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The SECOND 2011 issue of the Business Tax and Company Law Quarterly has been published. Abstracts of each article can be viewed below.

The Ambit of Section 8E of the Income Tax Act

The Meaning and the Mischief

Milton Seligson SC

Abstract

Section 8E of the Income Tax Act is one of the important anti-avoidance measures that are a common feature of the statute. The provision deems dividends declared on certain shares, defined as ‘hybrid equity instruments’, that would otherwise be tax exempt, to be taxable interest in the hands of the recipient. The underlying premise of this provision is that short-term share investments, which are redeemable by the investor within a period of three years, are in effect loans and should be treated as such for tax purposes. It is common in South Africa for companies to obtain financing by the issue of redeemable preference shares subscribed for by banks and other financiers for periods exceeding three years, and indeed for as long as five to ten years. Such preference share investments do not usually fall within the ambit of section 8E because they do not qualify as ‘hybrid equity instruments’, there being no obligation on the issuer company to redeem the shares, nor any right of the holder to redeem them at its option, or to dispose of them, within a period of three years from the date of issue thereof. Instead a ‘safe harbour’ period of more than three years is applicable to the redemption of such shares. This article is concerned with a situation that may commonly occur in practice, where there has been an issue of preference shares redeemable within a period in excess of three years, and after a lapse of more than three years from the date of their initial issue, but before the redemption date has been reached, the parties wish to extend the redemption date to a later date in the future. The thesis of this article is that such a change does not trigger the application of section 8E. In support of that conclusion, the article analyses the definitions that are pivotal to section 8E. It argues that the extended meaning assigned to the term ‘date of issue’ seeks to catch in the provision’s net preference shares the terms of which when issued do not initially provide for their redemption or disposal, but after their issue do so by virtue of a subsequent undertaking by the issuer to redeem, or the subsequent acquisition by the holder of a right to require redemption or to dispose of the shares, (none of which previously existed), within a period of three years of such undertaking or acquisition. The article further contends that, having regard to the real mischief at which section 8E is aimed — short-term redeemable share investments that are in reality loans — there is no justification for treating the preference shares as hybrid equity instruments where the parties agree to extend the redemption date after the ‘safe harbour’ threshold has been passed, and that the proper construction of section 8E militates against this. Finally, the article discusses an exchange of correspondence concerning section 8E between the late David Meyerowitz SC, when he was the editor of The Taxpayer, and SARS, as revealed in an article in that journal in 2008. From this it emerges that the broad interpretation given to the provision by SARS is unsupported by reasons and questionable, and that the late learned author also favoured the restricted construction contended for in this article. Postscript: The recently released Draft Taxation Laws Amendment Bill, 2011 proposes to extend the three-year period to ten years.

Executive Share Scheme

Tax Traps

Michael Rudnicki

Abstract

Senior employee incentivisation packages nowadays will commonly include some form of equity participation. The legal form will typically comprise either direct ownership in the underlying equity of the employer company, options to acquire ownership in the underlying equity, or a more synthetic version of equity ownership, namely participation through vested income rights in a trust. The latter equity variations are referred to as ‘equity instruments’ in section 8C of the Income Tax Act. The section provides that gains or losses determined in terms of this section will constitute remuneration, which will be subject to an employees’ tax withholding by the employer company. The consequence of the gain may be that the employee will find him or herself in a liquidity constraint, because the timing of the gain may not coincide with the disposal of the ‘equity instrument’.The timing of the gain or ‘vesting’, as it is referred to in the section, will depend on the restrictions that are placed on the equity instruments. The gain will typically be triggered when the restrictions lift or are no longer applicable. This article unpacks some of the aspects of section 8C as they relate to common forms of equity participation provided to executive employees.

Compensation for Surrender of a Right

The Income Tax and VAT Implications — A Case Note

Carmen Moss-Holdstock1

Abstract

In this article, the author examines a recent, but still unreported High Court Tax judgment which dealt with whether monies received by the taxpayer for early termination of an exclusive right to distribute certain whiskies in Southern Africa was of a capital or revenue nature, and for VAT purposes, whether the payment was consideration in respect of the supply of services and subject to VAT at the standard rate. As regards the capital or revenue nature of the compensation payment, the court found that the compensation received by the taxpayer constituted a receipt of revenue, and was therefore taxable as such. While the court acknowledged that the distribution of the whiskeys constituted a significant part of the taxpayer’s business, it held that the compensation was intended to compensate the taxpayer for its expected loss of profits due to the premature cancellation of its distribution rights. Importantly, the court again confirmed that while the method of calculation of the amount of compensation is an important factor, it is not determinative of the nature of the receipt. The other issue that required the court’s consideration was whether SARS was correct in declining to exercise its discretion in terms of section 89quat(3) of the Income Tax Act 58 of 1962 (“the Act) to waive interest payable in terms of section 89quat(2) on the underpayment of provisional tax. The court found in favour of the taxpayer on the basis that its treatment of the compensation payment as capital in its hands was not an unreasonable conclusion. There was also evidence that the taxpayer had taken advice from tax experts. As regards the VAT aspects, while SARS was successful in arguing that the surrender by the taxpayer of its distribution rights constituted a taxable supply of ‘services’ by it, the victory was hollow in that the court also held the relevant ‘services’ were in fact subject to VAT at the zero rate — being a supply made to a non-resident who was not in South Africa at the time the services were rendered. An important conclusion arrived at by the court was that the situs of an incorporeal right is where the debtor (in this case the grantor of the distribution rights) resides. While the supply of services to a non-resident is generally zero-rated for VAT purposes (section 11(2)(l) of the Value-Added Tax Act 89 of 1991 — ‘the VAT Act’), the supply is not zero-rated if, inter alia, the relevant services are supplied directly in connection with movable or immovable property that is situated in South Africa at the time the services are rendered. Thus, even if it could be said that the distribution rights were movable property, on the basis of the decision of the court, such movable property (intangible distribution rights) was not situated in South Africa at any time. 

About the editors:

Milton Seligson SC
BA LLB (UCT), LLM (Harvard) Member, Cape Bar
Advocate Seligson is one of the most senior silks practising in South Africa. He is a member of the Cape Bar and is involved mainly in the areas of tax and corporate law. He has acted as a judge of the High Court and the Special Income Tax Court. Advocate Seligson is also a former Chair of the General Council of the Bar of South Africa and the Cape Bar. He served as a member of the Judicial Service Commission for ten years between 1999 and 2009. He is a former law professor at the University of Hawaii Law School and part-time lecturer on the UCT Law Faculty. He currently serves on the UCT Council as an elected member, representing alumni.

Des Kruger
BCom LL B (KZN), H Dip Tax (Wits), International Tax Program, LLM (Harvard)
Des is a director in the Tax Practice Group at Webber Wentzel Attorneys and has over 30 years of specialized taxation experience. He was recently named one of the top tax consultants in South Africa by the International Tax Review, Chambers Global and The Legal Media Group Guide to the World's Leading Tax Advisors. Des was also selected for inclusion in the inaugural Best Lawyers list for South Africa in the specialty of tax. Prior to taking a position in the private sector, he worked at the Inland Revenue (now the South African Revenue Service – SARS) for nine years, where he held the senior position of Deputy Director in the Tax Structure Development branch. Des is co-author of Value-Added Tax in South Africa and Broomberg on Tax Strategy.

Michael Rudnicki
BCom (Rhodes), Hons BCompt (UNISA), BCom (Hons) (Taxation) (UCT), MComm (UJ), CA (SA) Tax Director: KPMG
Michael is a Director in Corporate Tax in Johannesburg and also heads the Tax and Legal Private Equity and M&A Groups. He has been with KPMG Inc since its merger with Andersen in 2002. Prior to this, Michael worked at both Andersen and PWC. He specialises in General Corporate Tax, Specialist Banking Tax, Mergers and Acquisitions Tax; liasing with Senior Counsel on particular matters requiring litigious consideration; implementation of large M&A transactions; Executive Compensation Schemes and Employees’ Tax. He is a member of The South African Institute of Chartered Accountants (SAICA) and The Association of Corporate Treasurers of Southern Africa.