The change to the Companies Act which now permits a company to buy-back its own shares, subject to certain solvency and liquidity criteria, is a hot topic at the moment.
The reasons for the change in the legislation, as given by the legislature, are:
* It allows strong companies to counter the effects of speculators, particularly international ones, who are able to manipulate the price of the company's shares, by repurchasing and cancelling some of the shares and thereby maintaining the value of the remaining shares;
* It enables companies with share incentive schemes to repurchase the shares of employees who are leaving the employ of the company;
* It provides the means to avert a hostile take-over; and
* It provides a means whereby a shareholder, or the estate of a deceased shareholder, of a company which is not listed, can find a buyer.
But what of the tax implications?
The legislation relating to buy-backs has replaced the legislation relating to share reductions, and seems to match the effect of such reductions in a number of ways. So, if you have ever been involved in reducing the shares of your company you can expect the tax effects for a share buy-back to be similar.
But, since the legislation relating to buy-backs was only promulgated recently (April 30, 1999), tax legislation does not yet cover the situation specifically (it still refers to the deleted share reduction provisions). It is therefore necessary to apply the general tax rules and the guidelines provided by the South African Revenue Service (SARS).
Let's first look at the position of the company wishing to buy back its own shares. It needs to have cash available to purchase the shares. If it doesn't have the cash available and has to borrow the funds, it will incur interest on the borrowing. Because it will not be borrowing the money for trading purposes, the interest will not be incurred in the production of the company's income (see my previous articles on the deductibility of interest). The interest will not, therefore, be deductible for tax purposes.
The next issue relates to the price paid for the shares. In order to buy its own shares at a price which is greater than their nominal value, your company may need to use retained income, or a capitalisation issue may have been made in the past using retained income at that time.
If this is the case, then the difference between the purchase price and the nominal value of the shares will amount to a dividend paid by your company to you.
When dividends are declared or deemed to have been declared by a company to its shareholder, it is obliged to pay secondary tax on companies (STC) on the dividend.
The STC amounts to 12,5 percent of the dividend declared (net of any STC credits applicable dividends accrued) and is payable to SARS by the end of the month following the dividend declaration (buy-back).
If, on the other hand, the company has been able to apply share premium to the buy-back, because this does not represent an application of retained income, STC will not be payable on that portion of the repurchase price. If the shares being bought back, are owned by another company, that company will qualify for an STC credit to the extent that STC has been paid on the repurchase price.
The tax you as the seller of shares the company buys back from you is unclear. It seems that if you are not a share trader and you sell your shares back to the company, you should not be taxed on the proceeds because they will represent either a capital profit on the sale of your shares, or a tax exempt dividend.
However, if you are a share trader, it seems that SARS intends to treat the total proceeds as the proceeds on the sale of the shares and will tax the profit, even though a portion of it has been treated as a dividend in the repurchasing company's hands.
The legislation allows your company's subsidiary to buy up to 10 percent of your company's shares, and it would appear that this would not then have any STC implications for the company itself. This may be a more favourable option.
But, perhaps we should wait for formal tax legislation before assuming the consequences!