Michelle Hawkins | Senior Tax Specialist, PKF Octagon

On 16 August 2025, National Treasury and the South African Revenue Service (SARS) published the 2025 draft Taxation Laws Amendment Bill (2025 draft TLAB) and the accompanying Explanatory Memorandum (EM) for public comment. The closing date for the public comments is 12 September 2025.

One of the proposals suggested in the Bill, was to make significant revisions to the hybrid-equity definition and rules in section 8E of the Income Tax Act, 58 of 1962, (“the Act”). Numerous concerns were raised by various stakeholders with National Treasury and SARS, that the current broad wording in the draft TLAB in relation to this proposal will effectively eliminate preference shares as a viable means of financing. In the Media Release of 3 September, National Treasury stated as follows: “On the advice of National Treasury and SARS, the Minister of Finance, has decided to retract the proposal on 3 September 2025, in respect of the definition of a “hybrid equity instrument” from the 2025 draft TLAB”. The withdrawal of a very controversial proposal even before the period to make submissions has closed, emphasises the balance of consultations on draft tax bills, which is clearly not seen as a tick box exercise.

Despite the said withdrawal of the proposed changes the matter is still on the table for future consultative processes, where proposals on structural changes to the taxation of hybrid equity instruments with all stakeholders will follow. Accordingly, as the future of hybrid equity instruments remain as is for now, we unpack what the impact on the proposed amendment would have caused and why many stakeholders raised their concerns in opposition to the proposed amendment.

Background and Purpose of Section 8E

A preference share is a class of share that gives its holder preferential rights over ordinary shareholders, especially regarding dividend payments and return of capital in the event of liquidation. A preference share (also called a preferred share) is a type of equity security that combines features of both shares and debt instruments. Preference shares often pay fixed dividends at regular intervals, similar to interest on a loan. These dividends are not deductible for the issuer but are taxed at a lower rate (20% dividends tax) for the holder, however when between companies, no dividends tax is payable, compared to interest income taxed at up to 27% for Companies and up to 45% on individual tax rates.

Section 8E was first introduced in 1989 as an anti-avoidance provision designed to prevent taxpayers from disguising debt as equity—particularly through the use of preference shares or other equity instruments with debt-like features. The provision counters structures, that sought to disguise what is, in economic substance, a debt instrument as an equity instrument, primarily in the form of preference shares. Section 8E deems a dividend or foreign dividend on a hybrid equity instrument to be an amount of income accrued to the recipient and will not be exempt from normal tax. The taxpayer is also not offered a deduction for the payment of affected dividends or foreign dividends.

Under the current section 8E, which has undergone several amendments since its introduction, and has been operative since 1989, a preference share is only treated as a "hybrid equity instrument" (and thus taxable) if it is redeemable within three years. However, National Treasury observed that many instruments are structured to mature just beyond this threshold (e.g., three years and one day) to avoid tax consequences. This structuring is seen as a deliberate circumvention of anti-avoidance rules which lead to the proposed amendment that is discussed below in which it is proposed to remove the three-year test and replace it with a principles-based test: if the instrument is classified as a financial liability under IFRS, it will be taxed accordingly.

Recently Withdrawn Proposed Amendments

National Treasury indicated in the explanatory memorandum that the policy objective was to ensure that the tax character of an instrument reflected its economic substance, as National Treasury found that certain preference shares, although issued in legal form as equity, functioned economically as debt and therefore produced tax outcomes that were misaligned with their substantive risk and return profile. However, they did not properly consider the broad use of preference shares with the after-tax pricing used in many commercial structures.

The Bill proposed to redefine the terms ‘financial instruments’ and ‘hybrid equity instrument’ in section 8E, so that it captured a far wider range of arrangements than those currently within scope. The proposal aimed to change the following:

• The definition of a “hybrid equity instrument” would be revised to include any share or financial instrument that is or would be classified as a financial liability under the International Financial Reporting Standards (IFRS) in the annual financial statements of the issuer.
• The long-standing three-year redemption period requirement, would be removed, thereby broadening the scope of the rule to capture instruments with longer maturities that are nonetheless debt-like in substance. Previously, a share was only considered a hybrid equity instrument if it had redemption features within three years. This test is proposed to be replaced with a principles-based test.

The effect would have been that any dividends declared on such hybrid equity instruments would be reclassified as income and taxed in the hands of the investor. If a share is classified as a financial liability under IFRS in the issuer’s financial statements, it will be treated as a hybrid equity instrument for tax purposes—regardless of its legal form or redemption period.

The Implications of These Proposals Were:

• Reclassification of Preference Shares – Under the current rule, Preference shares were only taxed under section 8E if they had redemption rights within three years. In terms of the withdrawn proposals any share classified as a financial liability under IFRS, would have been treated as a hybrid equity instrument, regardless of its redemption period and Preference Share funding structures which would have fallen within the scope of section 8E.
• Dividends on these instruments would be reclassified as income and taxed in the hands of the holder. These dividends would no longer be exempt, and the issuer would not be able to deduct them for tax purposes.
• Many funding agreements include tax gross-up clauses, meaning issuers must compensate holders for any additional tax. This proposal would have increased the cost of funding by more than 35%, (taking onto account the dividends tax rate and normal income tax rates that would have been applicable) making existing preference share structures economically unviable.
• Issuers would have faced economic double taxation—no deduction for dividends, while holders paid income tax on them.
• Companies would have needed to restructure or refinance their funding arrangements.
• The changes were said to apply retrospectively to dividends paid from 1 January 2026, even if the shares were issued earlier if the amendments were adopted.

While the proposed changes aimed to align tax treatment with IFRS accounting classification, this approach introduced several conceptual and practical challenges.

Accounting Standards serve different objectives as IFRS, as IFRS is designed to reflect the economic substance of transactions for financial reporting purposes — primarily to inform investors and stakeholders. Tax law, on the other hand, is built on legal form and policy objectives, such as fairness, simplicity, and revenue protection.

Using IFRS as a basis for tax treatment blurs the boundary between these two domains, potentially undermining long-standing tax principles.

Apart from this IFRS is subject to change as the IFRS standards evolve over time, often in response to global financial developments. Basing tax legislation on a moving target like IFRS, introduces uncertainty and volatility into the tax system. This could lead to unintended tax consequences if accounting standards shift — without any corresponding legislative review.

South African tax law has traditionally relied on legal certainty, especially in areas like share classification, dividend treatment, and funding structures. The proposed reliance on IFRS would have eroded predictability, especially for taxpayers who structure transactions based on legal form and statutory definitions.

PKF SA was in the process of finalising their submissions to oppose this proposed amendment together with other matters that were identified, due to the significant impact it would have had to the nature of the share, the negative tax treatment of the share and the fact that an IFRS classification and treatment of a hybrid equity instrument, cannot be adopted to be the legal treatment and classification of the instrument.

In light of the withdrawal and indication by National Treasury that all stakeholders will embark on a future consultative process regarding the structural changes to the taxation of hybrid equity instruments, we advise clients to obtain advise for viable alternatives as to the current preference share funding options in the interim, so as to avert any risks on future transactions until the matter has been clarified. 

We will keep you informed of the progress herein.