By Bobby Wessels, Senior Manager of Corporate and International Tax at AJM

It’s funny how, before we enter the working world, life seems to move in chapters: new schools, new places, new routines every few years. However once you settle into your professional life, things tend to take on a different rhythm and tend to become more stable and structured. In that rhythm, I’ve found myself spending more of my downtime reflecting, not just on life, but on the technical challenges I face at work. And, perhaps oddly, one of the topics that keeps me up at night (in a good way!) is the complexity of anti-avoidance provisions, particularly the fascinating world of dividend stripping rules. Since its inception in 2017, paragraph 43A of the Eighth Schedule serves as a clear legislative attempt to prevent a common form of tax avoidance: converting taxable capital gains into tax-exempt dividends. Prior to this provision, it was common practice for taxpayers to structure share disposals to trigger a buy-back and re-subscription, effectively extracting value through tax-free dividends instead of incurring capital gains tax.

Despite being in effect for nearly a decade, paragraph 43A continues to present pitfalls for the unwary, especially in its less obvious iterations, such as subparagraph (4), introduced in 2019.

The Nuances of Paragraph 43A

The core purpose of paragraph 43A remains to prevent dividend stripping, where the pre-sale dividends are extracted in a way that reduces the capital gain on share disposals. However, subparagraph (4) extends the scope to instances where there’s a reduction in effective shareholding, even in the absence of actual share disposals.

This provision often catches taxpayers off guard. It becomes particularly relevant in scenarios where a company declares a tax-exempt dividend to its shareholders and, within 18 months of that declaration, issues new shares, whether to an existing shareholder or to a third party. Even though no shareholder sold their shares, the existing shareholders equity stake is diluted. If any of the shareholders had a qualifying interest before the subscription, paragraph 43A(4) would apply to the extent that the exempt dividend also constitutes an extraordinary dividend. The exempt dividend received would be deemed a taxable capital gain without allowing a base cost deduction.

This distinction is key. While under paragraph 43A(2) dividends are factored into proceeds and the base cost reduces the gain, under sub-paragraph (4) the entire dividend amount becomes taxable without the base cost relief. This is a consequence that is often overlooked when the dividend has long faded from memory by the time new shares are issued.

Paragraph 43A: Cross Border

Additionally, paragraph 43A does not only apply to transactions taking place between resident companies. It could also apply, for example, where a non-resident company repurchases the shares of a resident company shareholder. Therefore, in a cross border context, where a South African resident holds more than 10% the equity shares and voting rights of a foreign company and that foreign company repurchases its shares, the amount received may be a tax-exempt dividend locally. Accordingly, if the laws of the foreign jurisdiction classify that repurchase as a dividend (as opposed to a return of capital), paragraph 43A can still apply. The characterisation of the transaction under the foreign law is key in determining its tax implications. Typically, the repurchase of shares is either classified as a dividend, a return of capital or in some instances a combination of both. Accordingly, to the extent that the foreign country treats the repurchase of shares as a foreign dividend, the ambit of paragraph 43A could potentially become relevant where the other requirements thereof have been met. Interestingly, paragraph 43A does not apply where a foreign company repurchases the shares held by a South African resident individual, even where the repurchase may similarly result in an exempt dividend.

Conclusion

What seems like a narrowly framed anti-avoidance rule is in fact full of nuance. Paragraph 43A is intricate and often misinterpreted or applied incorrectly. At times, my colleagues and I half-jokingly refer to a person’s understanding of paragraph 43A as an informal test of one’s depth in South African tax law. A jest with some truth.

If your company is planning restructures, buy-backs, or subscriptions, especially following recent dividend declarations, it is important to not let paragraph 43A become an afterthought.