The implementation of the Mineral & Petroleum Resources Development Act, which includes the Mining Charter, as well as the finalisation of the Black Economic Empowerment Charter (BEE) ahead of the announcement of this year`s Budget may result in an increased level of deals, as companies try to finalise their empowerment credentials.
According to Russell Eastaugh, partner at Deloitte & Touche Mining Taxation an aspect that could be particularly helpful to empowerment concerns was persuading the SARS that dividends were economically, taxable income. He added that it would be beneficial if dividends were subject to income tax in the hands of the recipient, with a corresponding credit given for tax paid by the paying company and for Secondary Tax on Companies (STC). "Empowerment concerns would benefit since it would make borrowing money to finance transactions cheaper," he said.
Dividends are currently exempt from income tax. According to Eastaugh, this is a crude method of ensuring tax fairness, since the dividends are paid out of profits that have already been taxed in the hands of the paying company. If a company were to distribute all of its profits as dividends, it would pay a total tax rate of about 38%, combining its Income Tax and Secondary Tax on Companies (STC) liabilities. This is slightly lower than the top rate of tax for individuals, but is higher than the rate many less affluent shareholders may be paying.
He added that since dividends were exempt from income tax and a person was normally seen as buying shares in order to earn dividends, any costs incurred by the owner in buying the shares would not qualify as an income tax deduction. "For example, if the owner borrowed money in order to pay for the shares, he would not be able to deduct the interest he paid when computing his tax liability. However, the bank from which he borrowed the money would still pay income tax on the interest it receives. So, the State benefits from taxing income without giving any relief to the payer of the interest," Eastaugh pointed out.
This effectively raises the cost of financing the purchase of the shares. For example, let`s say a company bought shares in another company for R10 million, borrowed the entire purchase price at an interest rate of 16% a year and will receive dividends of R1.5 million a year. As the law stands, assuming the company had no other income, its taxable income would be nil and it would have no income tax liability. Its cost of financing the purchase of the shares would be 16%.
According to Eastaugh if the law were changed in the manner suggested, the shareholder would be better off. The shareholder`s taxable income would now be the dividends received of R1.5 million, plus a tax credit reflecting the tax paid by the company of R 911 576, less the interest paid of R 1.6 million, giving R811 576. Its income tax liability would be R243 473, but it received a credit of R911 576. Thus, the shareholder is due a refund from the SARS of R668 103. It has paid interest of R1.6 million, but its overall outflow of cash was only R931 897, when the tax refund is into account. This reduces the company`s effective cost of borrowing to 9.3%.
"This suggested change would make the financing of empowerment deals cheaper without the need to use complicated mechanisms such as preference shares," he added.
Share
