South Africa: Cash-flow management and debt subordinations (COVID-19)

South Africa: Cash-flow management, debt subordinations

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.

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Implementing subordination agreements due to cash-flow difficulties may result in tax consequences

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. 

What are tax implications of subordination agreements?

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. 

When could anti-avoidance provisions not apply?

Apart from the matters highlighted above, consider:

  • Whether there is certification from a registered auditor providing that the payment, by the taxpayer, in terms of an instrument has been deferred by reason of the taxpayer’s market of assets being less than the amount of liabilities. If the certification is available, then the tax implications indicated may not apply.
  • Due to the wording of the definition of the HDI, and with reference to the specific terms and conditions of the subordination agreement, there are circumstances when merely having a subordination agreement in place may not necessarily result in the HDI anti-avoidance provisions finding application.


Read a June 2020 report [PDF 126 KB] prepared by the KPMG member firm in South Africa

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