On 1 March 2016, the South African Revenue Service (SARS) issued Binding Private Ruling 225 (Ruling), dealing with the dividends tax consequences for a non-resident issuer of hybrid debt instruments.
By way of background, according to the Explanatory Memorandum on the Revenue Laws Amendment Bill, 2004 (Explanatory Memorandum) s8F of the Income Tax Act, No 58 of 1962 (Act) was introduced to draw a distinction between debt and equity for tax purposes. The section was further introduced to limit the deductibility of interest by persons other than natural persons in respect of hybrid debt instruments which are debt in legal form, but have sufficient equity features to place them clearly at the equity end of the debt/equity spectrum.
As set out in the Explanatory Memorandum, s8F intends to counter tax avoidance by ensuring that equity is not disguised as debt. An example of such an instrument would be an interest-bearing debenture which allows the holder thereof to convert the debenture into an ordinary share of the company that issued the debenture. To further the aim of preventing equity from being disguised as debt, s8F(2) deems any interest incurred by a company in respect of a hybrid debt instrument, after it becomes a hybrid debt instrument, to be a dividend in specie declared and paid by the company on the last day of its year of assessment, which is not deductible in terms of the Act. The person to whom the interest accrues in respect of the instrument, is deemed to receive a dividend in specie on the last day of the company’s year of assessment.
Description of the transaction
In the Ruling, a non-resident company that does not have a permanent establishment in South Africa (Applicant) sought clarity on the application of s8F, s64D and s64EA of the Act, in the event that it issues secured and unsecured interest bearing notes (SA Notes) that will be listed on the interest rate market of the JSE. The terms of the SA Notes will, amongst others things, specify an interest rate payable in respect of the SA Notes, and that the obligation of the Applicant to make payments in respect of the SA Notes is conditional upon the market value of the Applicant’s assets being equal to or greater than its liabilities.
The salient terms of issue of the SA Notes are as follows:
- They will constitute unsubordinated and unsecured obligations of the Applicant and will rank pari passu amongst themselves and equally with all other like obligations of the Applicant.
- They will be denominated in Rand.
- Interest will be payable quarterly in arrears.
- The interest rate in respect of each issue of SA Notes will either be a floating rate or a rate calculated with reference to an index or a rate calculated with reference to a basket of financial instruments. Interest payable on a floating rate will be limited to the income derived on the corresponding income investment made by the Applicant in respect of that SA Note.
- The maturity date of the SA Note will be either five or six years after the date of issue.
- The redemption amount will be equal to the subscription price of the SA Note.
- The SA Notes are issued subject to early redemption provisions following the occurrence of events specified in the pricing supplement.
- The holders of the SA Notes will have no voting rights.
The Applicant indicated that it would use the proceeds of the SA Notes to invest in non-South African debt instruments, index-tracking instruments or other financial instruments in respect of which the Applicant will receive income. There will be no direct or indirect re-investment into South African assets.
SARS ruled that the SA Notes will constitute instruments and hybrid debt instruments for the purposes of s8F. The interest payments made by the Applicant in respect of the SA Notes will be deemed to be dividends in specie declared and paid by the Applicant on the last day of its year of assessment as contemplated in s8F(2). Furthermore, dividends tax will not be payable by the Applicant in respect of the interest paid on the SA Notes which have been deemed payments of dividends in specie. This is because s64EA(b) states that dividends tax is only payable by the issuer company on the distribution of an asset in specie if it is made by a resident company. There is also no duty on the beneficial owner to pay withholding tax as s64EA(a) exempts the beneficial owner from this liability where the dividend consists of a distribution of an asset in specie.
The ruling is valid for a period of three years from 2 February 2016.