Africa-Press – South-Africa. The proposed changes to the definition of a “hybrid equity investment” will have far-reaching implications for tax-efficient methods of financing business deals or raising debt.
A hybrid equity investment most commonly takes the form of preference shares, listed on the stock exchange to raise money for a company to finance an expansion of operations or a business deal.
Many South African companies, most commonly financial institutions, use preference shares to efficiently raise finance.
For example, companies such as Standard Bank, Discovery, Investec, FirstRand, Capitec, and Netcare have preference shares listed on the JSE.
Preference shareholders typically receive enhanced dividends, which are usually cumulative.
These dividends are also calculated differently from typical payouts to shareholders, with preference shareholders receiving a dividend based on their par value multiplied by a percentage of the prime rate.
This is where the National Treasury is looking to refine the definition of a “hybrid equity investment” in tax legislation to strengthen anti-avoidance measures.
In the release of the 2025 Draft Tax Bills and Draft Regulations for Comment, the Treasury proposed that if an instrument is recognised as a debt liability for accounting purposes, it will also be treated as debt for tax purposes.
PwC explained in a note that the proposal seeks to directly align tax legislation with established accounting substance principles by tightening the definition in section 8E of the Income Tax Act.
The firm said preference shares that are recognised as liabilities for financial reporting purposes are proposed to be taxed as debt instruments, and the current three-year redemption period will be scrapped.
Therefore, as dividends on such instruments will be treated as income, the amendment will have far-reaching implications for tax-efficient structuring of financing arrangements.
In addition, there is no proposed grandfathering of existing arrangements which could trigger tax gross-up clauses and make funding arrangements financially unviable.
The proposed amendments will come into operation on 1 January 2026 and apply to years of assessment commencing on or after that date.
Corporates being squeezed in South Africa
The proposed refining of the definition will cut off a valuable avenue for companies to efficiently raise capital to fund growth and business deals.
This is vital for economic growth, with South Africa having a relatively high cost of capital, which discourages the raising of finance for various projects.
A higher cost of capital creates a higher threshold that needs to be passed for a project to become economically viable.
This prohibits investment in the expansion of business operations and the ability for companies to increase employment.
Preference shares are one of the few avenues through which companies could relatively easily and efficiently raise capital for investment.
This also comes at a time when South African corporates are heavily taxed compared to their global peers, with a few companies footing the majority of the bill.
Globally, countries are reducing their corporate income tax rates (CIT) to 15%, which has been agreed upon as the global minimum.
As other countries reduce their CIT rates, South Africa’s 27% looks increasingly unattractive, warding off potential investment that would boost economic growth.
Moreover, the tax bill imposed on companies is often passed on to consumers in the form of higher prices, meaning that individuals ultimately foot the bill.
South Africa has one of the most concentrated CIT bases in the world, with only 1,051 companies covering 72.3% of the state’s revenue from this source.
This translates into 0.1% of all companies paying 72.3% of CIT in the country. These are companies classified by SARS as generating taxable income greater than R100 million annually.
SARS outlines this data in its annual Tax Statistics, the most recent edition of which was published in December 2024.
It showed that South Africa has a highly concentrated CIT tax base, despite over one million businesses being registered for tax in the 2023/24 financial year.
Of these companies, 287,802 made a loss and 637,435 had no taxable income. There were 198,695 companies which made a profit of up to R1 million and paid R7.4 billion in company income tax.
Another 41,709 had a taxable income of R1 million to R100 million and paid R82.5 billion in tax. They accounted for 25.5% of all company income tax.
72.3% of company income tax was paid by companies with taxable incomes of more than R100 million, and 66.5% by large companies with taxable incomes of more than R200 million.
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