A horse that looks like a cow is still a horse Ė Hybrid debt instrument taxed as dividends

transfer pricing 101By Donatella Callaway

The new anti-avoidance rules in respect of hybrid debt instruments, which were introduced by the Taxation Laws Amendment Act 2013 (TLA), became effective on 1 April 2014. The provisions were introduced to reduce the opportunity to create equity instruments that are artificially disguised as debt instruments.

The effect of these provisions is that any amount of interest incurred by a company in respect of a úhybrid debt instrumentĚ or any amount of hybrid interestĚ incurred is not tax deductible and furthermore deemed to be a dividend in specie.

A hybrid debt instrumentĚ is defined as any agreement in terms of which a company owes an amount if:

  • that company is entitled to, or obliged to convert or exchange that instrument to, or for shares in that company
  • the obligation to pay an amount in respect of that instrument is conditional upon the market value of the companys assets being more than its liabilities or
  • the company owes the amount to a connected person and is not obliged to redeem the instrument within 30 years. This excludes instruments payable on demand

Hybrid interestĚ is interest that is:

  • not determined with reference to a specified interest rate or
  • not determined with reference to the time value of money or
  • determined in terms of an interest rate which increased due to an increase in the issuers profits and if that amount is more than the interest amount that would have been calculated if the lowest interest rate during the current and past years of assessment was used

The application of the 30-year redemption rule is limited to instances when the issuer and the holder of the debt are connected persons. Companies should therefore pay special attention to loans between connected persons to ensure that the loans are compliant with the hybrid debt instrument provisions and should consider amending the terms to avoid unnecessary taxes and penalties.