Tag Archives: shares

Borrowing to purchase listed shares – 100% tax ineffective?

Where a person borrows money to purchase shares, the general rule would be that the interest paid on the funds borrowed to fund that acquisition would not be deductible for tax purposes, the reason being that the interest expense is not incurred in the production of “income”.

Similarly, interest paid cannot be said to be a cost incurred in the acquisition of an asset (such as a share) for capital gains tax purposes: by its very nature, interest is a recurring cost only incurred after acquisition of the underlying asset if funded through debt. One would therefore imagine that interest incurred on funds borrowed to acquire an asset can similarly not form part of the “base cost” of the asset for capital gains tax purposes, in other words, used to negate the capital gains tax cost which arises when the asset purchased is eventually disposed of.

Leaving aside the commercial wisdom of borrowing money to fund the acquisition of listed shares (and probably giving up assets as security in the process), the Eighth Schedule to the Income Tax Act contains a surprising exception to the general rule against non-capitalisation of interest costs for capital gains tax purposes. Paragraph 20(1)(g) determines that “… one-third of the interest as contemplated in section 24J excluding any interest contemplated in section 24O on money borrowed to finance the expenditure contemplated in items (a) or (e) in respect of a share listed on a recognised exchange…” may be added to the base cost of those listed shares acquired. In other words, whilst all interest incurred on such debt funding will not be taken into account to calculate the base cost of the shares, 33% of all interest incurred at least may be added to the initial cost of acquisition of the shares in determining its base cost, and eventually in calculating the capital gain realised on disposal of those shares in due course.

While interest is therefore not deductible for tax purposes on the debt used to acquire shares generally – and interest would moreover typically not rank as a cost to be taken into account for purposes of calculating the base cost of an asset for capital gains tax purposes – interest incurred on the acquisition of listed shares appears to be a definite exception.

The exception is definitely one of the lesser-known provisions in the Income Tax Act, and one which is often overlooked when listed shares are sold. Where a listed share portfolio is therefore built up over time, investors should take into account borrowing costs that may have been incurred over the years to shore up further investments in their listed investment portfolios.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

Treasury moves to close CGT avoidance loophole through share buybacks

Where one company previously sought to dispose of its shares in another company, it was able to do so without incurring an exposure for capital gains tax (“CGT”) or dividends tax, if that disposal were 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 shares in Company X (which stake is worth R500,000). A had acquired the 50% interest for R50. B approached A with an offer to purchase the 50% for R500,000. A straight sale of the 50% would give rise to a tax effect of little less than R112,000 for A (being R499,950 x 80% x 28%). To ensure that the aforementioned tax charge does not arise, A agrees with B that the effective transfer of the 50% interest will be structured by B subscribing for shares in X for R500,000. B will now have effectively acquired a 33% interest in X. X will utilise that R500,000 to buy back the shares that are already in issue to A. When A’s shares are cancelled therefore, it will have received the R500,000 contributed by B, while B will have 50% in X by virtue of A’s interest being cancelled. From a tax perspective, the buyback of shares is treated as a dividend, which is both income tax and dividends tax exempt for A. The result: A effectively disposed of its shares in X for R500,000 without incurring any attendant tax cost.

The use of linked share issue and buyback transactions to avoid CGT has been on SARS’ radar for quite some time already, yet without any meaningful remedy to counter such (we would argue, legitimate avoidance) transactions. Where such transactions were in excess of R10 million, those transaction had to be reported to SARS though in terms of section 35(2) of the Tax Administration Act, 28 of 2011.

National Treasury has now moved to close this “loophole” through the proposed introduction of paragraph 43A in the Eighth Schedule to the Income Tax Act, 58 of 1962. The proposed amendments to paragraph 43A are contained in the draft Taxation Laws Amendment Bill, and if accepted by Parliament in its current form, will become operational with effect from 19 July 2017 (being the date of publication of the draft Bill).

In terms of the proposed amendments, tax exempt dividends declared to shareholders (which could hold as little as 20% in the declaring company with the dividends being declared either 18 months prior to the disposal of those shares, or in anticipation of their disposal) will be treated as a capital gain in the hands of the shareholder and taxed accordingly when the shares held are disposed of. In our example above therefore, the share buyback of R500,000 will be taxed as a capital gain.

As noted above, the current draft legislation has not yet been enacted, and we will closely monitor developments to consider implications of the final version of the legislation ultimately introduced.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)

Interest free loans to directors

It is very often the case that a company extends an interest free or low interest loan to a director. This manifests either as a true incentive or benefit to that director (mostly the case in larger corporate environments) or in a small business environment in lieu of salaries paid. The latter is especially the case for example where a spouse or family trust would hold the shares in the company running the family business, but which business is conducted through the efforts of the individual to whom a loan is granted from time to time.

In terms of the Seventh Schedule to the Income Tax Act[1] a director of a company is also considered an “employee”.[2] This is significant, since directors can therefore also be bound by the fringe benefit tax regime applicable to employees generally.

Paragraph (i) of the definition of “gross income” in the Income Tax Act[3] specifically includes as an amount subject to income tax “the cash equivalent, as determined under the provisions of the Seventh Schedule, of the value during the year of assessment of any benefit … granted in respect of employment or to the holder of any office…”

Clearly, benefits received by a director of a company would therefore rank for taxation in terms of this provision. The question remains therefore whether loans provided to such directors by the companies where they serve in this capacity would amount to such a taxable benefit, and further how such benefit should be quantified.

Paragraph 2(f) of the Seventh Schedule is unequivocal in its approach that a taxable fringe benefit exists where “… a debt … has been incurred by the employee [read director], whether in favour of the employer or in favour of any other person by arrangement with the employer or any associated institution in relation to the employer, and either-

(i)            no interest is payable by the employee in respect of such debt; or

(ii)           interest is payable by the employee in respect thereof at a rate of lower than the official rate                of interest…”

Paragraph 11 in turn seeks to quantify the amount of the taxable fringe benefit to be included in the gross income of the director. Essentially, the taxable fringe benefit would be equal to so much of interest that would have been payable on the loan at the prime interest rate less 2.5%, less any interest actually paid on the loan. The benefit therefore does not only arise on interest-free loans, but also on loans carrying interest at less than the prescribed interest rate.

It is necessary to note that a fringe benefit otherwise arising will not be a taxable benefit if the loan amount is less than R3,000, or if it is provided to the director to further his/her studies.

[1] 58 of 1962
[2] Paragraph 1 of the Seventh Schedule, paragraph (g) of the definition of “employee”
[3] See section 1

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)