The South African Revenue Service (SARS) is expected to closely monitor and review loan subordination agreements that are entered into during the course of the coronavirus (COVID-19) pandemic.
The global community is going through unprecedented financial difficulties due to the effects of COVID-19. It is also not surprising that revenue authorities are seeking to preserve their tax base as much as possible, especially in light of the stimulus packages that are being implemented. One such method revenue authorities—including SARS—may apply is to closely monitor and review transactions entered into during this difficult period.
One mechanism that taxpayers may employ to manage cash flows could be to (re)negotiate for payment deferrals and enter into subordination agreements on current loan agreements. These agreements may assist taxpayers to ease their liquidity burdens and usually contain an undertaking by the creditor of a struggling debtor to refrain from demanding payment until the occurrence of a specified future event (or any undertaking of a similar nature). The issue, however, from the perspective of SARS, is that these arrangements may exhibit characteristics of hybrid instruments—i.e., debt having the characteristics of equity. As a result, the anti-avoidance provisions in the income tax law that seek to negate the effects of any hybrid debt instruments may be triggered.
South Africa’s income tax law provides that any interest incurred in respect of a hybrid debt instrument (HDI) is non-deductible. Furthermore, any interest incurred in relation to a HDI is deemed to constitute a dividend in specie which attracts dividends tax at a rate of 20%.
There are three types of HDIs and one of the three applies when the taxpayer’s obligation to pay an amount has been deferred in terms of a subordination agreement, and the deferral is a function of the market value of the taxpayer’s assets exceeding its liabilities.
Apart from the matters highlighted above, consider:
Read a June 2020 report [PDF 126 KB] prepared by the KPMG member firm in South Africa
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.