In his 2021 State of the Nation Address on 11 February 2021, President Cyril Ramaphosa proudly demonstrated how South Africa still remains an attractive investment destination for both local and offshore companies despite the difficult economic circumstances worsened by COVID-19, managing to receive, to date, ZAR773 billion in investment commitments towards a five-year target of ZAR1.2 trillion.

Working on securing additional foreign investment for economic recovery is a priority for South Africa. Any increase to the already high 28% corporate income tax rate would surely neutralise these good intentions.

If one takes a closer look at the recent tax changes, there does seem to be a clear, targeted and well-thought-out strategy to broaden the South African tax base as opposed to any intention of increasing the corporate income tax rate. This aligns with Minister Tito Mboweni's 2020 Budget Speech during which he spoke of an intention to broaden the corporate income tax base to create additional revenue to be used to reduce the corporate tax rate in the near future to help South African businesses grow.

Treasury's strategy towards broadening the tax base appears to include a close monitoring of market activity. In the recent years, the market has seen numerous unbundling transactions.

An unbundling transaction is one in which all of the equity shares of one company (the unbundled company (“Company B”)) are distributed by another company (the unbundling company (“Company A”)) to the unbundling company's shareholders in accordance with their effective interest.

South African tax rules make provision for tax deferral (not tax exemption) in unbundling transactions. The distribution of Company B shares by Company A to its shareholders would be tax neutral for Company A and there would be no dividends tax at the level of the shareholders. Treasury would allow this in anticipation that when the shareholders sell Company B shares, SARS would at this point collect the tax.

It then becomes a headache for Treasury where the recipient of Company B shares is a tax-exempt person (such as a public benefit organisation or a retirement fund) or a non-South African tax resident (these being disqualified persons) because that means after the deferral, capital gains or taxable income from subsequent disposals or distributions will fall outside of the South African tax net and the tax collection that Treasury was counting on becomes permanently lost.

Prior to the recent tax changes, in order to curb the abuse of distributing shares on a tax neutral basis if the shareholders are not in the tax net, the unbundling rules contained an anti-avoidance measure in terms of which the relief would not be granted if immediately after the unbundling 20% of the unbundled Company B shares were held by disqualified persons either alone or together with connected disqualified persons. This limitation was understood by the taxpayers as it had been around since 2008

The recent tax changes delivered a bomb shell that sent shock waves throughout the market. In respect of unbundling transactions entered into on or after 28 October 2020, no tax deferral will apply where a disqualified person holds at least 5% of the equity shares in the unbundling Company A (not the unbundled Company B) immediately before that unbundling transaction ensuring that, but for smaller shareholdings in listed entities of less than 5%, only shares distributed to persons that are not disqualified persons will benefit from the tax deferral.

Treasury realised that where disqualified shareholders were not connected persons, individually holding less than 20% of the unbundled shares but collectively held in excess of 20% of the unbundled shares, the manner in which the 20% exclusionary rule was designed still allowed a permanent erosion of the South African tax base as the distribution of the unbundled shares to foreign shareholders and retirement funds would still be tax free under such circumstances.

Given the significant aggregate percentage of the market capitalisation of South African companies listed on the JSE that is held by foreign shareholders and retirement funds, this change of including within the tax net equity distributions to such disqualified persons where there is holding of at least 5% of the equity shares in the unbundling company thereby broadening the base was an opportunity Treasury could not miss.

Treasury's strategy towards broadening the tax base also appears to include a close monitoring of the use of the participation exemption by South African tax resident shareholders.

In 2003, South Africa introduced a participation exemption which exempts from income tax any foreign dividends declared by non-resident companies to a South African tax resident holding at least 10% of the equity shares and voting rights in such companies. A further participation exemption in terms of the capital gains tax provisions exempts from capital gains tax any disposal of equity shares held by a South African tax resident holding a least 10% of the equity shares and voting rights in a non-resident company

These participation exemptions were introduced to encourage capital inflows and to provide an incentive for South African tax residents to repatriate foreign dividends or capital gains on shares acquired in foreign companies back to South Africa on a tax neutral basis.


Just like they noticed the increased use of the unbundling transaction provisions to erode the South African tax base, Treasury have noticed the increased use of the participation exemptions by South African tax resident shareholders and they have ceased the opportunity to take away these participation exemptions thereby broadening the South African tax base.

For example, where a South African tax resident company changes its tax residency to another tax jurisdiction and shares in that company are subsequently sold by South African shareholders, South African shareholders could qualify for a participation exemption.

As from 1 January 2021, under such circumstances, certain shareholders will be deemed to have disposed of all their shares at market value on the day before the company ceased to be a South African tax resident thereby triggering a taxable event for those shareholders

Another example, as from 1 January 2021, a real estate investment trust (“REIT”) no longer qualifies for the foreign dividend participation exemption thereby removing any opportunity for the REIT to shield other sources of taxable income from tax and retain profits in the REIT equal to the amount of the exempt foreign dividend.

Another example, given that from 1 January 2021, there is no longer a prohibition on loop structures in South Africa (loop structures are essentially arrangements where South African residents invest in offshore vehicles which, in turn, invest in South African assets), Treasury has thought of possible tax planning opportunities that could arise from the use of the current participation exemptions given this relaxation and have made sure to include provisions where the participation exemptions will not apply.

Treasury is gathering data establishing trends of activity. The above clearly demonstrate a structured intention of studying those trends and looking at opportunities of broadening the South African tax base. As the above demonstrates, tax provisions which we thought were settled because no changes have been made to them for a while may just not be as settled as we thought they were.

It is very unlikely that Treasury will increase the 28% corporate income tax rate. The question is what else they have up their sleeve towards the broadening of the South African tax base. The markets will be all eyes and ears as judging by the latest trends the 2021 budget speech tax proposals may just be intriguing.

Originally Published by ENSafrica, February 2021

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