Addressing the abuse of collateral lending arrangement provisions

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                    Jerome Brink

 

 

 

 

A large proportion of debt agreements involve the use of collateral, more specifically the use of equity (ie listed shares) as well as listed government bonds, as security for the repayment of the debt. The provision of collateral usually takes one of two forms, namely a pledge (no transfer of beneficial ownership with no tax implications) or an outright transfer (out and out cession of beneficial ownership with tax implications).  

Importantly the event of granting collateral by way of a pledge for securities lending is currently not subject to income tax and securities transfer tax because it does not involve the actual transfer of beneficial ownership. Similarly, the alignment of this tax treatment of collateral lending arrangements was extended in 2015 in respect of the outright transfer of collateral such that no income tax and securities transfer tax implications arise for collateral arrangements for a duration of up to 24 months.

Notwithstanding the recognition of this common business practice in South Africa’s relevant fiscal legislation, the Minister has announced the introduction of further measures to combat certain arrangements which amount to abuse. In particular, it has been identified that foreign shareholders reduce their dividends tax rate to zero by taking out a loan with a South African resident company and using the listed shares as collateral. In this manner, any dividends declared on the listed shares to the resident South African company is tax free on the basis of the dividends tax exemption of dividends declared between two resident companies. Thereafter, in accordance with the collateral agreement, the South African resident company pays an amount (called a manufactured dividend) based on the dividend received by that resident company to that foreign company, free of dividends tax.

While certain anti-avoidance rules already exist in respect of similar arrangements, the Minister has proposed further amendments to the legislation in order to close any loopholes.