The Steinhoff Saga Management review - University of Stellenbosch Business School

January – July 2021

Understanding the link between management innovation and competitive advantage

By Rudie Nel and Nicolene Wesson

  • JAN 2021
19 minutes to read

SHARE

What was this study about?

In 2012, dividends tax (a shareholder tax) replaced the secondary tax on companies (a company tax) regime in South Africa. To find out how this changed the payout methods of companies listed on the Johannesburg Stock Exchange, this study investigated the trend and composition of total payout distributed by these companies over a period of tax reform.

In the past, studies on tax-related dividends mainly looked at the impact of differential rates between dividends tax and capital gains tax, focusing on dividends as payout method. However, the unique South African tax reform environment calls for a closer look at the combination of payout methods used by JSE-listed companies.

The researchers started by investigating the payout methods of 116 JSE-listed companies for the financial reporting periods 2006 to 2018. The payout methods referred to here are dividends, capital distributions, additional shares (a possible substitute for cash dividends in cash-strapped companies or financially constrained companies that wish to preserve cash) and share repurchases (a possible substitute payout method for cash dividends to maximise shareholders’ after-tax return). The researchers looked at the payouts in terms of rand value and the frequency of election, and they included large, medium-sized as well as small companies. The focus was on two sub-periods: the six-year period from 2006 to 2011 (‘pre-2012’) and the six-year period from 2013 to 2018 (‘post-2012’).

The introduction of dividends tax during 2012 resulted in the possibility of tax arbitrage – the practice of profiting from differences that arise from the ways transactions are treated for tax purposes – encountered for the first time in South Africa as only certain shareholders were exempted from paying dividends tax. This meant that diverse shareholding in companies could give rise to conflicting tax preferences among different shareholders. Also, in terms of the tax reform, general share repurchases by JSE-listed companies were no longer regarded as a ‘dividend’ for tax purposes. The differential rate between dividends tax and capital gains tax could result in shareholders choosing payout methods other than dividends.

Investigating whether an increase in dividend payouts was accompanied by a decrease in other payout methods could provide an insight into how companies have responded when presented with conflicting tax preferences since the introduction of dividends tax.

This can also provide insight into the possible substitution of payout methods. For example, a dividend payout subject to dividends tax could be substituted for another payout method subject to capital gains tax (CGT) in order to minimise the taxes payable by a shareholder. Conversely, a payout method subject to CGT could be substituted for a dividend payout in order to benefit from the exemption of dividends tax and to minimise the taxes payable by a shareholder.

… the unique South African tax reform environment calls for a closer look at the combination of payout methods used by JSE-listed companies.

How was the study conducted?

To provide context, the researchers started by exploring previous research on South African payout methods – specifically dividends, capital distributions, additional shares and share repurchases. They also looked at the tax implications of these payout methods to formulate seven propositions about the trend and composition of payout based on tax reform. This is what they learned from literature in support of their propositions on each payout method:

Dividends

According to South African literature, dividends have increased from 2012 to 2014. Based on the relationship between dividend payout ratios and subsequent growth of earnings from 1960 to 2014, the introduction of dividends tax largely coincided with a period of increased dividend payout ratios. Companies were allowed to offset the secondary tax on companies (STC) credit, from the previous tax regime, during the first three years of the dividends tax regime – which would have resulted in dividends not being subject to dividends tax in a particular year and consequently increase the dividends received by shareholders. Offsetting STC credits could have encouraged increased dividends during the three years after the introduction of dividends tax to benefit shareholders subject to dividends tax.

Dividends tax can also benefit corporate, foreign and fund shareholders. Corporate (company) shareholders usually have sufficient influence to align the dividend policies of their investees with their tax preferences for dividends. Foreign investors were also likely to benefit from dividends tax because of the possible application of relief in terms of a Double Tax Agreement. Fund shareholders (institutional investors) would have benefitted from a dividends tax exemption not afforded previously, using this towards retirement savings. The dividends tax exemption afforded could have encouraged the use of dividends as a payout method during the six years after 2012.

The flexibility afforded by special dividends (and share repurchases) could also have affected the payment of ordinary dividends. Shareholders see special dividends as once-off payments, without expecting a similar payment during the next period. In addition, the flexibility hypothesis suggests that ordinary dividends are used to disburse permanent earnings and that more flexible payout methods (special dividends and share repurchases) are used to disburse transitory earnings. The flexibility of special dividends could also extend to a tax context as the use of special dividends can accelerate dividend declarations between different tax periods. However, there could be commercial reasons for special dividends that are unrelated to tax – such as large restructurings or divestments by companies. What’s more, special dividends as a result of unbundling transactions could qualify for roll-over relief for taxpayers, resulting in the deferral of normal tax consequences regarding the disposal of assets, which could result in no dividends tax being payable.

  • The expectation was that dividends (ordinary and special) post-2012 would be higher than dividends pre-2012 (Proposition 1). Retention rates calculated as retained earnings divided by dividends would be influenced by dividends distributed. The expectation was that retention rates of companies post-2012 would be lower than pre-2012 as a result of expected increases in dividends post-2012 (Proposition 2).

The introduction of dividends tax during 2012 resulted in the possibility of tax arbitrage – the practice of profiting from differences that arise from the ways transactions are treated for tax purposes …

Capital distributions

Capital distributions represent a return of stated capital to shareholders. Shareholders, however, have no legal right to a return of capital invested in a company. Capital distributions are thus submitted as a payout method based on a return of capital invested, which provides continued participation in future dividends if share capital is not reduced. A capital distribution would not be subject to dividends tax if paid from contributed tax capital but it would attract CGT if held with capital intent by the shareholder. Based on consecutive increases in applicable tax rates, the expectation was that the preference for a payout method not subject to dividends tax would drop. Share premium distributions by JSE-listed companies were noted as decreasing from 2011 to 2014, and as nominal in relation to dividends distributed from profits from 1999 to 2014. The trend of decreasing capital distributions was expected to continue after 2014 because of increases in the effective rate of CGT and an exemption from dividends tax forfeited by corporate and fund shareholders.

 

  • The expectation was that capital distributions post-2012 would be lower than capital distributions pre-2012 (Proposition 3).

 

Additional shares

Additional shares can be offered as a payout method in the case of a capitalisation issue or a scrip dividend. A capitalisation issue entails shareholders receiving additional shares, whereas a scrip dividend provides shareholders with the option to elect cash instead of additional shares. When shareholders can choose between cash dividends (subject to dividends tax) and additional shares (subject to CGT if held with capital intent), they can maximise their own after-tax receipts. For shareholders, this can be about more than merely reducing dividends. To incentivise shareholders to elect the shares, the value of the additional shares based on the share price is typically higher than the cash offer.

 

  • The expectation was that the value of additional shares issued in terms of scrip dividends during the post-2012 period would be higher than the pre-2012 period (Proposition 4).

 

Share repurchases

Share repurchases by JSE-listed companies have become popular since 2005. Although dividends were still the preferred payout method, they showed a lower growth rate than share repurchases over the period 1999 to 2009. What’s more, share repurchases have an inherent payout flexibility compared to cash dividends, and share repurchases could play both substitute and complementary roles where cash dividends are concerned. It is also necessary to distinguish between the two share repurchase types (i.e. general and specific) from a tax perspective because of different tax treatments as a result of the 2011 tax reform. Since 2011, the general repurchase (or open-market repurchase) of shares would not constitute a dividend. Hence, no dividends tax exemption was available to corporate or fund shareholders. As a result, the tax preference of corporate and fund shareholders for dividends could have discouraged the use of general repurchases as a payout method.

 

  • The expectation was that general share repurchases post-2012 would be lower than general repurchases pre-2012 (Proposition 5).

 

Specific share repurchases target specific shareholders compared with general share repurchases on the open market. Specific share repurchases would still constitute dividends to the extent that contributed tax capital is exceeded. The popularity of share repurchases conducted via subsidiaries (and the subsequent repurchase by the holding company from the subsidiaries) has resulted in general share repurchases not being the outright favourite share repurchase type in South Africa. A treasury share structure can subsequently be unwound if the subsidiary (or share trust) disposes of or distributes the treasury shares previously acquired to the holding company. Tax reforms introduced during 2007 broadened the base of taxable dividends as well as removed opportunities perceiving tax-avoidance relating to the unwinding of existing treasury share structures. Despite the tax reform introduced during 2007, specific share repurchases from subsidiaries between 1999 and 2009 were still found to be a method used extensively by JSE-listed companies. As specific repurchases are included as dividends, a resident subsidiary could qualify for an exemption from dividends tax since 2012. Specific repurchases from subsidiaries could have been deferred until the introduction of dividends tax in order to leverage the dividends tax exemption.

 

  • The expectation was that specific share repurchases from subsidiaries post-2012 would be higher than such specific repurchases pre-2012 (Proposition 6). Specific repurchases not from subsidiaries would also result in a dividends tax exemption being available to corporate and fund shareholders. The expectation was, therefore, that specific share repurchases not from subsidiaries post-2012 would also be higher than such specific repurchases prior to 2012 (Proposition 7).

 

The study also considered three confounding factors in payout behaviour, namely profitability, company size and macroeconomic conditions, which could explain payout behaviour. Where these three factors explained payout behaviour, a tax explanation for payout behaviour was seen as less warranted.

This meant that diverse shareholding in companies could give rise to conflicting tax preferences among different shareholders.

Which of these propositions were accepted?

 

Proposition 1: Dividends (ordinary and special) post-2012 would be higher than pre-2012

  • Accepting this proposition: Referring to ordinary dividends, a statistically significant increase in value and an increase in the frequency of election were observed during the post-2012 period. Contrary to expectation, special dividends not linked to unbundling transactions were not found to have increased after 2012. A possible explanation could be that share repurchases could have been utilised as a more flexible option than special dividends during this time to distribute transitory earnings. Higher ordinary dividends after 2012 would suggest higher profitability; however, lower profitability was noted during this period. Profitability is thus excluded as the main confounding factor for increased dividends during the post-2012 period.

 

Proposition 2: Retention rates post-2012 would be lower than pre-2012

  • Accepting the proposition: This proposition is supported as retention rates were statistically significantly lower during the post-2012 period, which corresponds with the higher dividends during the post-2012 period.

 

Proposition 3: Capital distributions post-2012 would be lower than pre-2012

  • Accepting the proposition: A statistically significant decrease in value and a decrease in the frequency of electing capital distributions were observed during the post-2012 period. Capital distributions, indicated as a reduction in contributed tax capital, would not constitute dividends resulting in CGT for the shareholder if shares were held with capital intent. Since 2012, increases in the applicable tax rates have adversely affected the tax preference for a payout method attracting CGT. The decrease in capital distributions shows that the payout policies of companies were adjusted as a result of the differential tax of dividends and capital gains.

 

Proposition 4: Additional shares issued in terms of scrip dividends post- 2012 would be higher than pre-2012

  • Accepting this proposition: Referring to additional shares issued as scrip dividends, this proposition is supported as a statistically significant increase in value and an increase in the frequency of election were observed during the post-2012 period. Despite the value of additional shares as a payout method being relatively low, this increase could provide insight into a payout method that empowers shareholders. The increased value and frequency of electing scrip dividends during the six years after 2012 could suggest an initiative by companies to empower shareholders with this choice since the introduction of dividends tax.

 

Proposition 5: General share repurchases post-2012 would be lower than pre-2012

  • Rejecting the proposition: The decrease in the value of general repurchases post-2012 was not found to be statistically significant. Also, the frequency of electing general repurchases increased post-2012. The increase in frequency of general repurchases post-2012 could also explain the decrease in frequency of electing special dividends to distribute transitory earnings during the post-2012 period.

 

Proposition 6: Specific share repurchases from subsidiaries post-2012 would be higher than pre-2012

  • Rejecting this proposition: The value and frequency of specific repurchases from subsidiaries decreased rather than increased during the post-2012 period. This happened despite the dividends tax exemption afforded, which could suggest motivations other than tax for entering into specific repurchases from subsidiaries. One reason, other than tax, could be the flexibility afforded by treasury shares in the management of the capital structure of companies.

 

Proposition 7: Specific share repurchases not from subsidiaries post-2012 would be higher than pre-2012

  • Accepting the proposition: A statistically significant increase in value and an increase in the frequency of specific repurchases not from subsidiaries were noted after 2012.

… the differential rate between dividends tax and capital gains tax could result in shareholders choosing different payout methods.

What are the main findings of this study?

The trend and composition of payout of selected JSE-listed companies in the six-year period after 2012 was expected to differ from the six-year period prior to 2012 based on seven propositions formulated. Five of the seven propositions were confirmed, indicating that the trend and composition of total payout did change as a result of the tax reform. These were main findings:

  • The preference is to use more than one payout method: The increased frequency of electing more than one payout method after 2012 suggests that more diverse payout methods are being used.
  • Ordinary dividends is the payout method most frequently used: The trend in value of payout methods showed that total payout has been dominated by ordinary dividends, which increased after 2012. Ordinary dividends (subject to dividends tax and affording an exemption for certain shareholders) and additional shares showed significant increases during the post-2012 period, while capital distributions dropped significantly.
  • There is an increase in scrip dividends: An increase in scrip dividends (additional shares with a cash alternative) post-2012 offered flexibility to shareholders to manage their own financial needs, including tax considerations. An increase in the issue of additional shares (with a cash alternative) as scrip dividends was noted after 2012.

 

What does this imply for policy? The policy implication is that the increasing use of ordinary dividends as a payout method could inform future government initiatives to generate revenue or provide tax incentives for saving. In the light of the increasing use of ordinary dividends, any further increases in the rate of dividends tax would not be advisable because shareholders that do not qualify for dividends tax exemption could be discouraged from investing in South African companies.

 

  • Find the original article here: Nel, R., & Wesson, N. (2021). The trend and composition of payout methods over a period of tax reform: Evidence from JSE-listed companies. Acta Commercii, 21(1), a882. https://doi. org/10.4102/ac.v21i1.882
  • Mr Rudie Nel lectures in Taxation at Stellenbosch University’s School of Accountancy.
  • Prof Nicolene Wesson lectures in Finance at the University of Stellenbosch Business School.

Related articles

Sep 14

13 minutes to read

Inclusion at the workplace: An...
Sep 14

13 minutes to read

Gender inequality at work

Join the USB Management Review community

Subscribe to receive an email alert for new content on USB Management Review.

SUBSCRIBE NOW