Dividend income, in relation to the recipient thereof, is subject to tax treatment which is more favourable than most other income.
Dividends received are exempt from income tax (section 10(1)(k(i) of the Income Tax Act). Dividends paid by one South African company to another are exempt from Dividends Withholding Tax (section 64F of the Income Tax Act).
With effect from 25 October 2012, specific anti-avoidance provisions in respect of dividends received in consequence of a cession of the right to those dividends, were introduced into the Income Tax Act (section 10(1)(k)(i)(ee), the implications of which are as follows: if a shareholder cedes to a company only the rights to receive dividends, without ceding all the rights attaching to the underlying shares to that company, then such cession of the right to dividends will not be exempt from normal tax in terms of section 10(1)(k)(i).
On 31 May 2018, the Supreme Court of Appeal handed down its judgment in the case of CSARS v KWJ Investments Service (Pty) Ltd (142/2017)  ZASCA relating to the tax implications of ceded dividend rights in the hands of the cessionary.
The central issue on appeal concerned whether when the respondent obtained rights to dividends declared but not yet accrued by way of cession, this constitutes a receipt or accrual for the purposes of gross income, and if so; does s 79 (1) of the Income Tax Act apply, namely was the assessment contrary to a generally prevailing practice of appellant.
The background and facts of the case are as follows:
The respondent conducted a business in redeemable preference shares and invested the funds so raised from the preference shares, thus making a profit. The respondent invested the surplus proceeds from the business with Investec Bank Ltd (Investec). The return on respondent’s investment was in the form of an antecedent cession of rights to dividends, that is, a cession of a right to dividends to be declared in the future.
In its tax return, respondent included in its ‘gross income’ all the dividends which had, in due course, accrued to it as cessionary of the rights so ceded, thus then treated this ‘gross income’ as being exempt from tax in terms of the Income Tax Act (prior to the insertion in the Act of section 10(1)(k)(i)(ee) which took place with effect from 25 October 2012).
The appellant issued additional assessments to the respondent on the basis that the respondent acquired unconditional entitlement to each dividend right upon the cession to it by Investec.
The appellant lodged an appeal against these additional assessments. The Tax Court held that the payment of the dividends was conditional and did not fall within the definition of gross income. The Act stipulates that it only an amount unconditionally received or accrued may form part of gross income.
On Appeal, the SCA had to consider the following: “Whether, when the respondent obtained certain rights to dividends declared but not yet accrued by way of a cession, the value of these rights constituted ‘gross income’ in the hands of respondent either in terms of s 24J(3) of the Income Tax Act 58 of 1962 as amended (the Act) or under the definition of gross income as set out in s 1 of the Act”.
In regard to the antecedent cession of rights to dividends, SARS contended that two separate and distinct accruals took place: the first accrual took place on the date of the antecedent cession of the dividend rights from Investec to KWJ. A second accrual then took place on the date when the companies so declaring the dividends paid them to KWJ, being the party so entitled to the dividends upon declaration.
The court held that “The definition of gross income includes ‘the total amount in cash or otherwise, received by or accrued to or in favour of any person’… An amount accrues to a taxpayer once the taxpayer becomes unconditionally entitled to such an amount; that is, a taxpayer’s right must be unconditional in order for the right to fall within the scope of gross income”.
SARS contended that the dividend rights received by KWJ constituted an amount which accrued to it unconditionally, in terms of gross income as defined in s 1 of the Act. Counsel for KWJ submitted that, while the cession as the mode of delivery was unconditional, the right ceded was conditional since the last day for registration of the shareholders (record date) had not yet arrived when the rights to dividends were ceded to respondent and therefore, respondent held no more than a contingent right.
The court found in favour SARS. The court held that the payment of the dividends took place subsequent to the cession of the rights to the dividends and consequently these were two separate amounts. Under the circumstances, the cession of the rights to dividends was unconditional and had a defined monetary value. Therefore, the court held that the cession of the rights to dividends constituted an amount that accrued to KWJ and thus fell within the ambit of gross income.
However, ultimately, SARS’ appeal was unsuccessful on a separate technical issue as it was held that the original assessments issued by SARS had prescribed on the basis of a practice generally prevailing at the time.
In conclusion, where a taxpayer, as cessionary, acquires the right to receive dividends, the taxpayer must account for tax effects separately on two distinct amounts: first, on the accrual of the amount of the right to the dividend and second, on the accrual of the amount of dividends as and when declared by the relevant company. In regard to the first accrual, where rights to dividends are ceded to a company without ceding all the rights attaching to the underlying shares to that company, then any dividends accrued to that company in consequence of the ceded dividend rights will not be exempt from normal tax.