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Sunday, April 1, 2007
Much to decide

“We are most encouraged by the removal of Secondary Tax on Companies (STC),” comments Mdu Bophela, Head of Solutions for New Businesses at First National Bank (FNB). “This should have a positive effect on investment in business ventures in South Africa.”

The move both reduces company liability for tax and simplifies its application.
The Budget replaces STC with a dividend tax, that is, the liability was transferred to the shareholder.
Mr Bophela believes this is likely to encourage business-owners to invest more profits into their businesses, and will help stimulate growth and expansion. “Keeping funds in the business may involve something like buying a commercial property, for instance, and this could well act as a spur to growing the business through opening a new branch or something of that sort.”

Phasing in

Comments Johan Troskie director of tax at Deneys Reitz, “STC will be phased in from 1st October 2007. On this date the following four changes will take effect:
• STC will be renamed as ‘dividend tax’;
• The tax base will be broadened to cover all distributions by companies and not just those from profits. This is because the determination of what constitutes profits available for distribution can be a complex and uncertain area of South African law. Provision will be made for the tax-free return of capital but anti-avoidance provisions will have to address inflated or transitory capital distributions.
• A more targeted exemption for amalgamation transactions will be introduced, depending on the analysis of the transactions concerned. 
• The tax rate will be reduced to 10%, down from the previous 12,5%, and this will mean bigger dividends for shareholders.

“Phase two commences during 2008,” says Mr Troskie. The following two changes will take effect:

• The formal legal liability for dividend tax will be moved from the company paying the dividend to the shareholder receiving it; and,
• A withholding tax on dividends paid of 10% will be imposed on companies paying dividends. “That is to say, companies will be required to pay the dividend tax on behalf of their shareholders. In the case of foreign shareholders, Treasury is currently negotiating treaties that deal with tax treatment of dividends,” he explains.

Preference shares

Another aspect of STC, however, may be cause for concern for holders of preference shares, according to Mark Appleton, Chief Investment Officer for Barnard Jacobs Mellet Private Client Services.
“For ordinary shareholders, the shift of tax burden from the company to the shareholder will have little impact as companies are likely to pay out higher dividends, thereby passing their tax savings onto shareholders.
“In fact shareholders could be slightly better off as the rate of tax has been reduced from 12.5% to 10%,” he notes.
However, he says that shareholders of preference shares could be negatively affected. This is because there is no legal obligation on the part of the issuer to pass on any tax savings to investors. On the other hand, the investor will now have to pay a 10% tax on all dividends, including those from preference shares.
“Many preference shares are linked to the prime interest rate,” adds Mr Appleton, “so there is no obligation on the company to increase their rates even if they are saving money on the removal of STC.”
Another point of concern is that companies have purchased preference shares in order to gain ‘STC credits’. There will no longer be a need to do this and it might affect the value of such shares. STC credits were acquired through receipts of dividends from other sources that can therefore be offset on dividends paid out. In the case of dividend receipts there is no difference between ordinary shares and preference shares. However, the point of preferring a holding in preference shares is that they can be used as a ‘structuring vehicle’ without onward declaration of dividends. At some stage distributions can be made from preference shares via the share premium account and these are not taxable because they are not declared as dividends. The benefits of this structuring tool fall away with the abolition of STC.
Another point to ponder is, what happens to the existing STC credits built up? If you no longer pay STC after 1st October, to what can you set off the STC credits to which a company is entitled?
Mr Appleton notes that, despite all this, preference shares may continue to be attractive, but only as a cheap source of funding. “Any source of price weakness in the preference share market might, however, come from the sale of these investments by companies who invested in them to gain STC credits, which they will no longer wish to do.”
From an individual investor’s point of view preference shares may remain attractive. Mr Appleton notes that even on an after tax basis, returns “are substantially in excess of what is achievable in the money market after tax.
“For example a preference share yielding 9.5% would now yield 8.6% on an after tax basis. This would still compare favourably with an after tax money market rate of less than 6%. So individuals should not be tempted to sell their preference shares.”
Footnote: the name ‘dividend tax’ will later be renamed “Shareholders’ Tax” after all the double tax agreements with countries have been amended. In any event, government has noted that ‘much still has to be decided about the new tax. By Nigel Benetton

Copyright © Insurance Times and Investments® Vol:20.3 1st April, 2007
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