The date (“Redemption Date”) on which a Preference Share is redeemed [buy-back] is significant when considering the definition of a ‘Hybrid Equity Instrument’ as defined in Section 8E of the Income Tax Act (“ITA”).
In terms of Section 8E, a Preference Share will be a Hybrid Equity Instrument if the Redemption Date is within 3 (three) years from the date a Preference Share was issued (“Date of Issue”) to a Preference Shareholder. The Redemption Date refers to the date:
- Where the company is obligated to redeem a Preference Share from the Preference Shareholder; or
- On which the Preference Shareholder has the option to compel the company to redeem a Preference Share.
Generally, the Redemption Date is determined on the Date of Issue to specifically fall outside the ambit of Section 8E of the ITA, however, circumstances (such as the company’s financial position) may dictate that the Redemption Date be amended. In such instances the following will be applicable:
- Where the original Redemption Date falls outside the three-year period, the original Redemption Date may be amended to a new date, subject to the new date being after the original Redemption Date. Consequently the Preference Share will not qualify as a Hybrid Equity Instrument; or
- Where a Preference Share is issued with an obligatory Redemption Date that occurs after the 3 (three) years from the Date of Issuance and the date is amended to a new Redemption Date that will occur before the expiry of the 3 (three) years from the Date of Issue, such Preference Share will qualify as a Hybrid Equity Instrument.
Consequently, where the obligatory Redemption Date is less than 3 (three) years from the Date of Issue, Section 8E of the ITA will trigger the following adverse taxing implications:
- The dividends received will not be exempt from normal tax in terms of Section 10(1)(k)(i) of the ITA; and
- The Preference Shareholder is required to account for normal tax on the dividends in its taxable income.
Therefore, it is imperative that the parties to any Preference Share arrangement thoroughly consider the redemption features not to fall foul to adverse taxing consequences of the 3 (three) year requirement in Section 8E of the ITA.