By Jean du Toit, Senior Associate – Tax & Commercial
The 2022 Tax Bills were promulgated on 5 January 2023. Among other changes, the final amendments to the definition of “contributed tax capital” (“CTC”) is now enacted.
What is CTC?
CTC is a notional amount which is derived from contributions made by shareholders of a company as consideration for the issuance of their shares. CTC is reduced where the company makes a distribution (return) of capital to its shareholders, by the amount determined by the directors of the company. This must be distinguished from a distribution classified as a dividend. In essence, the definitions of these concepts are mutually exclusive, and they result in different tax implications.
The tax implications arising from the distribution of a dividend depend inter alia on the nature and residency of the beneficial owner of the dividend. The liability for the tax depends on the nature of the distribution i.e., if it is a cash distribution or a dividend in specie.
A return of capital, where the corresponding share is held as a capital asset, either results in a reduction of the base cost of the share, or where the return of capital exceeds the base cost, the difference will be treated as a capital gain.
Shareholders may have a preference as to whether a distribution is classified as dividend or a return of capital. Most notably, resident companies would prefer a dividend distribution, as in their hands, it is exempt from normal tax and dividends tax. Natural persons may opt for a return of capital, as it effectively defers the tax consequences [potential increase in capital gains tax (“CGT”) upon disposal]. Non-residents may escape CGT altogether.
The varying tax consequences among shareholders incentivised the apportionment of distributions to the same class of shares, where a reduction of CTC is targeted at certain shareholders (where they would otherwise be liable for dividends tax). The result is a loss to the fiscus, which triggered a series of amendments, with the final changes promulgated by the Taxation Laws Amendment Act No. 20 of 2022 (“2022 TLAA”).
In the 2021 legislative cycle, the draft Taxation Laws Amendment Bill (“TLAB”) proposed that the definition of CTC be amended to clarify that shareholders within the same class of shares must share equally in the allocation of CTC. As the amendment was aimed at curbing abuse, it was proposed that it have retroactive effect, from 28 July 2021.
Pursuant to public comment on the draft and final TLAB, it emerged that the amendments may have adverse implications for legitimate transactions. The effective date was postponed to 1 January 2023 to allow for further consultation.
With the 2022 TLAA, the previous proposed amendments were withdrawn and replaced. The definition of CTC is now qualified by two limitations:
- When a distribution is made or where consideration is paid for the acquisition, cancellation or redemption of a share, a transfer may only be made from CTC if an equal amount is transferred to each share in that class of shares; and
- The amount transferred per share is capped and may not exceed the total CTC in respect of that class of shares divided by the total number of shares issued for that class.
As envisaged by the initial amendments, under the 2021 TLAB, targeted distributions are no longer possible. The amendment to the definition of CTC is deemed to have come into operation retroactively on 19 January 2022.