South African budget takes aim at hybrid debt instruments, share buybacks

by Peter Dachs

South Africa’s Minister of Finance has announced tax changes affecting business in the 2016 budget, including a measure to curb perceived abuses associated with hybrid debt instruments and a warning about future action on share buybacks

Under South African domestic law, hybrid debt instruments, i.e. debt instruments with certain equity features, result in the return thereon being treated as a tax-exempt dividend.

The budget, issued February 24, states that with immediate effect in circumstances where a nonresident issuer obtains a tax deduction for a payment on a hybrid debt instrument, the South African taxpayer receiving the return will be taxable thereon.

Unfortunately, although this has immediate effect, taxpayers will not be certain whether the return on such investments are tax exempt or taxable in their hands until the relevant legislation is finalised.

The budget also states that the widespread use of share buyback arrangements merits review to determine if additional countermeasures are required.

In certain circumstances, the budget states, sellers are avoiding capital gains tax on the disposal of company shares by requiring the buyer to subscribe for new shares and having the company then buy back its shares from the seller. These arrangements result in the seller obtaining  a tax-exempt dividend on the buyback of its shares instead of paying capital gains tax on the disposal thereof to the buyer.

The budget also provides that capital gains tax rates are increased to the following effective rates: 16.4 percent for individuals, 22.4 percent for companies, and 32.8 percent for trusts. These rates will become effective for years of assessment beginning on or after March 1.

Also, the proposed withholding tax on service fees has been withdrawn from the Income Tax Act.

It is further proposed that voluntary disclosure rules for non-compliant taxpayers will be relaxed for a period of six months from October 1 to allow such taxpayers to disclose assets held and income earned offshore. Essentially, this constitutes a further tax and exchange control amnesty.

The budget also states that, in circumstances where an interest-free loan has been granted to a trust, such interest-free loan will be treated as a donation to the trust thereby resulting in donations tax being levied. It seems that the donations tax will be levied on the entire amount of the interest-free loan and not merely on the gratuitous element thereof, namely, the non-charging of interest.

Also, assets acquired by a trust using the proceeds of a loan will be included in the estate of the founder of the trust at death. It cannot be the intention that this rule will apply together with the (deemed) donation in respect of an interest-free loan. Instead, perhaps the donation in respect of interest-free loans to trusts will apply from a specified future date and the treatment of the asset as an asset of the founder of the trust will apply in respect of existing loans to trusts. This will be made clear once draft legislation is released.

— Peter Dachs is a director at ENSafrica, Cape Town, where he specialises in financial services, mergers and acquisitions, and international tax. He can be reached at [email protected].