Tax implications of debt instruments with equity features

The 2013 draft Taxation Laws Amendment Bill (“DTLAB”) was issued by National Treasury for public comment on 4 July 2013. In accordance with the Explanatory Memorandum to the DTLAB, the tax legislation currently contains an anti-avoidance rule that deals with debt instruments that have equity features (“hybrid debt instruments”). The anti-avoidance rule denies a deduction in respect of any amount paid or payable in terms of a hybrid debt instrument. However, the hybrid debt instrument remains a debt instrument for all other purposes of the Income Tax Act 58 of 1962 (the “Act”).

The current anti-avoidance rules apply generally when a hybrid debt instrument is convertible into an equity instrument within a period of three years from the date of issue of that debt instrument. National Treasury have indicated that the deficiencies in the current legislation are:

  • the limitation of the conversion period to three years; and
  • that the artificial classification of equity instruments as debt go beyond the conversion features.

Accordingly, it is proposed that new anti-avoidance rules be introduced into the Act, in order to reduce the scope for the creation of equity instruments that are artificially disguised as debt. The first set of rules focus on the features relating to the instrument itself (contained in section 8F of the Act) and the second set of rules focus on the nature of the yield of the instrument (contained in section 8FA of the Act).

Section 8F

In terms of the proposed section 8F of the Act, any amount of interest which is incurred by a company during a year of assessment in respect of a hybrid debt instrument:

  • is deemed for the purposes of the Act to be a dividend in specie declared and paid on the last day of the year of assessment by the company; and
  • is not deductible in terms of the Act.

Similarly, any amount of interest which is accrued to the person to whom the amount is owed, in respect of a hybrid debt instrument, is deemed to be a dividend in specie accrued on the last day of the year of assessment of the company who paid the dividend for purposes of the Act.

A “hybrid debt instrument” is any instrument in respect of which a company that is a resident owes an amount during a year of assessment if in terms of any arrangement:

  • that company is not obliged to redeem the instrument within 30 years from the date of issue of the instrument, but excluding any instruments payable on demand;
  • the company is in that year of assessment entitled to convert or exchange that amount in any year of assessment to or for, shares in that company or in any other company that forms part of the same group of companies as that company; or
  • the obligation to pay an amount in respect of that instrument is conditional upon the market value of the assets of the company not being less than the liabilities of the company.

Section 8FA

In terms of section 8FA of the Act, any amount of interest which is, during a year of assessment incurred by a company, in respect of hybrid interest:

  • is deemed for the purposes of the Act to be a dividend in specie declared and paid on the last day of the year of assessment by the company; and
  • is not deductible in terms of the Act.

Similarly, any amount of interest which is accrued to the person to whom the amount is owed, in respect of hybrid interest, is deemed to be a dividend in specie.

Hybrid interest” means any interest in respect of a debt owed by any company that is a resident if the amount of that interest is not determined:

  • with reference to a specified rate of interest or the time value of money;
  • or  the obligation to pay an amount in respect of that instrument is conditional upon the market value of the assets of the company being equal to or exceeding the liabilities of the company.

The above anti-avoidance rules are proposed to come into operation on 1 January 2014 and will apply in respect of amounts incurred or accrued on or after that date.  However, it is proposed that rules will contain exceptions to simplify administration and ensure that South Africa is not placed in an uncompetitive situation.

Bookmark the permalink.