The income tax implications of a return of capital
The term “dividend”, as defined in section 1 of the Act, excludes, inter alia, an amount distributed to the extent that the amount results in a reduction of the “contributed tax capital” of the company making the distribution. A “return of capital”, as defined in section 1 of the Act, means any amount transferred by a South African tax resident company for the benefit for or on behalf of any person in respect of any share in that company to the extent that that transfer results in a reduction of contributed tax capital of the company (subject to certain exclusions, which are not relevant for present purposes).
Broadly speaking, “contributed tax capital” is defined, in relation to a class of shares of a company, as the consideration received by or accrued to that company for the issue of shares of that class, reduced by so much of the amount as the company has transferred for the benefit of a shareholder and which has been determined by the directors of the company to reduce the contributed tax capital of the company.
On the basis of the above, it is clear that whether a distribution constitutes a dividend or a return of capital is not dependent on the intention with which the shareholder holds the relevant share (ie whether a shareholder holds a share as a capital or revenue asset would not impact on the nature of any distribution made in respect of such share). As such, for example, it is possible for a person holding a share as a revenue asset to receive or accrue a return of capital or a dividend in respect of such share.
The Act clearly sets out the tax implications arising in respect of a distribution by a company that constitutes a dividend. The tax implications arising in this regard would depend on, inter alia, whether the dividend distribution is a cash distribution or a distribution of an asset in specie, the nature of the beneficial owner of the dividend (for example, a South African tax resident or exempt entity) and the nature of the share in respect of which the dividend is distributed. Whether the shareholder holds the share in respect of which a dividend is distributed as a capital or revenue asset should, however, generally not impact upon the tax consequences arising from a dividend distribution.
The following provisions of the Eighth Schedule of the Act may be applicable in the event of a shareholder receiving a return of capital in respect of a share held in a South African tax resident company:
The abovementioned provisions of the Eighth Schedule of the Act deal with the capital gains tax implications of a return in capital and should, accordingly, be applicable in circumstances where the shareholder holds the share in respect of which the return of capital is made as a capital asset.
It is apparent, on the basis of the above, that shareholders should carefully consider the South African tax implications arising in respect of dividend distributions and returns of capital received by or accrued to them – including returns of capital received by or accrued to persons holding the share in respect of which the distribution is made on revenue account.
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