Capital Gains Tax (“CGT”) is a form of income tax that is levied at a fixed rate when an asset is disposed of for an amount exceeding its base costs. Since its introduction, taxpayers have fathomed ways to avoid the payment of CGT. Usually a disposal of shares will be subject to CGT, unless such a disposal was structured as an issue of shares by the target company to the “purchaser”, followed by a corresponding buyback of shares by the target company from the “seller”.
For example: Company A holds 50% of the equity in Company X. Company A acquired the 50% interest for R50 and the current value of A’s interest is R500 000.00. B approached A with an offer to purchase the 50% interest for R500 000.00. A sale of the 50% interest would give rise to CGT. In order to avoid CGT, the transaction can be structured as follows: B will subscribe for shares in X (the target company) for R500 000.00. B will now have effectively acquired a 33% interest in Company X.
Company X will utilise that R500 000.00 (as the subscription price from B) to buy back the shares in issue from Company A. Company A’s shares are then cancelled and Company A received the R500 000.00 from Company X. There will be no CGT implications for either Company X or Company A as the buyback of shares is treated as a dividend.
However, National Treasury has now moved to address this loophole by introducing paragraph 43A to the Eighth Schedule to the Income Tax Act. In terms of the proposed amendments, the tax dividends, declared to a shareholder as per the arrangement explained above, will be treated as a capital gain in the hands of that shareholder and taxed accordingly.