Tax Treatment on Preference Shares

On 16 August 2025, National Treasury published the 2025 Draft Taxation Laws Amendment Bill,which proposes to revise the rules applicable to preference shares. Comment on the draft

legislation must be made by 12 September 2025. If the draft is brought into effect, it will becomeapplicable from 1 January 2026.

Our Companies Act allows a company to issue shares of different classes and in each class, theboard of the company may determine the preferences, rights, limitations or other terms. Unlessthese preferences, rights and limitations are expressly stated in the memorandum of incorporationof the company, the shares in the company will be treated equally.

It is quite common for companies to issue preference shares to banks as part of funding structures.

These shares typically provide for a guaranteed dividend to the bank and for the shares to be

redeemed on a defined date. They are particularly attractive in BEE funding structures.

From a tax perspective, the bank is able to treat the dividend paid on the preference shares as

dividend income which would not be subject to tax whereas the company is obliged to pay the

dividend from after tax income. This structure has enabled banks to offer funding at a lower rateas the dividend paid is free of tax.

Preference share structures have also been very popular for shareholders contemplating

establishing an empowerment structure. Existing shareholders typically convert their ordinary

shares into preference shares and then issue to empowerment shareholders new ordinary shares for nominal consideration. For the purposes of the BEE Code, the preference shares are treated as debt and not as equity and the new BEE shareholders, as the holders of ordinary shares,become, for the purposes of the BEE Code, the majority shareholder in the company.

These structures are now under threat by the proposed amendment to Section 8E of the Income

Tax Act.

Section 8E of the Income Tax Act provides that dividends derived from certain shares,

which are a hybrid equity instrument, are deemed to be income in relation to the recipient.

Currently, excluded from a hybrid equity instrument, is a preference share where the preference share may only be redeemed after a period of three years from the date of issue. All preference shares issued as part of a funding structure or issued as part of a structure designed to benefit from the provisions of the BEE Codes, have provided that they may not be redeemed within the first three years of issue.

The amendment proposes to delete the three-year redemption test.

In its explanatory memorandum, Treasury has indicated that many preference shares are in fact debt instruments despite being described as preference shares. If, for the purposes of IFRS, the share is regarded as debt by the holder of the share, then it will be treated as such from a tax perspective.

The dividend yield, for the bank or holder, will be recharacterized as income and not as interest, in the hands of the holder. However, for the company, the dividend payment will not be treated as interest, notwithstanding the recharacterization of the instrument as debt. The dividend payment will still have to be made out of after tax income. In other words, the distribution will not be a tax-deductible expense.

It is likely that this proposed amendment will receive significant opposition from banks and those who are involved in existing preference share structures. We anticipate that the amendment will be changed to be restricted to new structures so that the proposed change will not have retrospective effect.

However, it would be advisable to consider all existing preference share structures as they may

need to be changed.

Author:

Michael Jackson

Partner

mjackson@coxyeats.co.za

082 808 7891 | 031 536 8512