The ability to enter into loans over listed shares is an important part of the financial industry as it offers sellers of listed shares the ability to comply with their obligations to deliver shares under a short sale contract. This ability could ensure that the sale of listed shares do not result in failed trades, provided the relevant shares can be sourced and borrowed prior to the seller having to deliver the shares. The intended change by the JSE limited to move to from a T+ 5 to a T + 3 settlement date in order to align with its settlement period with the international norm, reinforces the importance of the share lending industry. As a result of the shorter settlement period, the ability to borrow shares to settle trades will be paramount to ensure as little failed trades as possible.
A share loan has various tax implications for both the borrower and the lender. In addition, parties such as JSE brokers and central securities depository participants may pick up tax risks where they are required to withhold or account for tax such as dividends tax and securities transfer tax (“STT”) and pay it over the South African Revenue Service. Lenders, borrowers and intermediaries should therefore understand the tax implications arising from entering into loans over listed shares.
Broadly speaking, share lending may have income tax, capital gains tax, dividends tax and securities transfer tax implications for both the borrower and lender. For example, the share loan would typically result in the transfer of beneficial ownership of the shares from the lender to the borrower, and the payment of manufactured dividends and lending fees by the borrower to the lender.
From an income tax perspective and in the context of a South African resident borrower and lender, as the shares are transferred in terms of a loan, based on case law the receipt of the shares should not have income tax implications. Furthermore, the entering into and closing out of the loan should not have CGT implications provided the loan qualifies as a “securities lending arrangement”. A “securities lending arrangement” is defined as a “lending arrangement” as defined in the Securities Transfer Tax Act. If the loan does not constitute a “securities lending arrangement” then it could have adverse CGT implications as a result of paragraph 38 of the Eight Schedule to the Income Tax Act (“Act”).
With regard the income flows resulting from the share loan, the borrower will be subject to income tax on the dividends that the borrower accrues. Such dividends would not qualify for the exemption from income tax in section 10(1)(k)(i) of the Act. If the borrower on-lend or on transferred the shares prior to a record date, then it would be taxed on the receipt of manufactured dividends or the sale proceeds, depending on the case. The borrower should be entitled to deduct the expenditure incurred in the production of such income. The lender would similarly be taxed on any manufactured dividends it received except in instances where the lender qualifies for a tax exemption (such as certain retirement funds).
Dividends which accrue to the borrower of listed shares would be subject to the dividends tax provisions but may qualify for exemption from dividends tax on the basis that the dividend has been included in the income of the borrower (see above), or if the borrower constitutes a South African resident company or qualify for one of the other exemptions from dividends tax.
The dividends tax provisions also contain deeming provisions which deem certain payments by a borrower to a lender to be a dividend. In particular, where certain persons (effectively persons that qualify for an exemption from the dividends tax) have borrowed listed shares after the date that a dividend is announced, then any amount paid by the borrower to the lender is deemed to be a dividend for purposes of the dividends tax, which is paid by the borrower to the lender for the benefit of the lender. The deeming provision only applies to amounts paid by the borrower that do not exceed the actual dividend paid on the shares. This provision places a withholding obligation on the borrower and may result in the lender being subject to dividends tax on such deemed dividend if the lender doesn’t qualify for one of the exemptions from the dividends tax.
From an STT perspective the transfer of shares are subject to STT at the rate of 0.25%. The loan results in a transfer for STT purposes from the lender to the borrower and vice versa. However, the lending of listed shares may be exempt from STT provided such loan qualifies as a ‘”lending arrangement” as defined and complies with the other specific requirements of the exemption.
Furthermore, to the extent that the share loan is collateralised, depending on the type of the collateral and the manner in which it is provided, the provision of collateral may also have tax implications. For example, where the security given results in the transfer of beneficial ownership of assets, the income tax and CGT implications resulting from the transfer of such assets should be considered. In addition, the dividends tax, interest withholding tax and STT implications may require consideration, depending on the type of asset that is provided as security. It is worth noting that although there is not a disposal for CGT purposes where an asset is transferred as security for a debt or by a creditor who transfers that asset back to that person upon release of that security, there is currently no STT exemption for the transfer of beneficial ownership of shares as security. Therefore, the transfer of beneficial ownership of shares as security results in STT implications upon entering into and closing out the transaction. The 2015 Budget Review did indicate in the context of securities lending arrangements that the tax treatment of the transfer of beneficial ownership of collateral will be reviewed to reduce negative effects on acceptable business practices. It is expected that this will include an STT exemption where listed shares are transferred as collateral for a share loan.
It is evident from the above that the entering into of shares loan may result in multiple tax implications for the parties involved. Although there are certain exemptions which may apply, both lenders and borrower should understand the requirements of these exemptions and the circumstances under which they may apply in order to ensure that they correctly account for and disclose the transactions for tax purposes.