Section 8F and s8FA of the Income Tax Act have been promulgated with a view to convert interest into dividends. These sections deal with a scenario where the debt instrument displays a number of equity characteristics, for instance if amounts are only payable if the assets of the issuer exceed its liabilities and/or where interest is not calculated with reference to the time value of money.
Unfortunately a number of transactions have been implemented which make use of the intentional recharacterisation of the interest into dividends. This is especially the case if the issuer is a non-resident, in which event the non-resident issuer is then treated to have paid dividends as opposed to interest to the South African holder.
It has been announced as part of the Budget proposals that, with effect from 24 February 2016, interest will no longer be reclassified as a dividend in the case where the issuer is a non-resident. The reason is that the non-resident cannot suffer any negative tax consequences in a South African context. Not only would the dividend then be exempt, but the issuer may potentially claim an interest deduction in the country of origin. Going forward the interest will no longer be recharacterised as a dividend and will thus be taxable in the hands of the South African holder if the issuer is a non-resident of South Africa.