The provisions of section 8F became effective on 1 April 2014. In terms of this section any interest incurred on or after that date in respect of a “hybrid debt instrument” will be deemed to be a dividend in specie declared and paid on the last day of assessment by the company; and is not deductible for income tax.
Section 8F defines a “hybrid debt instrument” as any type of interest-bearing arrangement or debt under which a company owes any amount, if it is part of any transaction, operation, scheme, arrangement or understanding (whether enforceable or not) or part thereof and:
- that company is, in that year of assessment, entitled or obliged to either convert or exchange that instrument to or for shares as the case may be, whether in the current or any future year, for any amount other than the amount (including interest) then owing under the instrument; or
- the obligation to pay any amount under the instrument is conditional upon the market value of its assets being at least equal to its liabilities; or
- any amount owing is due to a connected person (as defined in section 1 of the Act) and no obligation to redeem the instrument will arise within 30 years from the date of issue of the instrument or from the end of that year of assessment. In determining whether the 30-year period threshold has been breached, if the company has the right to convert or exchange the instrument into an instrument other than a share, the two instruments are treated as one and the same and, consequently, the redemption rights under that replacement instrument must be considered in determining whether the 30-year period is transgressed.
Where any interest incurred in respect of a “hybrid debt instrument” is deemed to be a dividend, it will be treated as a dividend in specie declared and paid by the issuer on the last day of the year of assessment and accruing to the holder on the same day. This will therefore give rise to a liability for the 15% dividends tax, payable by the company declaring the “dividend”. Furthermore, there is also a risk that the dividend in specie will not qualify for relief from the 15% dividends tax on the basis that the creditor is not the “beneficial owner” of the dividend as defined. In essence, a “beneficial owner” is defined as the person entitled to the benefit of the dividend attaching to a share. As it would be difficult to argue that the dividend in specie under section 8F is a dividend attaching to a share, it may not be possible to obtain relief from dividends tax in instances where section 8F applies.
National Treasury noted that the purpose of the revised provisions of section 8F is to ensure that instruments that have equity-like features, as opposed to debt-like features, are caught by the provisions of section 8F. Instruments which National Treasury will target include instruments that lack a maturity date for repayment. There is therefore a risk that National Treasury and SARS will target inter-group interest-bearing loans that have no fixed date of repayment. There is an argument that, despite the fact that such loans have no fixed date of repayment, they are in fact demand loans (if one has regard to the common law and case law) and consequently section 8F can never apply to them. Be that as it may, we recommend that taxpayers consider either documenting that the relevant loan is repayable on demand or that it will be repaid within a period of less than 30 years.
It must also be noted that the provisions may find unintended application in certain circumstances, for example in instances where a debtor is placed in business rescue in terms of the Companies Act 71 of 2008. One of the powers of the business rescue practitioner is that he may suspend any obligation of the company under any agreement for the duration of the business rescue proceedings. If the suspended agreement happens to be an interest-bearing loan agreement, coupled with the fact that:
- the business rescue process is generally embarked on by a company whose liabilities exceed its assets; and
- for income tax purposes interest accrues on a day-to-day basis regardless of whether it is paid or not,
there may be an argument that the obligation to pay interest in respect of that instrument is conditional upon the market value of the assets of that company not being less that the market value of the liabilities of that company and, as such, the provisions of section 8F would apply. This would further compound an already dire situation for the debtor company as a denial of an interest deduction may result in a tax liability.