Requirements of the Companies Act and tax effects

When considering company distributions, we most often think of cash dividends, being one form of the return on investment for the shareholders. The definition of a distribution in accordance with section 1 of the Companies Act of 2008 (from here on referred to as “the Act”) also includes share buybacks, shareholder’s debit loans, loans written off and payment of capitalisation shares.

This article will address the requirements that must be met before any distribution can be made to a shareholder, the director’s liability if distribution is made when the requirements are not met and the income tax effect on the distributions. It will mainly focus on cash dividends, share buybacks and shareholder’s debit loans.

In accordance with Section 46 of the Act the company may not make any proposed distribution unless the following 3 criteria are met:

  1. The distribution:
    • Is pursuant to an existing legal obligation of the company or a court order; or
    • the board of the company, by resolution, has authorised the distribution; and
  2. It reasonably appears that the company will satisfy the solvency and liquidity test immediately after completing the proposed distribution; and
    • The financial information used to calculate the solvency and liquidity test must satisfy the requirements of section 28 and section 29 of the Act.
  3. The board of the company must acknowledge by way of a resolution that it has applied the solvency and liquidity test and reasonably concluded that the company will satisfy the test immediately after completing the proposed distribution.

 

In accordance with Section 46(3) of the Act should the distribution not been made within 120 business days after the board resolution, court order or existing legal obligation as the case may be:

  • The board must reconsider the solvency and liquidity test on the distribution to be made pursuant to the original resolution, court order or legal obligation; and
  • The company must not proceed with any such distribution despite any law, order or agreement unless the board adopted a further resolution and re-evaluated the solvency and liquidity of the company.

Director’s liability for contravention of section 46 of the Act

If the directors approve a distribution when the above criteria are not met, the directors who were present at the meeting and failed to vote against the unlawful distribution may be held liable for any loss, damages or costs sustained by the company as a direct or indirect consequence of the distribution made to the shareholders. A good example will be if the company is unable to pay their debts as they fall due after the distribution and they may incur penalties, fines or interest.

The amount of the director’s liability can be limited. Section 77(4) (b) of the Act states that the liability does not exceed, in aggregate, the difference between:

  • the amount by which the value of the distribution exceeded the amount that could have been distributed without causing the company to fail to satisfy the solvency and liquidity test, and
  • the amount, if any, recovered by the company from persons to whom the distribution was made.

Income tax effect on the above mentioned distributions

Cash dividend

The beneficial owner (shareholder) will be liable for 20% dividend withholding tax.  There are certain exemptions from the dividend withholding tax. The main exemption that may apply in the case of the declaration of a cash dividend is where the beneficial owner of such dividend is a South African resident company. Other exemptions include dividends received by beneficial owners that are Public Benefit Organisations and Pension Funds.

Share buyback

  • To the extent to which the payment to the shareholder is a return of contributed tax capital, there is no tax payable.
  • For anything paid to the shareholder in excess of contributed tax capital, this will be treated as a dividend in the case of a share buyback as per the definition of Dividend in the Income Tax Act. 
  • If the shareholder is exempt from dividends tax in accordance with section 64F then the share buyback transaction will be subject to Capital Gains Tax.

Shareholder’s debit loans

  • If the interest rate charged on the loan is less than the market related interest rate, the difference in the interest charged and the market related interest is deemed to be a dividend.
  • The deemed dividend will be subject to dividend tax at 20%.
  • The tax on deemed dividends is payable by the company and not the beneficial owner as in the case of cash dividend.

Conclusion

Distributions of company assets to its shareholders, whether in the form of cash or otherwise, are regulated by the Act. Any director making unlawful distributions may be held liable for any loss, damages or costs sustained by the company. Furthermore it is important that the tax effect on the various types of distributions and/or deemed distributions are understood and taken into account.

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