People invested in preference shares do not have to worry that they are about to be hit by an income tax bill from out of the blue.
The South African Revenue Service (SARS) this week gave an assurance that dividends from preference shares are non-taxable.
Frans Tomasek, the assistant general manager for legislation at SARS, says the only instance in which preference share dividends are taxable is if they are redeem-able within three years of issue or if there is an option to redeem them within three years of issue.
SARS confirmed that preference shares are non-taxable after Personal Finance received a number of queries from readers who have been told by financial advisers that they should avoid investing in preference shares because their tax status is uncertain. Instead they were encouraged to invest in commission-earning investments.
Tomasek says preference share dividends are treated for income tax purposes like any other dividend-earning local investment.
He says if at any stage SARS did decide to make preference share dividends taxable - and he is not saying that this is going to happen - it would not be retrospective.
Preference shares are a useful way of generating income, particularly for pensioners with discretionary investments who have exhausted their income tax exemptions on interest earnings.
The confusion over preference shares' tax status is regarded as one of the reasons why they have lost value recently.
Standard Bank is about to launch another tranche of non-cumulative, non-redeemable preference shares. Their terms of issue will be identical to the bank's preference shares currently in issue.
Standard Bank has also issued a statement saying "there is no ambiguity in tax law about these preference dividends. The Income Tax Act is clear that dividends paid by these preference shares are tax- exempt in the hands of a South African taxpayer."
The difference between a preference share and an ordinary share listed on a stock exchange is that preference shareholders are first in line for the payment of a dividend.
Holders of non-cumulative preference shares receive a dividend only if one is declared for the financial year of the issuing company. If the company does not declare a dividend in a tax year, non-cumulative preference shareholders are not entitled to receive a larger dividend in future years.
Holders of cumulative preference shares, however, are entitled to receive a fixed dividend every year.
Preference shares are subject to capital gains and losses because once they have been issued, they are tradable on a stock exchange. Investors need to take this factor into account when assessing the risk of the investment and their capital gains tax liability.
In calculating the return on a preference share, you need to take both the price of the share and the dividend payments into account - this will provide the "yield" on your investment.
Taxpayers under the age of 65 are entitled to tax-free interest earnings of R16 500 a year, and those of 65 and over receive an exemption on the first R24 500 of interest earnings.
In deciding whether to invest in preference shares as opposed to interest-earning investments (after you have made full use of your interest tax exemptions), you need to take into account that you will not pay tax on the dividends, thereby improving your actual yield on the preference shares.
You need to have about R100 000 to purchase preference shares when they are first issued.
Standard Bank's private placement of its latest tranche of preference shares closes on December 1.
As an incentive to invest in them, early-bird investors will not have to pay any investment costs, apart from stockbroker fees. Contact a stockbroker for further information and to apply to purchase Standard Bank's preference shares.