The South African corporate finance landscape stands on the precipice of a seismic shift due to the proposed amendments to the anti-avoidance sections of 8E and 8EA in the draft Taxation Laws Amendment Bill 2025 (TLAB). This article focuses on the proposed amendments to section 8E which signals a paradigm shift in policy.

The draft TLAB proposes to replace the existing criteria of the "date of issue" concept and the three-year redemption test with a single, principles-based test. A share will be a "hybrid equity instrument" if it is classified as a financial liability in the issuer's annual financial statements prepared in accordance with the International Financial Reporting Standards (IFRS).

The Explanatory Memorandum to the draft TLAB identifies the "three years and one day" redemption as problematic and the reason for the proposed amendments to section 8E.

"… Specifically, with reference to the anti-avoidance provision in section 8E of the Act, these products are often structured with a term exceeding the prescribed three-year period (e.g., three years and one day). This extended term is intentionally designed to circumvent the application of section 8E, which would otherwise deem dividends on such "hybrid equity instruments" to be taxable income for the recipient." (Emphasis added.)

The current situation presents a fundamental change in approach taken in respect of the treatment of preference share funding transactions.

The three-year redemption rule has served as the primary test for identifying 'hybrid equity instruments' ever since section 8E was first introduced into the Income Tax Act 58 of 1962 more than 35 years ago (ie from 9 June 1989).

Through the reportable arrangement notice issued on 3 February 2016, the South African Revenue Service (Sars) has effectively monitored the use of preference shares structured to comply with section 8E. The notice required the reporting of an arrangement that would have qualified as a "hybrid equity instrument" under section 8E if the prescribed period in the section had been 10 years (excluding listed instruments). In essence, the notice created a hypothetical 10-year rule for reporting purposes, capturing instruments with longer redemption periods. Sars has been aware of taxpayers legitimately structuring their funding arrangements precisely to comply with the three-year bright line test since 2016.

Possibly in response to the information gathered on the targeted preference shares, Sars circulated a draft interpretation note for public comment on the topic of whether changing a share's redemption terms resets its original date of issue. The draft was finalised as Interpretation Note 123 (IN 123) dated 26 September 2022 (ie more than 6 years after 2016). Crucially, in both the draft and final interpretation notes, paragraph 4.2 states that

"… Any redemption after three years from the date of issue, for example three years and one day, will result in the share not being regarded as a hybrid equity instrument. …". (Emphasis added.)

There appears to be a disconnect between the historical application of section 8E in IN 123 above and National Treasury's current policy objective to close the circumvention of the three-year test in section 8E.

Most preference shares currently used for funding in South Africa, particularly those that are redeemable or carry cumulative dividend rights, could be classified as financial liabilities under IFRS. There is, however, a fundamental difference between the nature of (i) the obligation to pay preference dividends on preference shares; and (ii) the obligation to pay interest on debt instruments.

A debt issuer's duty to pay interest on a loan is unconditional and must be met regardless of the company's financial position. In contrast, the obligation to pay a preference dividend is always contingent upon the company satisfying the solvency and liquidity tests in the Companies Act 71 of 2008. Therefore, while the preference share agreement may require a preference dividend payment, there is no unconditional obligation to pay the preference dividend until these tests are met.

The rationale postulated by Sars for the change in approach is to treat preference shares as a debt instrument if the preference shares have debt like features from an accounting perspective. This is certainly one lense through which preference shares can be considered but another lense, as mentioned above, is a company law lense. Notwithstanding a contractual obligation to pay dividends or redeem the preference share, the holder of the preference share has no enforceable right to require the payment of a dividend or the redemption of the preference share if the company does not pass its solvency and liquidity tests at the time the dividend is required to be paid or the redemption is required to be made. This is not a consideration under a loan agreement.  As such, if one had to apply a company law lense there is a marked difference between a loan and preference share.  The risk that the holder of a preference share has is equity like in nature.

The financial consequences of the proposal are severe primarily due to the common inclusion of "tax gross-up" clauses in funding agreements. If dividends on these instruments become taxable in the hands of the holder, these clauses will contractually obligate the issuer to make additional payments to ensure the holder's after-tax return is preserved. This could increase the cost of funding for issuers by more than 35%, rendering many existing preference share structures economically unviable and potentially triggering a wave of corporate restructurings and refinancings.

The proposed effective date for this change in the draft TLAB is for the years of assessment commencing on or after 1 January 2026. Critically, the proposal is intended to apply to all preference dividends paid from that point, irrespective of when the preference shares were issued.

The proposed effective date means that preference shares held by companies with financial years ending on 31 December 2025 could have their preference shares classified as hybrid equity instruments from 1 January 2026. Any preference dividends received by them from 1 January 2026 would be deemed to be income subject to tax in their hands. The issuer companies for these preference shares would likely be required to gross up any preference dividends paid from 1 January 2026. The issuer companies would not be able to claim a tax deduction for the amounts of preference dividends distributed, underscoring the asymmetrically punitive implications of section 8E and its resulting potential economic double taxation.

National Treasury usually circulates a draft response document and introduces the tax bills in the National Assembly when the (2025) Medium Term Budget Policy Statement (MTBPS) is published (in this case, November 2025). The tax statutes are then published in the Government Gazette around late December (2025) or early January (2026), with the date of publication being the effective date the tax statutes become law (date of promulgation).

In the interim, the proposed amendments have caused great uncertainty on how to treat preference shares which would become hybrid equity instruments if the proposed amendments take effect in their current form from the date of promulgation. Any amendments to existing or negotiation of new preference share terms take time. However, existing and potential issuers and holders are caught in a difficult predicament. No one can draft or redraft to comply with a law that is not yet known and will likely only be known shortly before the amendments are effective – not leaving much time for a refinancing.

Webber Wentzel will be making submissions on these proposed amendments which are due by 12 September 2025.

Written by Joon Chong & Khurshid Fazel, Partners at Webber Wentzel