Foreign investors investing in South Africa via a South African holding company structure, may be adversely impacted by section 8G of the Income Tax Act (ITA) due to the inability to extract their capital investment as a return of capital tax free, notwithstanding the investment being an equity contribution. Section 8G of the ITA was introduced as an anti-avoidance mechanism to counter schemes that create contributed tax capital (CTC) and avoid the payment of dividends tax to foreign shareholders.
Where a South African holding company, held by a non-resident company, issues shares to its non-resident shareholder to acquire shares in a South African target company, section 8G limits the CTC attributable to the shares issued by the holding company. This will be applicable if the target company and the non-resident company formed part of the same group of companies (i.e., 50% or more of the equity shares or voting rights) prior to the transaction.
Broadly speaking, CTC is defined, in relation to a class of shares of a company, as the consideration received (i.e. share capital and share premium) by 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 be a reduction of the CTC of the company.
The intention of section 8G is to curb stepping up the CTC of a South African holding company by transferring the shares of an existing South African company to the South African holding company in exchange for shares at market value. Section 8G, however, has a broader impact as discussed below.
While it is not the intention for section 8G to trigger the negative tax consequences discussed in the above-mentioned scenarios, in its current state, the section could disadvantage foreign investors who provide genuine equity capital into South Africa and are then unable to return their original capital tax free.
Without further clarity from the South African Revenue Service, or amendments to section 8G, taxpayers are advised to carefully consider the application of section 8G to any proposing funding through a South African holding company structure.