The National Treasury’s proposal to only allow tax exemptions on preference shares that have a redemption period of at least 10 years could destroy the financial feasibility of most black economic empowerment (BEE) transactions.

The proposal is set to more than double the tax burden of BEE schemes.

“Many BEE deals are under water right now, if this proposal is implemented it will wipe them out,” a leading tax adviser told Business Report.

Because the majority of BEE deals have been structured around the tax benefits of three-year preference shares, the removal of that benefit threatens their viability.

The proposal is part of the draft Taxation Laws Amendment Bill, which was announced by the National Treasury at the beginning of this month.

In addition to the damage it is set to wreak havoc on BEE, the preference share proposal has already had a chilling effect on planned investment into the country. One tax adviser, who believes the National Treasury will reverse the proposal once it realises the full effect, said the uncertainty that had already been created was “causing havoc with our clients and foreign investors”.

Gordon Young, a financial adviser to Ditikeni empowerment group, said that new companies and expanding companies found preference share finance a flexible and convenient financing tool. He added: “BEE would be nigh on impossible without preference shares. I can think of few BEE transactions that have not involved preference shares.

“(The proposal) amounts to double taxation and is obviously intended to exterminate redeemable preference shares.”

The proposal has also caused consternation within the banking sector as each of the large banks is estimated to have billions of rands worth of preference shares on their balance sheets.

Currently dividends paid on three-year preference shares are taxed as if they are interest in the hands of the holder. The Treasury is proposing that with effect from April 1 next year the three-year period will be extended to 10 years.

This meant “such preference shares may not be redeemed or be capable of being redeemed for a period of at least 10 years from the date of issue”, law firm Bowman Gilfillan said in a tax note, adding: “Many funding structures will, as a result, no longer be feasible.”

Bowman Gilfillan’s note also alluded to the possibility that non-resident banks who did not face the same tax restrictions as locals might be able to provide more attractive funding if the preference share proposal was implemented. - Business Report