Big changes coming for BEE funding in South Africa

A new Bill proposes reclassifying most preference shares as debt for tax purposes, a move that would significantly raise funding costs, disrupt BEE, renewable energy, and M&A transactions, and is likely to face strong industry opposition.

On 16 August 2025, the National Treasury published the 2025 Draft Taxation Laws Amendment Bill and the accompanying Explanatory Memorandum.

Bowmans legal experts Wally Horak, Jan Kruger, Amanda Jones and Michael Rudnicki said the Bill introduces significant revisions to the hybrid-equity rules in section 8E of the Income Tax Act.

“Because many banks and other financial institutions participate as preference shareholders in funding transactions, the proposed changes warrant careful consideration,” said Horak, Kruger, Jones and Rudnicki.

“Further, almost all BEE transactions, several renewable energy transactions and many other acquisition and M&A transactions are funded through these instruments.”

This means that implementing this proposed legislation would immediately impact existing transactions, as the cost of funding would increase materially. It would also stifle any similar proposed transactions.

Essentially, Section 8E of the Income Tax Act prevents companies from disguising debt as equity to gain tax advantages.

It targets shares with debt-like features, such as preference shares that function like loans. Dividends on these hybrid equity instruments are taxed as normal, not exempt, income, and issuers cannot claim a deduction for paying them.

A share’s classification depends on its issue date and must be reassessed if redemption rights or terms change.

Horak, Kruger, Jones, and Rudnicki explained that the National Treasury’s primary objective in drafting the legislation is to ensure that an instrument’s tax character reflects its economic substance.

“Treasury considers that certain preference shares, although issued in legal form as equity, function economically as debt and therefore produce tax outcomes that are misaligned with their substantive risk and return profile,” they said.

Rule changes

To address this misalignment, Horak, Kruger, Jones and Rudnicki said the Bill proposes redefining the terms “financial instruments” and “hybrid equity instrument” in section 8E.

This amendment aims to capture a far wider range of arrangements than those currently within the section’s scope.

First, the draft redefinition would expand the concept of a hybrid equity instrument to include any share or financial instrument (as redefined).

It would apply where the instrument is, or in the future would be, recognised as a financial liability in the hands of the issuer for International Financial Reporting Standards (IFRS) purposes.

“In other words, the issuer’s legal form is no longer determinative,” the legal experts explained.

“If, applying the IFRS classification principles, the instrument is treated as debt in the annual financial statements of the issuer, it will constitute a hybrid equity instrument for income-tax purposes for the holder.”

The Explanatory Memorandum explicitly states that the tax legislation leverages IFRS’s ‘rigorous classification principles’ to align tax outcomes with economic reality.

“However, the tax treatment will still not align with the accounting treatment, which treats the instrument as debt both for the holder and the issuer,” they said.

Secondly, the amendment proposes deleting the current three-year redemption test. Currently, a preference share only qualifies as a hybrid equity instrument if the issuer must redeem it, or the holder can demand redemption, within three years of issue.

“Once the time-based safe harbour is repealed, any instrument that is classified as debt under the IFRS, regardless of its contractual tenure, will fall within section 8E,” they said.

“Consequently, the dividend yields on these instruments will be re-characterised as income (not interest) in the hands of the holder.”

However, they said that the issuer’s distributions will not be treated as interest, notwithstanding the re-characterisation of the instrument as debt.

The practical effect of these changes is that once the amendments become operative, most commercially issued preference shares are expected to fall within section 8E.

The legal experts added that most preference share funding structures rely on contractual redemption obligations and dividend distributions.

Therefore, distributions paid after the effective date will no longer be exempt dividends in the hands of recipients. Instead, they will be subject to normal income tax, and the issuer will not be entitled to any deduction for the payment of the dividends.

“Treasury has invited public comments on the draft legislation by 12 September 2025, and it is anticipated that the proposed amendments will elicit robust opposition from industry participants, including ourselves and other professional advisers,” they said.