By Duncan McAllister, consultant with Webber Wentzel
The recently-introduced section 9K to the Income Tax Act triggers a potential tax liability when dual-listed shares are migrated from a South African to an offshore stock exchange
When the Rand depreciates, buying dual-listed shares on an offshore exchange instead of a South African exchange offers advantages under para 43(1) of the Eighth Schedule for individuals and non-trading trusts. But this advantage does not seem to be available under the recently-introduced section 9K of the Income Tax Act 58 of 1962 (Act), which applies when shares are transferred from a South African exchange to an offshore exchange on or after 1 March 2021.
Why section 9K?
Section 9K triggers a deemed disposal and reacquisition of the shares that are migrated to the offshore exchange, thus accelerating the imposition of income tax (including capital gains tax (CGT)) on any unrealised gain. Given that the shares remain within the South African tax net after the deemed disposal, the need for this measure is questionable. It may be intended to reduce the future risk of loss to the fiscus from non-disclosure when the shares are subsequently disposed of on the offshore exchange, or to discourage capital flight.
The Explanatory Memorandum on the Taxation Laws Amendment Bill, 2020 explains the background to the introduction of section 9K as follows:
“As indicated in Annexure E of the 2020 Budget Review, Government proposes to review the current exchange control rules to be replaced by implementing a new capital flow management framework that is aimed at promoting investment, reducing unnecessary burdensome approvals by SARB and providing a modern, transparent and risk-based approvals framework for cross-border flows. One of the changes to the current exchange control rules is the phasing out of the approval requirement by SARB when a resident individual or company that owns a listed domestic security is exporting that listed domestic security abroad.”
Before examining section 9K, it is worth taking a look at para 43 to understand the benefits of investing on an offshore exchange, rather than buying the identical share on a South African exchange.
Para 43 advantage
Before 1 March 2013, the sale of a foreign equity instrument was dealt with under para 43(4), which, in simple terms, translated the base cost to Rands at the time of acquisition and the proceeds to Rands at the time of disposal. But on or after that date, para 43(4) was deleted and natural persons and non-trading trusts were required to determine a capital gain or loss under para 43(1) when buying and selling a share in the same foreign currency. Under para 43(1), the capital gain or loss is determined in the foreign currency and translated to Rands using the spot rate at the time of disposal or the average exchange rate for the year of assessment in which the asset is disposed of. If natural persons or non-trading trusts dispose of a share in different currencies (including the Rand), they fall into para 43(1A) together with companies and trading trusts. Para 43(1A) determines a capital gain or loss in the same way as the old para 43(4).
The effect can be illustrated with a simple example:
Jack bought 100 dual-listed shares on the JSE for ZAR20,000 and sold them on the same exchange for ZAR50,000 five years later. His capital gain is ZAR30,000.
Jill bought 100 of the same listed shares on the LSE when £1 = ZAR10 and paid £2,000 for her shares on the same date as Jack. She too sold her shares on the LSE five years later when £1 = ZAR20. She received proceeds of £2,500 and made a capital gain of £500. Under para 43(1), Jill has a Rand gain of £500 × ZAR20 = ZAR10,000.
Jack’s capital gain is therefore ZAR20,000 higher than Jill’s, because his base cost has remained fixed while Jill’s base cost is determined in GBP and translated at the rate ruling at the time of disposal. Her base cost in Rand is £2,000 × £20 = ZAR40,000 compared with Jack’s base cost of ZAR20,000.
So, if your view is that the Rand is going to continue to depreciate against the currency of the offshore exchange, it would be more tax efficient to buy the shares on the offshore exchange.
Section 9K triggers tax on delisting on South African and listing on offshore exchange
Section 9K came into operation on 1 March 2021. It applies to any security listed on an exchange outside South Africa on or after that date. It provides as follows:
‘9K. Listing of security on exchange outside Republic.—(1)Where a natural person or a trust that is a resident holds a security in a company and that security is delisted on an exchange as defined in section 1 of the Financial Markets Act and licenced under section 9 of that Act, and subsequent to that delisting that security is listed on an exchange outside the Republic, that person must be treated as having—
(a) disposed of that security for an amount received or accrued equal to the market value of that security as contemplated in the definition of “market value” in section 9H (1) on the day that the security is listed on the exchange outside the Republic; and
(b) reacquired that security on the same day on which that security is treated as having been disposed of under para (a) for expenditure in an amount equal to that market value.
(2) For the purposes of section 9C (2), a security that is listed on an exchange outside the Republic as contemplated in subsection (1) must be treated to be one and the same security that is delisted.’
The term ‘market value’ as defined in section 9H(1) reads as follows:
‘ “[M]arket value”, in relation to an asset, means the price which could be obtained upon a sale of that asset between a willing buyer and a willing seller dealing at arm’s length in an open market.’
The term ‘security’ is not defined in the Act and would probably have its ordinary meaning. The Cambridge English Dictionary (online) defines ‘a security’ as ‘an investment in a company or in government debt that can be traded on the financial markets’. It would therefore include dual-listed shares, depository receipts and bonds and debentures.
Section 9K(1) refers to a situation in which
· ‘a ‘security’ is held by a resident natural person or trust;
· ‘that security’ is delisted on a South African exchange; and
· ‘that security’ is then listed on an offshore exchange.
In these circumstances, the holder is treated as having disposed of ‘that security’ for an amount equal to its market value and to have reacquired it for expenditure equal to the same market value.
The security referred to is the security trading on the South African exchange, and its market value must therefore be determined in the currency in which it trades on that exchange, which is the Rand. Since the reacquisition cost is the same market value, it too will be denominated in Rand, even though section 9K does not explicitly deal with the currency of disposal and reacquisition. This interpretation is consistent with the exit charge in section 9H. Section 9H(7) provides that for the purposes of section 9H(2) and (3), ‘the market value of any asset must be determined in the currency of expenditure incurred to acquire that asset’.
Therefore, transferring dual-listed shares to an offshore exchange will not provide a natural person or trust shareholder with any CGT advantage under para 43 when the shares on the offshore exchange are subsequently disposed of, for example, upon cessation of residence under section 9H or as a result of a sale to a third party. The proceeds will be in the foreign currency of the offshore exchange, while the base cost will be in Rands and the natural person or trust will therefore fall under para 43(1A).
The time of disposal and reacquisition is the date on which the shares become listed on the offshore exchange. There was no need for a ‘day before’ deeming rule, since the shareholder remains a resident after the deemed disposal.
The three-year safe haven rule in section 9C(2)
Section 9K applies to securities, whether held as capital assets or trading stock.
Under section 9K(2), for the purposes of determining whether the disposal of the security (in this instance an equity share as defined in section 9C(1)) gives rise to a receipt or accrual of a capital nature under section 9C(2), a security that is listed on an exchange outside South Africa as contemplated in section 9C(1) must be treated as the same security that is delisted.
Under section 9C(1) the definition of ‘equity share’ excludes a share in a company which was not a resident, other than a company contemplated in para (a) of the definition of ‘listed company’ in section 1(1). Para (a) of the definition of ‘listed company’ refers to a company with its shares or depository receipts listed on an exchange, as defined in section 1 of the Financial Markets Act 19 of 2012 and licensed under section 9 of this statute. Section 9C(2) therefore applies to shares in a non-resident company with shares listed on a South African exchange, and would include a dual-listed share.
Example – Transfer of a listed share from a South African exchange to an offshore exchange
Jim owned 100 shares in XYZ plc which he acquired on the JSE at a cost of ZAR100,000 on 1 March 2019. In February 2021, he instructed his broker to transfer his shares to the LSE, which was done on 1 March 2021. On that day the shares were trading at ZAR5,000 each on the JSE and at £250 a share on the LSE. The exchange rate was £1 = ZAR20. On 30 April 2022, Jim ceased to be a resident, and on 29 April 2022 the shares were trading at £280 a share and the exchange rate was £1 = ZAR21. Jim elected to use the spot rate to determine the capital gain or loss.
Under section 9K, Jim is deemed to dispose of and reacquire the shares on 1 March 2021 for proceeds of ZAR500,000 resulting in a capital gain of ZAR400,000 (ZAR500,000 − ZAR100,000). He is deemed to reacquire them at a cost of ZAR500,000 on 1 March 2021. On 29 April 2022 Jim will be deemed to dispose of the shares under section 9H, and since their base cost is denominated in Rands, the calculation of the capital gain must be determined under para 43(1A). The proceeds in Rands are 100 × £280 × 21 = ZAR588,000. Jim therefore will have a capital gain of ZAR88,000 (ZAR588,000 − ZAR500,000) on 29 April 2022. Since he had held the shares for more than three years, the capital gain will be of a capital nature, based on section 9C(2) read with section 9K(2).
For South African residents, there are adverse tax consequences for transferring dual-listed shares to an offshore exchange. The payment of tax will potentially be accelerated and the resident may be exposed to foreign death duties and dividend withholding taxes.