Preference shares under fire

Are they still a smart way to raise money?

For years, South African businesses have leaned on preference shares as a clever way to raise funding. The idea was simple: instead of borrowing money and paying interest, companies issued preference shares to investors. These shares came with fixed dividends and a promise to buy the shares back later.

The appeal? Dividends on preference shares were tax-free for certain investors, making them more attractive than loan interest, which usually isn’t deductible for the borrower. In other words, preference shares gave companies access to cash while investors enjoyed lighter tax treatment.

But all of this may be coming to an end.

What changed?

On 16 August 2025, National Treasury and the South African Revenue Service (SARS) released the 2025 Draft Taxation Laws Amendment Bill (Draft TLAB). Buried in this Bill is a significant change to section 8E of the Income Tax Act – the section that deals with “hybrid equity instruments”, or shares that behave more like debt than real equity.

Until now, section 8E only applied to preference shares with redemption periods of three years or less. To avoid falling foul of this rule, funding deals simply stretched the redemption period beyond three years. It was a neat workaround that kept dividends tax-free.

The Draft TLAB aims to close this loophole. The amendment says that any preference share or financial arrangement that looks like debt in a company’s books – according to international accounting rules (IFRS) – will be taxed as debt, regardless of the duration. In practice, this means dividends from funding preference shares will no longer be tax-free. They’ll be taxed as income.

Why the crackdown?

Treasury’s reasoning is straightforward: substance should trump form. While preference shares are legally shares, in substance they often operate like loans. The government believes this has created “tax arbitrage”, where companies and investors have gained an advantage that wasn’t really intended. By aligning the tax rules with accounting standards, Treasury wants to shut down this arbitrage.

What about existing preference shares?

The sting in the tail is that the new rules will apply not just to new issues after 1 January 2026 but also to dividends on preference shares that are already in place. For example, if a bank holds preference shares issued in 2025 and its tax year starts on 1 April 2026, all dividends from that date will be treated as taxable income.

That’s because the law looks at whether the instrument counts as a hybrid equity instrument during the relevant tax year. If it does, all dividends paid that year are taxable, no matter when the shares were first issued.

Why this makes preference shares expensive

Most preference share agreements include “gross-up” clauses. These clauses kick in when tax laws change, requiring the issuing company to pay investors extra dividends to make up for any tax they now owe. With the Draft TLAB, those gross-ups will be triggered – and they’re costly.

For example: for every R100 dividend, the company may now need to pay c. R136.99 to keep the investor whole. That’s far more expensive than ordinary debt, where gross-ups are not involved.

The bottom line

If these changes go through as written, preference shares will lose their appeal as a funding tool. The cost will outweigh the benefit, and companies may simply return to traditional debt funding.

There is still a glimmer of hope: Treasury and SARS invited comments on the Draft TLAB, with a deadline of 12 September 2025. But unless there’s a major rethink, the message is clear – the preference share era may be over.

SD Law can help

If you have any questions on how the proposed legislative change will affect you or your company, contact Simon on 086 099 5146 or email sdippenaar@sdlaw.co.za for a confidential discussion.

SD Law – Simon Dippenaar & Associates Inc.

Attorneys, Notaries & Conveyancers

SD Law is a Cape Town law firm with a strong practice in divorce and family law, urgent eviction matters, antenuptial contracts, liquor licence applications and selected commercial disputes. Clients instruct us when the matter is urgent, high-stakes or strategically sensitive, and when they want direct, clear legal advice backed by practical litigation experience.

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