PART 2: SHAREHOLDERS BEWARE

Accountancy SA, May 2008 by West, Craig, Cramer, Peter

1. Introduction

In Part 1, capital distributions arising in terms of the provisions of the Companies Act, 1973 (the Act) in the context of the dividend definition and the treatment of capital distributions for capital gains tax (CGT) purposes prior to 1 October 2007 were examined. The record-keeping requirements of which shareholders would need to be aware in order to take capital distributions into account in their CQT determinations were also highlighted. Part 1 further referred, in broad terms, to the amendments to the CGT regime regarding capital distributions embodied in the Revenue Laws Amendment Act, No. 35 of 2007 (the Amendment Act). The amendments increase the urgency for shareholders to ensure that their records are complete and that they understand the CGT implications of capital distributions, including the potential cash flow implications of the amendments.

In Part 2, these amendments are explored more fully and the new treatment of dividends paid out of pre-acquisition profits to shareholders in the same group is briefly examined.

2. The old and the new treatment for capital distributions

In terms of paragraph 74 of the Eighth Schedule, a 'capital distribution' is a distribution by a company that is not a dividend, or is a dividend that is exempt from secondary tax on companies by reason of section 64B(5)(c) of the Act This would be, for example, where a company distributes original share premium to its shareholders instead of declaring a dividend.

Prior to the amendment, capital distributions received before to 1 October 2001 on shares disposed of after that date had the effect of reducing the base cost of the share. Whereas capital distributions received after 1 October 2001 were only added to proceeds in the year of disposal.

It is submitted that some of the difficulties highlighted in Part 1 may have prompted the amendments to paragraph 76' and 76A2 of the Eighth Schedule to the Income Tax Act Under the old rules, capital distributions received after valuation date (1 October 2001) were treated as proceeds only on the eventual disposal of the shares (including deemed disposals, e.g. on the death of the taxpayer). Under the new regime, a capital distribution received after 1 October 2007 must, in terms of the new paragraph 76A(1)(b), be treated as a part disposal in the year received or accrued.

Part disposals are considered in paragraph 33. The approach in general is to establish the base cost that must be deducted from the capital distribution on a proportionate basis as follows:

[(capital distribution/market value of entire holding as at the date of the distribution) x qualifying paragraph 20 expenditure (or paragraph 29(4) market value at valuation date, if applicable)].

3. Transitional effects

Transitional effects were introduced by the amendments to facilitate the treatment of capital distributions received prior to 1 October 2007. The implications for these capital distribution are addressed below.

3.1 Capital distributions received prior to valuation date:

Where a capital distribution was received prior to valuation date (normally 1 October 2001), the capital gain impact will occur on disposal of the share. The distribution must be treated as a reduction of the paragraph 20 expenditure. This treatment has remained unchanged by the Amending Acts. While there does not appear to be a limit to this reduction, logic would imply that paragraph 20 expenditure could only be reduced to nil. However, in determining the valuation date value in such cases, it is submitted that the taxpayer would still have the options granted in paragraphs 26 and 27. It is further submitted that should the capital distributions received prior to valuation date exceed the qualifying expenditure per paragraph 20, the adoption of market value as valuation date value would override such effects. Furthermore, as proceeds (in such a case) would always exceed such 'reduced' expenditure, paragraph 26 would allow the adoption of such market value and paragraph 27 would be inapplicable. It is possible that additional complications could arise in the determination of base cost, but those are beyond the scope of this article. Note that it would appear that this approach for pre-valuation date capital distributions is equally applicable to shares where the base cost is determined using the weighted average method (in contrast with capital distributions after valuation date - as detailed below).

3.2 Capital distributions received after valuation date but prior to 1 October 2007 (excluding the weighted average method):

Those capital distributions that had been received between valuation date and 1 October 2007 will have to be brought to account in one of two ways:

(a) If the share is disposed of prior to 1 July 2011, the capital distributions (received to date of disposal) will be added to the proceeds at disposal date (as was the case prior to the amendment); or

(b) If the share has not been disposed of by 1 July 2011, the capital distributions accumulated since valuation date to 1 October 2007 will be treated as a part disposal of the share on 1 July 2011. This will have the potential effect of including taxable capital gains in the taxpayer's 2012 taxable income, resulting in the associated cash outflows.