Changing the landscape of preference share transactions
The recent Draft Taxation Laws Amendment Bill released at the beginning of June has several far reaching consequences regarding the financing landscape as we currently know it, not least of which is the impact on preference share transactions.
As of 1 April next year the new amended sections prescribe that any dividend declared in respect of an hybrid equity instrument or a third-party backed share on or after that date will be deemed to be interest, which is taxable and not a tax-freedividend as it currently stands.
Currently, redeemable preference shares will be regarded as a “hybrid equity instruments” for the shareholder if one of the following conditions applies –
· the company (i.e. the issuer) is obliged to redeem the preference shares in whole or part within a period of 3 years from "date of issue";
· the preference shares may at the option of the holder be redeemed in whole or part within a period of 3 years from "date of issue"; or
· the holder has a right of disposal which may be exercised within a period of 3 years from the "date of issue".
The definition of "date of issue" remains unchanged and continues to mean the date upon which the share is issued or, subsequent to the issue of the share, the date when (i) the company undertakes wholly or partially to redeem it at a future date or (ii) the holder obtains the right to require it to be redeemed in whole or in part.
The new concept of a "third-party backed share" is essentially any share where the holder has a right to require any party other than the issuer to acquire that share from the holder or in respect of which a 3rd party may have the obligation to acquire the share from the holder (effectively covering both put and call options). It also includes a share where any payment in respect of that share is guaranteed or otherwise secured in favour of the holder.
The Bill now defines hybrid equity instruments, as inter alia any share where the holder has a "right of disposal" in respect of such share which may be exercised within a period of 10 years from the "date of issue" of that share.
In terms of the Bill, this period has effectively been extended from 3 years under the old regime to what will now be a period of 10 years and accordingly, any preference share in respect of which the holder can require the issuer to redeem or repurchase that share during the 10 years from date of issue will constitute an hybrid equity instrument.
In addition, the amendments to the definition of "right of disposal" under section 8E effectively remove the entering into of a put option agreement or any other document in terms of which the holder is entitled to dispose of the share to a party other than the issuer from the ambit of an hybrid equity instrument. Any perceived respite though is however short lived, because that door is immediately closed by the new section 8EA and the provisions relating to "third-party backed shares".
According to the Bill, a "right of disposal" now means a right which the holder of a share has to require the issuer (the insertion of "the issuer" being the notable departure from the old wording) of that share to –
· acquire that share from the holder; or
· procure or assist with the redemption of that share (in whole or in part), the repayment in whole or in part of the capital subscribed for that share or the conversion of that share into any other share which is redeemable in whole or in part within a period of 10 years from the date of issue.
The Bill moves away from what has become the traditional preference share funding structure where funders were careful to ensure that the preference shares they subscribed for would not fall foul of the "3-year mark". Going forward, as of 1 April 2012, if someone holds a preference share (or any other share) and is entitled to force the company to redeem or repurchase that share within a period of 10 years from the date of issue, the dividends declared in respect of those shares will be deemed to be interest in the hands of the holder.
Under the new 8EA, any preference share that is secured in any manner whatsoever will be a "third-party backed share" and any dividend declared in respect of that share will also be deemed to be income. Notably, this section does not specify any timeline within which any of the security rights need to be exercised i.e. the share can have a lifespan of 1 month or 20 years and still constitute a "third-party backed share" if it meets the requirements of section 8EA.
