The use of preference shares in financing or corporate structuring has become increasingly prevalent in recent years. Preference shares, being equity in nature, when used as a financing instrument, can take the form of a debt instrument, blurring the boundary between debt and equity. Accordingly, the South African government has proposed significant amendments to Section 8E of the Income Tax Act 58 of 1962 (“ITA”) in the form of the 2025 Draft Taxation Laws Amendment Bill (“Bill”) published for public comment on 16 August 2025. The proposed amendments aim to align the tax treatment of “hybrid equity instruments” such as preference shares with their true economic substance. As it stands, these changes will come into effect on 1 January 2026.

Current anti-avoidance rules under section 8E
Where instruments have the characteristics of debt but are structured as equity, the anti-avoidance provisions embodied in section 8E of the ITA become applicable. The taxing event envisaged by section 8E of the ITA is that when an instrument is a "hybrid equity instrument", dividends received from such an instrument, whether equity or preferential, will be re-classified as taxable income. The application of section 8E is quite technical, but in short, to qualify as a hybrid-equity instrument, the holder of the instrument must have had an enforcement right to have the instrument redeemed within a period of three years following its issue.
 
Loopholes in the three-year rule
However, the government believes that this anti-avoidance rule is being undermined by setting redemption periods slightly longer than the three-year mark, which has been a popular strategy to get around the statutory definition of a hybrid equity instrument while still generating returns similar to those of debt.

Proposed amendments: Substance over form
The proposed amendments aim to close the gap through strengthening the definition of a “hybrid equity instrument” by emphasising the concept of “substance above form”. Any instrument that is recognised as debt under International Financial Reporting Standards (“IFRS”) will be treated as debt for tax purposes, regardless of its legal form or redemption date. Any share or financial instrument will be automatically treated as debt for tax purposes under the proposed amendment if it is or would be recognised as a financial liability in the annual financial statements of the issuer, in accordance with IFRS. The three-year rule will be removed and instruments with mandatory redemption obligations, regardless of their duration, will fall within the ambit of section 8E of the ITA.

Tax consequences for preference shares
As a result, it is proposed that dividends paid on preference shares that are redeemable at the option of the holder thereof will be subject to ordinary income tax. The effect of the Bill, if it becomes law in its current form, will simply mean that preference shares and similar instruments that are seen as debt will be taxed as debt. This change considerably lessens the allure of the use of preference shares in finance models.

Impact and next steps
To sum up, the Bill marks a significant change in how preference shares are treated tax-wise. The law prioritises substance over form when deciding tax outcomes by doing away with thresholds and connecting instrument classification to IFRS. Although these reforms seek to improve the consistency and fairness of South Africa's tax system, they will impact the appeal of preference shares to issuers and investors. South Africa, in so doing, also closes the gap with international best practices by aligning its tax treatment with accounting standards. The Bill is open for public comment until 12 September 2025.

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