1 January 2011. In other words, a company must determine its CTC on 1 January 2011 as the total of its share capital and share premium account on that date, excluding any amounts thereof which would have constituted a dividend had they been distributed prior to that date. After 1 January 2011, the CTC will be increased by any consideration received by the company in respect of the subsequent issue of shares.


If a company had issued several classes of shares, CTC must be maintained separately on a per class basis. Therefore, CTC created by virtue of an ordinary share issue cannot be allocated or re-allocated to preference shares. Similarly, distributions in respect of preference shares cannot be utilised to reduce the CTC associated with ordinary shares. If a company makes a distribution out of CTC in respect of a given class of shares, the CTC distributed will be pro rata allocated to the shareholders of that class of shares.


To the extent that the selling shareholder is a company, as opposed to an individual, such dividend would also not be subject to dividends tax at a rate of 20% due to the fact that a dividend paid to a resident company is exempt from dividends tax and instead capital gains tax (“CGT”) at the normal company rate of 22.4% is paid.


It must be remembered that the directors of the company or some other person or body of persons with comparable authority must determine the amount that will reduce the contributed tax capital.  This must be evidenced from the minutes.


Capital Gains Tax

To the extent that the distribution does not constitute a dividend, the potential CGT implications require consideration since the amount so received would constitute a “capital distribution” for CGT purposes. “Capital distribution” is defined in paragraph 74 of the Eighth Schedule to the Act as “any distribution (or portion thereof) by a company that does not constitute a dividend.”


In terms of paragraph 76 of the Eighth Schedule, where a capital contribution of cash or an asset in specie is received by or accrues to a shareholder in respect of a share, the shareholder must treat the amount of cash or the market value of the asset in specie as “proceeds” when the share is disposed of. In other words, should the capital distribution received in consequence of the share buy-back, exceed the base cost of the share in the shareholder’s hands, a taxable capital gain would arise.


Such distribution is deemed to be a disposal resulting in an immediate CGT liability. Paragraph 76A of the Eighth Schedule provides that the shareholder must be treated as having disposed of part of the share on the date of receipt or accrual of a capital distribution of cash or an asset in specie received by or accrued to the shareholder. The shareholder would therefore be deemed to have disposed of its shares in the company buying back its shares on the date of the share buy-back.


The term “proceeds” is defined in the Eighth Schedule to the Act and under the current circumstances would be regarded as the amount received by the shareholder as consideration for the shares. Paragraph 35(3)(a) of the Eighth Schedule provides that the proceeds from the disposal of an asset must be reduced by any amount of the proceeds which have been included in the gross income of that person before the inclusion of any taxable capital gain.


As dividends constitute “gross income”, to the extent that the share buy-back consideration constitutes a dividend, the amount of proceeds derived by the shareholder would therefore be reduced. The non-dividend portion would, however, constitute proceeds for CGT purposes. Conclusion

Before contemplating a share buy-back, no matter how simple or complicated the transaction may seem, it is important to carefully consider the proposed arrangement against the above sections of the Act, especially if the share buy-back is for more than 5% (five percent) of any class of the issued shares of the company or is to be acquired from a director or prescribed officer of the company.


The amount paid to the shareholder by the company to acquire the share(s) would therefore constitute a dividend for tax purposes, except to the extent that the payment results in a reduction of contributed tax capital. The proceeds for CGT purposes would be reduced by this amount.              


When in doubt, please take advice from you’re your trusted professional transaction specialist. Should you wish to make contact regarding that all important transaction, please feel welcome to contact us on info@accts.co.za Our services include:

  • M&A

  • Shareholders

  • Investments

  • Corporate Strategy

  • Disposal transactions

  • Finance raising transactions

  • Structuring advice

  • Mergers

  • Acquisitions




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