Secondary tax and its effect on the cost of capital and shareholder value of South African JSE listed companies

Abstract

BACKGROUND: The introduction of a secondary tax on companies (STC) and the lowering of the normal income tax rate in 1993 constituted a dramatic change in the tax structure of South African organisations. The original intention of these changes was to encourage organisations to re-invest profits to make use of capital investment opportunities. It was also anticipated that these tax changes would lower the cost of capital of organisations. PROBLEM INVESTIGATED : Announcements during the 2007 budget again raised questions about how the proposed changes in STC would affect the value of organisations. The impact of these tax changes has been the topic of some speculation in the absence of concrete research results to date. PURPOSE : The purpose of this study was to investigate the effect of these tax changes and all subsequent changes since 1993 on the cost of capital and shareholder value. APPROACH : A model of a hypothetical company, representing the 'average' listed South African organisation was used to determine the effect of the introduction of STC and the changes to the STC and company tax rate on the cost of capital and the value of the organisation. FINDINGS : The study found that, contrary to expectations, the tax changes actually caused the cost of capital to go up. Overall, the combined effect of the higher cost of capital and the lower company tax rate caused the theoretical value of organisations to increase, constituting an improvement of shareholder value. VALUE OF RESEARCH : It is the first local study that endeavoured to analyse and quantify the impact of the introduction of STC and the lowering of the company tax rate on the cost of capital and the value of organisations. CONCLUSION : The introduction of STC in and the lowering of the company tax rate in 1993, as well as changes to these two forms of taxes since then, seem to have been justified in terms of shareholder value creation.